The Global Supply Chain: Whos Hot, Whos Not

Planes and boats and trains…and trucks? Yup. They’re all part of one big interrelated system. Guess which one is flying highest?

By Jack O’Connell

Last month I attended a transportation conference in Miami sponsored by a major investment firm and came away enlightened. I mean, here I thought the whole industry revolved around shipping – ocean shipping and inland transportation – and in many ways it does. After all, about 90 percent of global commerce travels by ship. But what happens when it reaches port? How do all those containers and bulk cargoes and petroleum liquids reach their final destination? And so I discovered the fascinating world of “intermodal,” a buzz word on everybody’s lips these days, and found out what all those trains and planes and trucks do. And more importantly, how they’re doing.

My eyes were immediately opened by the UPS presentation. “Big Brown” had a record year in 2010 and expects even better results this year. Huh? 2010 was a disaster for most maritime companies, and 2011 doesn’t look much better. Yet here was the world’s biggest package delivery company, with operations in 220 countries, saying things couldn’t be better. So that right away got my attention. Here’s something else that got my attention: a video showing how UPS has expanded its business with Toshiba, a long-time customer, by dedicating 10,000 feet of warehouse space in its Louisville facility to fixing Toshiba laptops. That’s right. UPS is in the computer repair business. Instead of shipping the laptop from the customer to the Toshiba repair facility and back again, UPS fixes the computer itself and does it all in one central location, reducing the average time from initial customer pickup to final delivery of the fixed product from three weeks to four or five days. How’s that for innovation?

The upbeat theme continued with a presentation by Union Pacific, the U.S.’s largest railroad. UP carried 1.5 million containers last year, about 14 percent of the total market. That’s intermodal in action. Its major routes for containers are Los Angeles to Chicago and Chicago to Dallas. So when all those boxes arrive from China at LA/Long Beach, a good number of them are loaded onto flatbed cars for the 2,100-mile journey by rail to Chicago. Most of the others go by truck, and we’ll get to that in a minute. Like UPS, UP had a record year in 2010 and expects to do even better in 2011. In addition to intermodal, its major drivers include coal from the Powder River Basin in Wyoming, autos and auto parts, and lumber.

A fascinating part of its business has to do with shale drilling – you know, all those shale deposits of natural gas – and even oil – that are now accessible because of horizontal drilling technology? Well, each deep well can require as many as 100 rail cars of something called “frac sand,” which apparently works the same way as drilling mud does in conventional wells. Frac sand is a big product for UP along with the drill pipe and rocks for road construction leading to the well. As if that wasn’t enough, UP expects container loadings from Asia to increase 10 percent this year. Incidentally, those double-stacked container trains you see if you’re lucky enough to live close to a major trunk line? They average 154 cars in length, about a mile and a half.

Common Themes

If there was one overwhelming message that emerged from the conference, it was this: Happy days are here again. Demand is picking up across the board. Supplies are tight. Carriers have a modicum of pricing power for the first time in a long time. “I’m turning down 1,000 loads a week,” boasted one West Coast trucking company owner. Capacity is constrained not only on trucks but on the rails and airfreight as well. The one notable exception to this rosy scenario? Ocean shipping, where there is a massive oversupply of vessels, rates are falling, and moods are glum. Why the disconnect? That’s an excellent question, and that’s why it makes sense to look at the other modes for possible answers.

Let’s start with airfreight. It costs twenty times as much to ship by air as it does by ship. And yet this is the fastest growing segment of the global supply chain. Why? Because companies are putting more and more emphasis on “just in time” delivery and maintaining lean inventories to keep costs down. “Taking costs out of the operating system” was, in fact, a common refrain among all shippers. But airfreight occupies a special niche. Only two to three percent of all cargo goes by air – mainly high-tech items, pharmaceuticals, perishable foods and the like – and Asia represents half the market. Capacity is tight. Older planes are being retired at a faster rate than new ones are being built. Delays in delivery of Boeing’s new 747-8 (“Seven four seven dash eight”) have further exacerbated the capacity problem. Compare this to the situation in ocean shipping, where there is excess capacity everywhere you look.

Atlas Air (Nasdaq: AAWW) is a typical company. It operates mainly 747-400 SFs (Special Freight) and is awaiting delivery of its first 747-8s. Two of its 747-400s are chartered to SonAir, which transports oil workers from Houston to Luanda, Angola, three times a week – the so-called “Houston Express.” Private charter services such as SonAir can be very profitable. Atlas Air also does a lot of business with the military and with governments around the world, another common denominator of the business. Whenever there’s an emergency or a need for fast delivery anywhere in the world, airfreight is the mode of choice.

Trucking is also booming, for many of the same reasons as airfreight, including the emphasis on just-in-time delivery. It’s a $500 billion business in the U.S., and it’s highly fragmented. The biggest player is Phoenix, Arizona-based Swift Transportation (the name comes from the Swift meatpacking business, its first customer), whose $2.5 billion in revenues represents less than one percent of the market. The company went public last year and its shares (Nasdaq: SWFT) are in demand. It operates 15,000 tractors and has a lucrative cross-border business with Mexico. Its average haul is 444 miles (deliberately short to keep drivers fresh and alert), and average weekly revenue per tractor is approximately $3,000. Swift was one of the few companies to talk about values and how it keeps its eye on the “wildly important goal” – two factors that have no doubt contributed to its success.

Speed Bumps

There are issues, of course, as in any industry. One is the high cost of fuel, which shows no indication of abating. This affects vessel operators, air carriers and truckers in particular, where fuel can account for more than 50 percent of total operating costs. Rails are less affected. This can be offset to some extent by imposing fuel surcharges, but customers will stand for only so much, and a number of smaller carriers in the trucking industry have thrown in the towel recently as a result of cash-flow pressures due to rising fuel costs.

Another complicating factor is emission-control regulations mandating the use of higher-cost, low-sulfur fuels and/or the installation of expensive scrubbing and other equipment. This is a variable that won’t go away as governments – and the general public – become increasingly concerned about the growing volume of emissions of greenhouse gases and volatile organic compounds and their impact on the environment. Safety is another concern, requiring constant monitoring and training – not to mention added expense – for carriers.

Perhaps the biggest issue of all is a shortage of qualified personnel, especially in the marine and trucking industries. Readers of this publication are familiar with the difficulties of crewing vessels and how, in a cyclical business like shipping, it’s hard to get back those mariners who left during the last downcycle. The lack of qualified drivers in the trucking industry is an analogous problem, and the turnover is even higher. According to one investment bank report, average driver pay in for-hire fleets (as opposed to captive fleets) last year was $47,000 with turnover of 50 to 100 percent. If you have to replace at least half your drivers every year, you’ve got a problem! Raising the average pay to $55,000 would cut the turnover figure in half, and a further raise to $64,000 would cut it in half again. Not-for-hire (captive) fleets, for example, pay just that – an average of $64,000 per year for their drivers, and the turnover rate is a manageable 10 to 15 percent. So these are expensive tradeoffs, largely dependent on what the market will bear. Driver turnover is also a major reason why trucking companies invest so much money in driver-ed programs, health benefits and the like.

Inland Waterways

One of the most interesting presentations came from Kirby Corporation (NYSE: KEX), the big inland barge and bunkering company. Its long-time CEO, Joe Pyne, is a noted advocate of America’s Marine Highway – inland waterways – as an alternative to clogged highways and pollution-belching semis. Given the well-known rule of thumb that one barge has the carrying capacity of 50 rail cars or 160 trucks, why isn’t more cargo moving on the water? When I asked Pyne that question, he pointed out that one of Kirby’s subsidiaries, Osprey Line, is the preeminent mover of containers on barges, connecting Houston, Lake Charles, Memphis, Chicago and Pascagoula, among other river ports. He noted that the absence of adequate terminal and offloading facilities at many ports was an inhibiting factor to the growth of container traffic on inland arteries. In Europe, where 50 percent of containers are transported by ship, the geography is different, with more navigable rivers that can accommodate large freighters and more big cities located on navigable rivers. He reluctantly conceded that America had a long way to go to make the dream of America’s Marine Highway – at least for containers – a reality.

Kirby is an interesting company in more ways than one. A voracious consolidator, it recently announced its intention to acquire K-Sea Transportation, an operator of tank barges and towboats in the coastwise trade of refined petroleum products along the U.S. East, West and Gulf Coasts, as well as Alaska and Hawaii. The $600 million acquisition is a logical extension of Kirby’s inland tank barge business, in which it is already the country’s largest operator, and nicely complements its other two businesses – bunkering and diesel engine services. The company is well worth a look.

So there you have it. Air, water, highway and rail – all rolled into one neat package. In case you missed it, the answer to the question posed in the subtitle is, of course, airfreight. But you already knew that, right? – MarEx

Jack O’Connell, the Senior Editor of this magazine and a former maritime executive, is a private investor who may own shares in some of the companies mentioned in his columns. The views expressed are his and his alone and are not in any way to be construed as investment advice.