Factors Impacting the 2021 Class 8 Truck Market

Steve Katz:                   Hello again, and welcome to the Hilco Global Smarter Perspective Podcast Series. I’m your host, Steve Katz. Today, we’re speaking with Brian Courcier, Senior Vice President of the Transportation and Construction Advisory within Hilco Valuation Services, about how factors including the current semiconductor chip manufacturing shortage and COVID-19 restrictions, requiring changes in auction practices, have impacted the Class 8 truck market. We’ll also discuss steps that lenders can take in the months ahead to ensure limited portfolio exposure when industry production does ultimately catch up with demand. Just as a little quick background, ABLs and manufacturers alike have achieved a high level of success in partnership with Hilco Valuation Services based upon its disciplined process, industry-leading bench strength, systematic and collaborative approach, and throughout the pandemic, Hilco has amassed critical insights and data that are enabling delivery of highly accurate valuations across the transportation industry and the associated supply chain during this continuing, volatile period. With that said, and it was a mouthful, welcome to the podcast, Brian.

Bryan Courcier:            Hi, Steve, great to be back with you. Thanks for having me.

Steve Katz:                   Yeah, absolutely. We’re glad to have you on and get your thoughts on what’s been happening in the Class 8 truck market since the last time that we spoke, which I believe was back in the earlier stages of the pandemic. So it’s been quite a while. Brian things were pretty rough for the industry through about this time last year, and then there was a shift. Can you talk a bit about what took place? How that’s impacted the operator’s perspective on investment and growth? And what kind of volume and pricing changes we’re looking at year over year?

Bryan Courcier:            Yeah, absolutely Steve. Demand for trucking has dramatically increased and rebounded over the past 12 to 15 months. No question about that. Most of it has to do with all sorts of freight demand from coast to coast and while orders for Class 8 trucks in 2020 were down, there’s been a dramatic increase in 2021 as well. Right now, what we’re facing more than anything else is not so much demand, but supply issues. OEMs are still struggling to get back up to speed with production, and according to ACT research, which is one of our major providers of detailed and incredible information in the space, Class 8 sales dropped more than 5% month over month and 12% year over year in the month of June.

Now that’s not related to demand, it’s more related to the fact that they can’t provide the trucks that are needed in the space. As compared with June of 2020, the average used price was 63% higher in 2021. And that’s the case, despite the fact that utilization for those trucks was down about 5% year over year. That’s a major indicator that this is an unusual situation in which used trucking is actually increasing in value and plastic or traditional depreciation not occurring, which in the 15 years that I’ve been in the industry has never occurred. And it’s relatively unheard of in modern commercial trucking in the United States at all.

Steve Katz:                   Interesting. So some promising numbers and improvement there for sure, but still significant struggles, correct? In terms of delivery timeframes, can you talk a little bit about that?

Bryan Courcier:            Yeah, absolutely. So even with many truck orders being canceled or postponed by weary fleet operators during the pandemic, those who didn’t cancel are now in many cases, seeing delivery, not only between 40 and 60% of the vehicles in their original fleet orders. As they struggle to catch up, many truck makers are only now beginning to take orders from 2022. And the percentage of those orders, which can be reasonably expected to be fulfilled by the end of next year remains in question. On the bright side, the last eight preliminary orders for June reached 25,700 units. That was an 11% increase over May, and a 61% rise is compared with June 2020. And that again was according to ACT research, who really is a comprehensive data provider for the space.

Without question, this continues to be a seller’s market. With used inventory and extremely high demand and OEM productions still lagging, we believe pricing for Class 8 trucks is unlikely to soften until early to mid-2022. And even having said that, with the more conversations that we have in the marketplace, it seems like that chip shortage is getting pressed further and further into 2022, to the point where we don’t necessarily see an end in sight to when those chips are going to be in regular production and available in the way that we all came to expect in the past.

Steve Katz:                   Interesting. So right now, based on what you’re saying, it seems that supply rather than demand is really the issue for the industry. And as I mentioned in my introduction, supply chain issues or driving that you just talked a little bit about that. What can you tell us about the issues surrounding the production of semiconductor chips in more detail? Like what are the root causes in terms of the creation of the problem itself, and why the impact is so significant for the industry overall?

Bryan Courcier:            Sure, absolutely. I mean, obviously, it was widely reported. The global shortage of semiconductor chips is notably impacted production across the overall automotive market in 2021, but it also is affecting other industries as well. The shortage resulted in large part from semiconductor manufacturers, quit pivot in the face of vehicle assembly, plant shutdowns in 2020, where there were really no commercial auto or consumer auto being produced in the early stages of the global pandemic. Those people pivoted to creating semiconductor chips for other industries, consumers required to spend the majority of their time in their homes, had more demand for consumer electronics, and dramatically increased the demand there. So while entertainment and other home dining, this included entertainment and other items in the home appliances, what have you. One key driver, if this was the very real need for home office equipment, which nobody had anticipated before. Recognizing these developments, many semiconductor manufacturers quickly shifted their production and emphasized away from automotive to fill this gap as a means of sustaining their businesses.

When demand for new vehicles ultimately returns sooner than expected, a semiconductor chip supply shortfall occurred. Furthermore, because the assembly of these types of chips, necessitates extended lead times that cause more issues. And in terms of why this is a particularly troubling issue for the industry, these components are highly critical. In fact, on average 17 different clusters of semiconductor chips are utilized in a typical Class 8 truck tractor. Factors, including regulatory compliance, the complexity of the vehicles themselves, their size and required braking, power, all contribute to the need for this technology. Chip clusters control the functioning of everything from lights, brakes, dashboard displays, and communication systems. The GPS fleet tracking, electronic timeout, logging, and logistics reporting. Just some food for thought, if the trucking and auto manufacturing industry is this reliant upon chips for these types of systems now, just think about the volume of chip users that will be needed as we shift to more autonomous vehicles. On the road, those and other supply chain realities will surely impact the speed with which we see the evolution of autonomous driving taking place, moving ahead.

Steve Katz:                   I mean, it does seem like the volume of the chips it would be required for that sort of evolution could become a supply chain nightmare, when you think about it. It’s really- especially given the amount of chips in those clusters now. So hadn’t really thought about that. That’s really some good food for thought. And I know we’re going to be talking on future podcasts about the evolution of electric vehicles and autonomous driving. So that’s something that I definitely want to think a little bit more about as I put those podcasts together. Thanks for that.

Based on what you just said, the circumstances and factors that have evolved such as the increased cost of manufacturing, raw materials, the next question would be in what steps are manufacturers taking to adjust? And is it helping? Is it really making a difference?

Bryan Courcier:            Well, manufacturers are certainly working with chip suppliers to understand delivery cycles, and minimize the further negative impact on their customers. That’s a moving target though. They’ve been adjusting production schedules is needed scheduling and instituting dot days or weeks based on anticipated periods of significant supply chain bottlenecking are occurring, but really being able to put your thumb on exactly when, where you’re going to be able to get high volumes of chips is still a question mark. It’s worth noting that given continued labor force challenges, it’s highly likely to even in if some semiconductor chips were readily available, the vehicle assembly would still be notably slowed. Additionally, with steel prices getting record nearly every week and copper prices reaching 15-year highs, OEMs are incorporating surcharges on some trucks just to keep pace with cost and materials.

What I’ll also say is oftentimes some of the bells and whistles on consumer and commercial vehicles are causing complications in terms of delivery. So many OEMs are offering vehicles with less semiconductor chips in them, and they’re only providing the semiconductor chips, which are relevant to the core operating of those vehicles. And some of the more luxury items can be delivered at a later date after taking delivery of those vehicles, which is causing all sorts of question marks down the line as well.

Steve Katz:                   Wow. So it’s such an interesting series of developments. I mean, when you look at how it’s just kind of evolved. I guess, added to the situation, there have been other complications rights, such as bringing used trucking assets to market effectively via auctions, which I know Hilco has a long heritage in the auction industry, I believe has been less publicized than some of the other aspects of what’s going on in the market, and I think that our listeners would probably be really interested in hearing more about that. So what can you tell us regarding the challenges that are being faced in address in the auction markets right now?

Bryan Courcier:            Yeah, Steve that’s true. The pandemic has required most auction operators to sell vehicles remotely in the past year, meaning there are no physical audiences at most facilities that used to have large auditoriums on the day of the sale. And this has created significant challenges with buyers experiencing limited time and restrictive processes to review inventory for sale in person leading up to an auction. Principal among these has been the need for those conducting auctions to have trained personnel that can provide an enhanced level of visual and written documentation, having access to a very limited workforce during the pandemic. These vehicles are heavy-duty, industrial assets, which at some point before payment, require a live inspection to ensure they’re as advertised. As a result, we’ve seen a much higher incidence of collapsed sales. Even among those auction houses, with the best reputations in the business.

While auctioneers have done their level best to photograph and describe the vehicles in great detail, these limitations have been felt by buyers who either didn’t see an issue in the photos or the videos provided or believed they were not accurately informed about details of the vehicles they purchased. With COVID restrictions becoming more relaxed, we expect to see more live auctions and fewer collapsed sales in the months ahead. Those on both ends of these transactions are clearly hoping that recent developments regarding the spread of the Coronavirus Delta Variant does not derail the progress in that direction.

Steve Katz:                   Yeah, well let’s hope that’s the case. I think across all industries right now, everybody’s concerned about that and things do not seem to be looking great, unfortunately. So to wrap it up, I wanted to ask you what thoughts you might have for lenders with trucking operators and manufacturers in their portfolios that can really help them best work with those businesses in a productive manner while minimizing risk in the months ahead. Certainly through the end of the year, and then just some thoughts maybe into the beginning of next year.

Bryan Courcier:            Certainly, I think lenders who may have in the last year been hesitant to add current technology level, Class 8 truck tractors. Meaning diesel units, they’re not autonomous and driven by human operators. I don’t think that they should hesitate to lend into and invest in those types of companies. Driver-guided vehicles will be the norm for the foreseeable future. That being said, in the near term with trucks remaining in short supply and continuing to increase in value, it is critically important for lenders to maintain a close eye on the recent shifting value of the assets. We are far outside of normal cyclical trending in terms of pricing right now. At some point, likely before the end of 2022, chip manufacturing and mainframe production will catch up with demand. I think OEMs will figure out a formula to put the volume back into the market. When that occurs, lending into large, older fleets will require a thorough knowledge of those hard assets, As values are likely to drop rather rapidly, eventually for those fleets.

With this in mind, Hilco recommends that initial appraisals during the current period include a reasonably sized onsite fleet sampling to ensure accuracy. These should be supplemented by a desktop appraisal as six months followed by another onsite between six and twelve months after that, based on our knowledge and our proprietary data pertaining to the value of these types of assets, over the past 30, 60 days. Now, one thing I’ll also say is a lot of operators are taking advantage of the current market. So they are asking for updated appraisals while their hard assets are selling at a premium in the marketplace. I think lenders need to be aware that if they are getting updated appraisals in the next 30 to 120 days, they need to be also aware that those markets could dip pretty significantly at some point in 2022. So there needs to be an awareness that while things are going very well in that space right now, I think that good used equipment is going to fall off a little bit once production catches up the speed.

Steve Katz:                   Well, Brian great info, and I want to emphasize for the audience as well, that what you’re talking about is coming from a significant position of knowledge-based not only on the valuation work that you guys have been performing on behalf of clients throughout the pandemic but also on Hilco’s own acquisition and ongoing operation of two transportation industry, leasing businesses during the course of the pandemic as well. So kudos to you on that, Brian, I know had a big hand in those efforts and that only adds to the perspective that you’ve brought us today. And for those of you listening in today, we encourage you to reach out to Brian and the valuations team to take advantage of those pandemic learnings. They can provide perspective, as Brian said, in guidance, on your distinct portfolio holdings, based on their knowledge, and the proprietary data that they’ve accumulated regarding the value of those assets over the past 30 to 60 days. So with that in mind, Brian’s email is bcourcier@hilcoglobal.com. That’s B as in Brian, C O U R C I E R @hilcoglobal.com. Brian, thanks again for joining us today.

Bryan Courcier:            You bet Steve. Really appreciate having me out and we look forward to helping any of our clients with their future valuation needs.

Steve Katz:                   Terrific. And listeners, we hope that today’s Hilco Global Smarter Perspective Podcast provided you with at least one key takeaway that you can put to good use in your business or share with a colleague or client to help make them that much more successful moving forward. Until next time for Hilco Global, I’m Steve Katz.