Moving Things from Here to There…

By almost any measure Corporate America performed well in the first quarter. Revenues of S&P 500 companies grew on average 8.5% over year ago levels, and earnings before taxes advanced 13.2%. But behind these rosy numbers a few concerning items stood out. High freight costs weighed on results of a wide range of companies.

Some of these price pressures are the result of cyclical factors. The U.S. economy is on a roll and that is pushing up prices for fuel and labor – the two key components of any transportation company’s costs. Oil prices averaging over $60/barrel sent fuel costs for many firms up over 20%. Competition for drivers has heated up as well. Transportation research firm FTR estimates that carriers will add 50,000 drivers in 2018 alone. Wage pressures in the trucking sector are unlikely to abate any time soon given that enrollment in commercial driving schools is at a 15-year low at the same time the existing work force is aging.

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Secular trends are also at work. Between 1985 and 2007, global trade volumes grew at around twice the rate of global GDP. Growth since 2007 has remained robust with particular strength in mail delivery (see chart above). Escalating trade tensions could well have a short term, negative impact on growth rates. But longer term, the growing success of e-commerce and rising expectations for how and when goods are delivered should underpin steady increases in shipping volumes.

These trends are already forcing logistics firms to rethink and retool how they do business. Until fairly recently, the response to rising trade volumes centered on simply adding more capacity – more trucks, more containers, more ships etc. This capital intensive approach resulted in more costly and time consuming outcomes. The Economist reports, for example, that shipping a 70kg package from Shanghai to London with DHL Express by air takes three times longer and costs four times as much as sending a person of the same weight that distance. Containerized freight, while typically cheaper, is weighed down by a heavy bureaucracy. A wide range of middlemen (freight forwarders, insurers etc.) are involved in the process, and communication systems remain antiquated. Paper trails of every item shipped are the norm and delayed arrivals often last weeks.

Until now, key industry players have had little incentive to change. Heavy fixed costs have limited the threat of new entrants and stifled competition. Freight forwarders, who typically get paid as a percentage of the total cost of a shipment, have also had little incentive to embrace new processes. But new entrants employing new technology are forcing change.

Faster and more accurate transmission of data is having the biggest impact. Greater use of cellular and satellite networks is allowing transportation companies to coordinate deliveries and match spare capacity with cargo demand in real time. New apps like Cargomatic and TruckerPath which pair loads with drivers is threatening to do to traditional trucking firms what Uber has done to the taxi business. The continued adoption of Radio Frequency Identification (RFIN) which uses electromagnetic fields to identify and track tags attached to objects is improving efficiency.

Big e-commerce companies including Amazon in the U.S. and Alibaba in China are behind much of this transformation. Amazon has created its own logistics division which provides freight forwarding services and includes cargo airline Amazon Air. Alibaba, whose business model is similar to eBay’s, already delivers 70% of the ecommerce packages in China. Transportation firms across the industry owe much of their recent success to the growth in package delivery fostered by these firms. But these legacy transportation firms should watch their backs. E-commerce giants like Amazon store and track customer delivery data, and that represents quite a significant competitive advantage in the business of moving goods.

This Is What Makes Our Business So Interesting...And Also So Difficult...

It was Joseph Schumpeter, the Austrian-born American economist, who spoke of “creative destruction,” the dynamic, change-oriented and innovation-based tendency of Capitalism. The market is constantly replacing old ways of doing things with new ways. New mouse traps are constantly being devised. 

All this makes for a very interesting and frustrating investment business, trying to figure out the future. Retailing is a case in point. The traditional ways of doing business are changing rapidly. E-commerce made up just 5% of total retail sales in 2012. Today this is up to 8.5%, and growing. Amazon alone is responsible for nearly half of all online retail sales so far this year. Anyone in the path of Amazon -- they call it ‘Death by Amazon’ -- is potentially very vulnerable. Whereas the Standard & Poor’s 500 is up by double digits the past year, the Retail index is down by double digits. Sears, Macy’s, Payless ShoeSource, Radio Shack and many, many others have closed multiple stores.

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There will be winners in the traditional retail space going forward, however. Online sales are not going to take every dollar we spend. But figuring out the winners and the losers is well nigh impossible right now. Best Buy was once thought of as ‘Amazon’s Show Room.” You checked out the item in the store and then you bought online. Best Buy has since staged an impressive recovery, emphasizing what store employees can do that online can’t, but again it is far from certain that this initial recovery will continue.

Jason Zweig of The Wall Street Journal wrote in 2016 that there have been 44 U.S. stocks the past 30-years which have generated cumulative returns of 10,000%. These ‘super stocks’ are what everyone would like to find. One very interesting fact is that each of these 44 had a “near death experience”, losing 70% to 80% of their value at some point in their history. The companies had to change how they did business and when they successfully did this, a major stock price recovery ensued. There will probably be super winners in the retail space as these adjustments are made. The problem is, right now these future winners are still tinkering with their business and many look like real losers. This is what makes Value Investing so difficult.

In the meantime it is also interesting to note that “creative destruction” has a flipside. The Wall Street Journal recently reported that total job gains in e-commerce exceed job losses in traditional retail. Yes, Amazon is killing many stores and yes, Amazon is very technology focused (think automation, robots and artificial intelligence) but they still need plenty of bodies to manage the warehouses, the computers and the fulfillment centers. 

The secret to investment success is trying to identify some trends of the future, choosing the companies you think will succeed within these sectors and then sticking with your investments through thick and thin. It’s not market timing that is important, it’s judgment, courage and patience.