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Price Competition in the Transport Industry

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					Transport Industry
       Industry Vitals




       KordaMentha Research Unit
                  Publication 505


                 September 2005
Industry Vitals
September 2005




                  Transport Industry

                  Sector:            Road Freight
                  Service Line:      Corporate Recovery Services



                  Overview
                  •   Over the previous five years, the road freight transport industry has
                      experienced limited growth in operating margins and a decline in
                      asset utilisation. These reflect both the sustained competition and an
                      increased investment in logistics infrastructure within the road
                      transport industry over this period.
                  •   The road freight transport industry is facing increasing competition
                      from the expansion of existing market participants into substitute
                      services such as rail and sea freight transport services. Examples of
                      such investment include the investment in Pacific National Pty Ltd
                      (rail/sea freight) by Toll Holdings Ltd and Patrick Corporation Ltd
                      and the potential investment in FCL Transport Pty Ltd (rail/sea
                      freight) by Patrick Corporations Ltd.
                  •   The performance of the road freight industry is heavily influenced by
                      the performance of ‘up-stream’ industries, specifically:
                      −    Manufacturing;
                      −    Wholesale and retail trade;
                      −    Construction;
                      −    Agriculture; and
                      −    Mining.
                  •   The industry experienced a real revenue growth rate of
                      approximately 4% in the 12 months to June 2004 due predominantly
                      to the absence of significant downturns in ‘upstream’ industries.
                      However manufacturing, wholesale and retail trade, and construction
                      have all slowed over the last 6 to 12 months, prompting concerns that
                      the road freight transport industry faces negative real growth in the
                      medium term.
Industry Vitals

                           •   Due to low barriers to entry and a large number of generic suppliers,
                               price competition is fierce. Increasing crude oil prices have also
                               increased pressure on margins across the industry as service
                               providers have absorbed some or all of these cost increases in the
                               face of price competition.




                                   Source: AAA Petrol Price Monitor


                           •   Facing industry maturation, some market participants have exploited
                               growth opportunities through the investment in, and provision of
                               ‘value-added’ services of integrated logistics and warehousing.
                               However, this has resulted in an increased risk of the service
                               providers’ reliance on a small number of customers.




Profit and Loss Analysis   Revenue

                           •   Secure contracted revenue at profitable margins is critical to
                               underpinning ongoing viability.
                           •   Due to the high level of price competition, and in the absence of
                               contracted revenue streams, small to medium size operators are
                               generally price takers, and consequently absorb any increase in
                               direct costs, specifically fuel costs, resulting in an unsustainable
                               erosion of margin.




                                                                                                Page 2
Industry Vitals

                                                       Cost Structure
INDICATIVE COST STRUCTURE                              •   In the absence of a secure contracted revenue base, the indicative
                                                2002
Revenue                                       100.0%
                                                           cost structure analysis demonstrates the importance of scale on
                                                           profitability, in light of relatively small profit margins. Furthermore,
Wages                                          35.7%
Vehicle running expenses                       27.2%       it indicates the requirements of service provision to be correctly and
Rent                                            7.7%       accurately costed in order to protect margins.
Subcontract                                     6.7%
Capital expenditure                             5.7%
Depreciation                                    5.0%   •   The majority of costs are represented by wages and fuel, i.e.
Purchases                                       1.7%       direct variable costs. With an increase in crude oil prices of
Other                                           7.3%
Profit                                          3.0%       approximately 60% over the prior 24 months and in the absence of
Source:                                                    the supplier recovering increasing fuel costs via an index-based levy,
IBISWorld - Road Freight Transport in Australia,
16 February 2005.
                                                           the proportion of costs represented by vehicle running expenses has
                                                           significantly increased.
                                                       •   Depreciation and maintenance expenses should be considered
                                                           within the context of the service provided. Assets employed in an
                                                           agricultural context (livestock transport in difficult terrain) will have
                                                           shorter useful lives than specialised assets used in long haul
                                                           operations.
                                                       •   Wages and subcontractor expenses should also be considered
                                                           within the context of service provided. The workforce of those
                                                           operators providing services subject to seasonal/sporadic
                                                           fluctuations, i.e. livestock transport, tend to be comprised a greater
                                                           proportion of subcontract labour.
                                                       •   Whilst the industry is predominantly labour intensive, capital costs
                                                           can become substantial. Compliance and safety expenditure in
                                                           respect of the transport of hazardous materials, and OH&S
                                                           legislation, such as ‘working at heights’ obligations, may require
                                                           significant capital outlays.
                                                       •   The cost of tyres typically represents around 3%, depending on the
                                                           desire of the service provider to use ‘recaps’.
                                                       •   The ability of a business to sustain non-recurring, extraordinary
                                                           losses such as major vehicle repairs, environmental reparation or
                                                           even expenses relating to freight theft can weigh heavily on the
                                                           ability to operate as a going concern.




                                                                                                                           Page 3
  Industry Vitals


  Balance sheet issues                                 Fleet Management

                                                       •   Small to medium size operators using debt or lease facilities to
      Net cashflow

(+)
                                                           finance fleet and equipment generally require very high utilisation
                                                           rates/load factors to generate positive cash flows. Operators using
                                                           equity to finance fleet and equipment can survive on lower utilisation
                               t                           rates/load factors but instead forego a return on capital employed.
(-)

                                   Lease term          •   Our experience indicates that the importance of sourcing or
                                   Asset useful life
                                                           matching appropriate assets to forecast revenues is often
      Net cashflow
                                                           overlooked by management, i.e. inappropriate assets for job
(+)
                                                           requirements. Furthermore, when financing fleet or equipment, a
                                                           mismatch can exist between the finance term and useful life of the
                                                           relevant asset, resulting in unsustainable cash flows.
(-)
                               t
                                                       •   Insurance premiums can be reduced with an increase in aggregate
                                   Lease term              excess, a potentially costly method of self insurance. Consider the
                                   Asset useful life
                                                           area of freight specialisation i.e. livestock transport vehicles operate
Source: KordaMentha internal analysis                      in rough terrain, long haul general bulk confined to highways.




  Cash flow issues
                                                       •   In the absence of an Electronic Data Interface system (“E.D.I.
                                                           system”), incorrect allocation of cash receipts from high turnover
                                                           debtors can arise, diminishing the entity’s collection capacity,
                                                           particularly in the event of a formal appointment. Debtor
                                                           reconciliation can be a long and costly process. EDI essentially is an
                                                           on-line invoicing facility between customer and service provider.




                                                                                                                           Page 4
Industry Vitals


Management and Systems   KPI’s

                         •   The ability to capture relevant utilisation, earnings and costing
                             rates is of crucial importance. Relevant basic controls, on an hourly
                             or per kilometre basis depending on billing arrangements, are:
                             −    Revenue per kilometre/per hour;
                             −    Revenue by customer;
                             −    Capacity measures such an average tonnes/litres/head per
                                  kilometre by customer;
                             −    The appropriateness of practices such as back loading and
                                  mass management to improve performance;
                             −    Tyre/maintenance cost/per kilometre; and
                             −    Daily kilometres travelled/hours travelled.
                         •   Our experience indicates this approach is crucial both to substantiate
                             increases in cartage rates or close unprofitable routes to stabilise a
                             distressed business.
                         •   Management skill is crucial to the success of small to medium
                             operators, particularly the ability to interpret relevant information.
                             Our experience indicates that the decision as to the provision of
                             service can often be based on poor job costing methods. The ability
                             to monitor costs to protect thin margins is of paramount importance.
                         •   Generally management have been in and around transport companies
                             for most of their life and have not worked in other industries. In
                             many cases, management style and thinking is significantly
                             influenced by ‘old style operators’ and practices.
                         •   Many small to medium sized operators in the industry have lacked
                             the funding to invest in management training and development
                             and have been unable or unwilling to pay market rates for good
                             middle to senior management. This often contributes to poor
                             business performance.
                         •   Pressure on management will increase as customers with highly
                             skilled supply chain people, particularly retailers, continue to out
                             negotiate operators into agreeing to uncommercial contract terms.




                                                                                           Page 5
Industry Vitals


Exit strategy considerations
                               •   In circumstances of financial distress, our experience indicates that
                                   directors’ valuations of fleet and assets are often optimistic.
                               •   In the event of a ‘trade-on’ scenario, valuation and existence
                                   verification of fleet and assets can be a costly and time consuming
                                   matter, particularly if the entity operates in remote locations.
                               •   Environmental cost can diminish the realisable value of land assets.
                                   These costs arise principally from the storage of hazardous chemicals
                                   such a fuel, oil and vehicle cleaning chemicals. Furthermore, lack of
                                   containment around vehicle cleaning bays can create significant
                                   reparation liabilities.
                               •   On appointment, the provision of, or access to, tyres, spare parts and
                                   fuel may be hampered by retention of title claims by various
                                   creditors. In particular, entities with a broad geographic coverage
                                   usually rely on fuel cards for access to fuel. The support of creditors
                                   suppling fuel can therefore be critical.
                               •   As vehicular condition represents a large risk in the context of a
                                   ‘trade-on’ scenario (in addition to a diminution in realisable asset
                                   value), the ability of the entity to provide an accurate assessment as
                                   to fleet condition is of great importance. Our experience indicates
                                   that vehicular condition declines in the event of financial distress, but
                                   the employment of a robust maintenance program can mitigate this
                                   risk.
                               •   The risk of responsibility for goods in transit should be mitigated
                                   as best as possible. Whilst some customers may require the service
                                   provider to bear this risk, some entities choose to implicitly adopt
                                   this risk and self insure against such a risk.
                               •   On appointment, assets in the possession of external repairers with
                                   an unsecured claim can give rise to possessory liens being exercised,
                                   hampering the facilitation of a trade-on strategy.




                                                                                                   Page 6
  Industry Vitals


  Industry snapshot/outlook

          $           Average Sales to Fixed Assets
                                                                              •   Road freight is the dominant mode of freight transportation in
 3.00                                                                             Australia with around 65% of domestic freight being transported by
 2.50
                                                                                  road. The share of road freight on the major Australian freight
 2.00
                                                                                  corridors compared with other transport modes is as follows:
 1.50

 1.00                                                                              −   Melbourne to Sydney                  89%
 0.50

 0.00                                                                              −   Melbourne to Brisbane                79%
               2000     2001           2002         2003        2004

                              Average Sales      Trend line                        −   East coast to West coast             23%
  Source: KordaMentha Bloomberg analysis
                                                                              •   The majority of industry revenue is derived from short distance
                                                                                  haulage (56%), compared with intrastate long distance haulage
                         Industry turnover
                                                                                  (23%) and interstate long distance haulage (21%).
       $'000

16,000                                                                 6.0%
                                                                       5.0%
                                                                              •   The concentration of turnover is low, with K & S, Linfox, Toll and
12,000

 8,000
                                                                       4.0%

                                                                       3.0%
                                                                                  Heggies Bulkhaul accounting for approximately 18% of market
 4,000
                                                                       2.0%
                                                                       1.0%
                                                                                  turnover. Consolidation is anticipated to increase following the
   -
               2000    2001           2002       2003         2004
                                                                       0.0%
                                                                                  current expansion of these participants into other modes of freight
                         Indus try revenue    Real grow th
                                                                                  transportation, and the consequent offering of integrated intermodal
  Source: KordaMentha Bloomberg analysis                                          logistics solutions. The development of rail infrastructure,
                                                                                  predominantly resulting from these expansions, is considered the
                                                                                  main source of competition to the road freight industry in the
                                                                                  medium to long term. This process will be hastened with the Federal
                                                                                  Government’s Auslink investment program.
                                                                              •   The Auslink funding package announced by the Federal
                                                                                  Government in June 2004 aims to improve national, interregional
                                                                                  and international logistics. Despite the program’s direct investment
                                                                                  in both rail and road based projects, the aim is to make rail rates
                                                                                  more competitive with those offered by road transport operators. It
                                                                                  is envisaged that the market for long distance bulk and general
                                                                                  freight i.e. freight that is less time sensitive, will experience further
                                                                                  competitive pressures as a result of the Auslink program.
                                                                              •   Given the reliance of the road freight industry on ‘up-stream
                                                                                  industries’ and the competition posed by increased investment in
                                                                                  rail transport, growth in road freight industry revenues is
                                                                                  anticipated to be limited.
                                                                              •   Road freight operators have been subject to increasing diesel fuel
                                                                                  prices on the back of ever increasing oil prices, with no offsetting
                                                                                  appreciation in the $AUD to offset the rising price of oil. Our
                                                                                  experience indicates that the purchasers of freight services are
                                                                                  hesitant to absorb these increasing costs. The margins of smaller
  Source: Datastream
                                                                                  scale operators often suffer, due to their weak bargaining position.


                                                                                                                                                    Page 7
Industry Vitals


Further resources
                               •   Federal Government AusLink site
                                   −    www.auslink.gov.au
                               •   Federal Department of Transport
                                   −    www.dotars.gov.au
                               •   Transport Industry news articles
                                   −    www.transport.industry-news.net
                                   −    www.fullyloaded.com.au
                               •   Diesel fuel prices
                                   −    www.fueltrac.com.au




Contact             Craig Shepard                        David Winterbottom
                    Melbourne                            Sydney
                    03 8623 3334                         02 8257 3030
                    cshepard@kordamentha.com             dwinterbottom@kordamentha.com
                    Robert Hutson                        Bill Buckby
                    Brisbane                             Townsville
                    07 3225 4949                         07 4724 5455
                    rhutson@kordamentha.com              bbuckby@kordamentha.com

                    Brian McMaster                       Stephen Duncan
                    Perth                                Adelaide
                    08 9221 6999                         08 8223 8106
                    bmcmaster@kordamentha.com            sduncan@kordamentha.com




                                                                                         Page 8
                             About The KordaMentha Research Unit

Background
KordaMentha partners undertook the first voluntary administration in Australia, the largest voluntary
administration in Australia (Ansett with 42 companies, 15,000 employees and >$1 billion assets) and
the largest group of voluntary administrations in Australia (Stockford with 84 companies).
The strength of the KordaMentha experiences and our expertise makes us well placed to monitor and
evaluate issues and developments in the insolvency industry and to recommend changes.


Statement of Direction
The KordaMentha Research Unit aims to:
•    Develop intellectual property
•    Share our knowledge of specialist topics with insolvency stakeholders
•    Develop balanced solutions for issues in the industry. We will do this by preparing position papers
     on topics of interest, and encouraging discussion with a view that changes to the industry will
     result.


Personnel
The KordaMentha Research Unit is headed by Andrew Malarkey (amalarkey@kordamentha.com).
All KordaMentha Partners and Directors contribute to the KordaMentha Research Unit.


Current Research
The KordaMentha Research Unit has conducted research in a number of areas, including:
•       301:          Ansett - Part 5.3A and Chapter 11
•       302:          Melbourne Development and Construction – A Period of Consolidation
•       303:          Large and Complex Administrations – The Courts and Ansett
•       304:          Regulatory Review of Australia’s Insolvency Laws
•       305:          Employee Entitlements
•       306:          Rehabilitating Large and Complex Enterprises in Financial Difficulty
•       401:          Melbourne Residential Investment Market – Retraction and Consolidation
•       402:          Grouping of Entities in the Event of Insolvency
•       403:          Lewingtons Transport Group – A Case Study in Turnaround
•       404:          Tassal Turnaround – A Case Study in Turnaround
•       405:          Overview of US Chapter 11
•       501:          Industry Vitals – Wine Industry
•       502:          Property Investment Due Diligence and Risk Management
•       503:          Shareholder Claims – Shareholders want some of the credit
•       504:          Industry Vitals - Clothing Wholesalers
•       505:          Industry Vitals – Transport Industry
•       506:          Industry Roundup – Agribusiness December 2005
•       601:          Industry Roundup – Agribusiness January 2006
•       602:          Industry Roundup – Agribusiness February 2006
•       603:          Industry Roundup – Agribusiness March 2006


These papers can be accessed via the KordaMentha website – www.kordamentha.com

This document is intended for discussion purposes and should not be relied upon for any other purpose. No part may be reproduced
or transmitted by any process or means without prior written permission of the Authors.

				
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