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 email@example.com firstname.lastname@example.org Robert Hutson Bill Buckby Brisbane Townsville 07 3225 4949 07 4724 5455 email@example.com firstname.lastname@example.org Brian McMaster Stephen Duncan Perth Adelaide 08 9221 6999 08 8223 8106 email@example.com firstname.lastname@example.org 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 (email@example.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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