Rising costs on supply chains

This analysis is by Bloomberg Intelligence analysts Lee A Klaskow, Andrew Cosgrove, Talon Custer, Scott J Levine, Karen Ubelhart, Holly Tyler, Gina Martin Adams and Peter Chung. It appeared first on the Bloomberg Terminal. 

The inflationary pressures from rising transportation costs
The impact of rising trucking, railroad, dry-bulk and air-freight rates will reverberate across supply chains and affect multiple sectors. Increased economic activity and a tighter trucking market should push truckload rates up 8-12% and intermodal 10-15% higher this year. This will mitigate the benefits generated from increased demand and tax cuts on shippers.

Trucking rates poised to increase in 2018
Truckload and less-than-truckload (LTL) rates appear to have strength in 2018 on the heels of increased economic activity and tighter capacity. Contractual truckload rates will likely rise by high-single to low-double digits in 2018 as they catch up to strength on the spot market. About 25-35% of rate increases will be passed onto drivers in the form of higher wages and bonuses, helping attract and retain employees. About a third of rate increases have historically been retained by carriers, which should bode well for EPS growth.

Higher intermodal rates will follow
Tighter trucking capacity, economic growth and EIA’s forecast for 10% higher diesel prices will drive intermodal’s 2018 performance. U.S. traffic in the segment may gain 4.4%, or about 1.6x GDP expectations, according to FTR. Rising diesel prices and trucking rates will make the 10-30% savings from intermodal more compelling for shippers. Rails will increase rates while keeping the percentage discounts intact. Shippers could see intermodal rate increases by mid-single digits in 2018.

Shipping rates face higher tides
Increased demand, a more rational order book and further consolidation of the liner industry could lead to higher container rates in 2018. Global container demand is expected to increase 5% in 2018 and outpace supply growth by 90 bps, according to Clarksons. Optically, rates may not rise as quickly in previous cycles since the inflow of larger ships and productivity improvements have lowered the average cost per container.

Dry-bulk rate recovery appears shipshape on supply restraint
Prolonged growth in dry-bulk rates will hinge on the industry’s ability to remain rational with supply and the sustainability of Chinese import demand. Rates have almost quadrupled from the Feb. 10, 2016, bottom through Feb. 14. A 12% advance is expected in 2018, based on a Bloomberg survey.

Capesize leading dry-bulk rates higher
Dry-bulk rates are being led higher by capesize vessels, which are up about 53% on average this year through Feb. 14 compared with the year-earlier period. Fewer orders for new ships and robust Chinese demand have pushed up rates. Order book-to-total capesize capacity remains low at 14%, compared with 23% in 2014. This should help rationalize the capesize fleet, which may expand 2.9% net of scrapping in 2018, according to Clarksons. Gains will also hinge on the sustainability of Chinese iron-ore demand.

Bulks, base metal premiums on watch from rising freight costs
The coming uptick in seaborne freight rates and softening prices from coal to iron ore could make transport costs a larger share of landed commodity prices. A jump in U.S. trucking costs should continue to prop up domestic aluminum and copper premiums.

Rising freight rates have mixed implications for industrials
Rising freight rates likely have mixed implications for industrials in 2018. Read-through should be positive for truck manufacturers, given the outlook for positive demand. The impact on equipment providers, distributors and waste companies will likely be more dire as rising transport costs dampen margins.

Higher freight costs hurt margins, yet materials matter more
Rising freight transportation costs will shrink industrial margins in 2018, yet rising material prices are a much larger factor. Freight expense represents less than 10% of the cost of goods sold for machinery companies, while materials costs are 75-80%. Pricing should improve modestly, yet freight and fuel outlays could temper operating leverage as demand rebounds in a global industrial recovery.

Higher transport, labor rates crimp waste margins
A rise in transportation costs would likely add to pressure on waste-company margins in 2018 due to their use of third parties for transfer, though they should be able to recover at least a portion of this via increases in disposal pricing. Waste companies could also face pressure from higher labor costs, as they often draw from the same hiring pool as the trucking industry. Increases in intermodal and rail prices could be another dampening factor, though likely a much smaller one than truck rates.

S&P 500 margins thrive even as inflation pressures mount
Inflation offers no immediate threat to profitability, as tax cuts and improving revenue expectations should take the S&P 500 to new margin highs. Commodity sectors are benefiting from improving prices, while service industries should post double-digit gains. Over time, margin expansion usually leads the pace of inflation.

Operating margin leads the pace of inflation
Inflation watchers should pay attention to corporate profit margins, as history has shown they tend to lead the pace of prices by at least two quarters. Over the past 20 years, the S&P 500’s operating margin had a 0.53 correlation to the year-over-year growth of headline CPI and wages combined. At a two-quarter lead, however, the correlation increases to 0.67 as profit variability tends to shift ahead of wider economic pricing pressures.

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