With major structural changes set to transform the road freight industry: what’s your exposure?

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While the demand for road freight is forecast to increase over the next five years, the industry is expected to undergo major structural changes, as a result of internal and external pressures. Lenders and investors need to be aware of the four key challenges faced by the industry to ensure long term viability of their stake.

Phil Campbell-Wilson comments:
“Fringe players already operating on low margins, without access to capital and the ability to gain scale, will find it very difficult to compete and are unlikely to survive. Opportunity is with those who can and move first to invest in scale, niche markets, technology, training and OH&S”

Road freight remains a highly fragmented, competitive industry that services a diverse range of clients and sectors of the economy. Approximately 80% of freight relates to the manufacturing, retail, wholesale, construction and agricultural sectors, all of which are sensitive to either economic or climatic change. As a result, over the past 5 years, industry profitability has been challenging, with EBIT averaging between 5-10% in 2013-14. Demand for road freight is forecast to increase over the next 5 years with industry revenue expected to grow to $59.8 billion in 2018-19. Despite these forecast increases, it is expected that participants will struggle to remain profitable due to increasing costs and service requirements.

In this article, we explore the key challenges for the road freight industry, as well as discuss the implications and opportunities arising for lenders and investors in the industry.

Key challenges for the road freight industry

There are four key challenges participants will need to address to maintain profitability and remain competitive in changing market conditions.

Rising salaries and wage expenses

  • The workforce is ageing, with the average driver aged at 50 years,  the industry is therefore competing for new operators with other sectors (such as mining).
  • A shortage of skilled drivers will lead to increasing wage costs as the industry seeks to attract the required skills.
  • Average wage costs have increased annually since 2008-2009 and this is forecast to continue at between 3-5% per annum.

Rising fuel costs

  • Fuel costs have been rising and are forecast to continue to do so at 2-3% per annum.
  • Whilst medium to large sized operators have successfully introduced and passed on fuel surcharges to customers, not all industry participants have the market power to pass these costs on.

Productivity gains and regulatory pressure

  • The industry has traditionally achieved productivity gains via larger and more fuel efficient vehicles.
  • Whilst community concerns are acting as a barrier against the industry continuing to adopt larger vehicles in the pursuit of productivity, Government and Industry are working hard to overcome these barriers.
  • In the immediate term, it is likely that the industry will remain reliant on current vehicle sizes and therefore future productivity gains will be more difficult to attain.

Changing competitive landscape

  • With historically low profit margins, participants will need to investigate long term contracts and methods to increase scale and volume. On this basis, whilst the industry will continue to grow in the medium term, consolidation is required if profitability is to improve.
  • In this regard there is the potential for international players to enter a market that has been traditionally dominated by local operators. For example, Kuwaiti based Agility Logistics see the opportunity and have an increasing presence in the Australian market.

Implications and opportunities for investors and lenders

The four key challenges listed above reveal several implications and opportunities for stakeholders. Industry participants are operating in a low-margin environment with average ‘net profit after tax’ between 3-5%. With operating costs such as fuel and salaries and wages forecast to increase, it will be difficult for industry participants to remain profitable without long-term contracts and volume/scale efficiencies. 

Questions to ask yourself:

Freight reliability

As congestion on roads gets worse, so does road freight reliability. Whilst multi modal integration and High Productivity Vehicles (HPVs) are seen as a solution, access to all roads for HPVs can be limited.

  • Is your investee or borrower considering its future business model to accommodate these solutions?
  • Does your investee or borrower have sufficient capital to adopt HPVs and increase scale?
  • Will your investee or borrower have access to road infrastructure and capacity for appropriate utilisation of HPVs to achieve productivity gains?

Increased cost pressures

Cost pressures and low-margin squeeze on key players is changing the industry landscape. Small to medium operators without a niche market are struggling to compete, and larger operators will continue to grow and achieve maximum utilisation through acquisitions and consolidation of industry participants.

  • Does your investee or borrower understand and have a strategy to deal with the changing industry landscape?
  • How is your investee or borrower placed? Are they likely to be part of the ‘consolidation’ pile, or will they require additional capital for acquisitions and hence scale?
  • Is being part of the consolidation process an attractive option to ensure some protection of enterprise value?
  • Do they have a niche market to pursue, and hence a reduced need to compete with larger players in the sector for volume?

Safety

Safety concerns, including fatalities, are a constant challenge for the industry, and maintaining vehicle safety standards rests with the individual industry participant. These also present reputational risk issues for investors and lenders alike. In an already highly regulated sector, regulation is only likely to increase.

  • Is your investee or borrower a reputable operator in the sector regarding maintenance of vehicles and high standards of OH&S?
  • Are they investing in technology such as GPS tracking to assist monitoring of speed, stoppage, and routes allowing for collation of essential data to improve efficiency and safety?
  • Does your investee or borrower have sufficient capital to maintain and/or upgrade vehicles?This could be essential to win and maintain key contracts in a commoditised market.

Lenders and investors should ensure they are aware of changing industry conditions and confident of how their participants are handling issues related to freight reliability, cost pressures, and safety to ensure the long-term viability of their stake. Those organisations who look to multi modal integration, expanding their fleet to include HPVs and uphold their reputation in the market will be well placed to maintain profitability and remain competitive in changing market conditions.

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