André Hardy:
Welcome to the Industries in Motion Podcast from RBC Capital Markets, where we'll be exploring what's new and what's next in today's fast moving markets and industries to help you stay ahead of the curve. Please listen to the end of this podcast for important disclaimers. My name is André Hardy and I am head of Canadian and Asia Pacific Research. Let us get into today's episode.
André Hardy:
Supply chain issues became front and center in 2021 with shippers in all areas of the world beset with delays in getting their goods to market. This caught the attention of investors as well, with the words supply chain taking over the top spot over COVID-19 as the most referenced word on company Q3 results conference calls. And supply chain is by definition a transportation issue, and covering transportation companies we hear firsthand every day intricacies of this issue. What we'll be addressing today is how the supply chain issue came about, who are the winners and losers, and when might it all be resolved.
André Hardy:
I'm very happy to introduce our next guest Walter Spracklin. Walter's responsible for the firm's equity coverage of the North American railroads and waste management sectors, as well as the Canadian airline, aerospace, trucking logistics and plastics and packaging sectors. Walter has two decades of experience in equity research and over the course of his career has been consistently cited as a top ranked analyst by the major analyst rating organizations in Canada. I've had the pleasure of working with Walter for about 15 years of his 20 years of experience on the street, and I'm really excited to have this conversation with him today on the podcast. Walter, thanks so much for joining today.
Walter Spracklin:
Thanks for having me, André.
André Hardy:
Walter, to kick things off, help us understand what happened to create the current supply chain problem.
Walter Spracklin:
So supply chain, when we think about it, an imbalance happens whenever there is too much of something or not enough of another and so the system gets thrown out of whack. And in this case we had too much demand for goods, but more importantly, the thing we did not have enough of was transportation services to get those goods to market. So on the demand side, demand was increased when liquidity was injected into the systems by governments worldwide to keep our economies going. And that was part of the issue, but more importantly, the key problem was really on the supply side, our ability to provide the transportation services needed to get those goods to market when there was so much disruption at play.
Walter Spracklin:
So to understand the supply chain issue it is important to understand how complex and internationally integrated our global transportation network really is. Now think of all the moving parts involved in getting the item you order online to your front door – the manufacturer of the good itself, perhaps in China, the movement of that good by container to the Chinese port, the loading of that container onto a vessel, the vessel then traveling to a North American port, offloading that container into the North American port, moving it onto a train and then to an intermodal facility in the destination end market, the trucking of that good to a distribution center, and then ultimately, the sorting and delivery from that center to your home. Now that sounds complicated, but it actually oversimplifies the process. Ultimately our transportation system is a circuitous ever moving and finely honed system. Now this system is designed to accommodate disruption. You get the odd hurricane here, perhaps a strike over there, maybe even a recession or two, but our system is simply not designed to accommodate the extent of the disruption caused by COVID-19.
Walter Spracklin:
COVID caused the all-out shutdown of activity across our network, first at ports in China, and then here in North America. And then you layer on disruption on top of that and things get really ugly. We had weather issues, hurricanes, massive semiconductor shortages that put a limit on equipment availability. And on top of that we had a driver shortage that was aggravated by the COVID relief programs that made it less attractive for a person to get in a truck and drive our products from one place to another rather than collect a check at home.
Walter Spracklin:
All of this adds up to massive disruption and the ability of carriers to get the product to its end destination. And as with any integrated system, a bottleneck in one area creates a bottleneck in another area, and that's an overall ripple effect that results in massive delays everywhere, dozens of vessels waiting to dock at port, mountains of containers building up. Nike was quoted as saying what would typically take 40 days to get a product from China to North America, it's now taking 80 days. So that's how the supply chain issue began, it was essentially a series of massive disruptions that had ripple effects across entire network and were aggravated by elevated demand that was created as a result of massive injection of liquidity that hypercharged our economy.
André Hardy:
Thank you very much for that overview, Walter. When I take a step back, major disruptions or major changes typically create opportunities and challenges. So with that in mind, who benefits from the current supply chain challenges and who's negatively impacted?
Walter Spracklin:
Yeah, let's start with the winners, okay? So first when you think of a supply chain issue, intuitively you would say that, "Okay, these are transportation problems and therefore transportation players are the ones that lose." Well, not even close. I'd put it this way, railroads and trucking companies are today the providers of a very scarce asset, and that's transportation service, and everyone is absolutely desperate for transportation services. So when you've got a customer that can't get enough of your service and they're desperate for you to give it as much to them as you'll give to them, no matter the cost, then that's not such a bad thing.
Walter Spracklin:
So what are transportation players doing? They're raising their rates. Our Shipper Survey that we just published this week pointed to rate increases that were among the most significant on record, and we've been doing this for 15 years. And that doesn't even include accessorial charges, which I'll get to in a moment. So while it's true that transportation companies weren't able to haul as much as they otherwise would have, and perhaps not to the same efficiency, the third quarter results that were just reported showed that these were overall fairly minor issues from the company's perspective, and they're making it all up with higher pricing. So things aren't all that a bad for railroads and truckers alike. So they're not the losers, they're actually a beneficiary.
Walter Spracklin:
Who else is benefiting? Well, let's say that when you're moving a really high valued good and getting this good to the store shelf before the holidays is really important, well even paying the accessorial charges that the railroads are charging still doesn't get your good to the shelf on time, then what do you do? Well, you're going to go by air. Well guess what? 50% of the international air freight capacity used to move by the belly space of passenger airlines, they're not flying right now. So as a result, air freight prices are up huge, two, three times what they've been historically. So if you're in the business of providing air freight services to expedite delivery companies, that's a really good space to be in, and these are clear winners.
Walter Spracklin:
So who are the losers? Well, if you produce a product that you don't have pricing power with your customer, then you're kind of in big trouble. But if you do have pricing power or the transportation component of the good's total cost is low, then you can pay up to prioritize your shipment. And you do that by paying these accessorial charges. You do that, shippers can expedite the transit of their container on a much quicker basis, but it's not cheap to do this. Or as I mentioned, you can send your goods by air, also not cheap. More often than not though your product is simply going to be delayed. So in the end, it's the shipper that is the most impacted by the supplied chain disruptions that we're seeing today.
André Hardy:
Thanks, Walter, for helping us better understand what has been happening. So what happens next? Where do we go from here?
Walter Spracklin:
Well, the quick answer is it's likely to get worse before it gets better, that's the bad news. If you look at work done by my colleague, Mike Tran in a recently published RBC Digital Intelligence Strategy report on supply chain issue, he pointed to inherent problems that have no real quick fix. Analysis by our RBC Elements™ data science team also pointed to indications that perhaps by mid-year next year we'll start to see some level of normalcy. But a key carrier that we hosted at our recent Shipper Forum suggested it might even be a year before we dig ourselves out from this mess, and that's assuming there's no more supply shocks. And some are asking if regulation or government intervention could be the solution, which I don't think will be the case. There's news out there this week that the regulator’s in fact proceeding with the review of reciprocal switching as a mechanism designed to control rail rates by artificially introducing competition.
Walter Spracklin:
Now, the key though is that freight rate increases are highest rate now actually in trucking, which has the most competition. And on top of that, reciprocal switching, if you really look into what it does, it's intended to add more competition to the rail sector, but in fact has the negative side effect of reducing capacity. So we're proceeding with a hearing to evaluate a mechanism that is designed to increase competition, which as the data shows won't work in lowering prices, but it will result in lower capacity at a time when that capacity is needed most. So let me say no, regulation is not the answer. So what is the answer? In my mind it's time, hopefully the seasonal slowdown that occurs post the holiday season provides us some time to get through this backlog. And fingers crossed we don't get more shocks to the system like we had over the last couple years.
Walter Spracklin:
Now, the good news is, as I mentioned before, our network is indeed resilient. It has latency and buffers built in, and in normal times, or even abnormal times, the system works really well. It's those truly extra ordinary times we simply have to manage through and learn from to better prepare us for the next extraordinary time.
Walter Spracklin:
And what have we learned from this one? Well, a few things. First, shippers and consumers are likely going to have to pay more for freight or accept slower delivery times. And I'll tell you this, I attend a lot of industry conferences and one thing I hear from shippers all the time is that consumers want more and they want it sooner, not less and slower, which means if we want to fulfill that customer demand for getting goods to our doors faster, then we're going to have to pay more for transportation services. And I'm not referring to general inflationary pressures that's impacting all sectors like we're seeing today, no, we need structurally higher pricing, because if we want these companies to build out substantially higher capacity to deal with more volatile fluctuations, that's going to come at a cost. More investment will be needed both on infrastructure, equipment and actually the hiring and retention of qualified operators across all modes.
Walter Spracklin:
Secondly, I anticipate that we'll likely be seeing some significant onshoring moves. Walmart has already announced that they're going to be spending $350 billion over the next decade on supplies produced, grown, or assembled in the United States. Our Shipper Survey also pointed to 18% of the shippers that we spoke to are confirming to us that they are going to be doing on onshoring to some degree, some to a significant degree. Another 34% indicating they're still evaluating that question. So no doubt, we'll see some move toward onshoring, meaning all transportation moves that previously went into assembling a product over in Asia is now going to happen here in North America. And in our view, driving up demand for transportation services even more.
Walter Spracklin:
And the wildcard out of all of this is technology. In the near term I expect technology will be a big driver of both safety and efficiency. Canadian National Railway's automated inspection portal, which I viewed in North Toronto, is a great example. This increases efficiency and substantially improves safety. And further down the road, we have to look more toward disruptive technologies. Transportation is still a very manual process, it's improving at the dock with equipment used by terminal operators getting more and more sophisticated, but railroading, for example, still has a ways to go, and that could open the door to greater efficiency, greater flex capacity and that might be what we need to get more handle over some of these extraordinary shocks. And that said, it would be nice to see a more normalized environment for a while, but I wouldn't bank on it.
André Hardy:
Walter, thank you very much for your insights on what is an absolutely fascinating and relevant topic. So what else lies ahead in today's ever evolving markets and industries? We'll be keeping track right here on Industries in Motion. We also ask that you listen to Lori Calvasina's podcast Markets in Motion provided by RBC Capital Markets. Until then, thank you for joining us on this episode recorded November 16th, 2021. Make sure you subscribe to Industries in Motion wherever you listen to your podcast. If you'd like to continue this conversation, or if you are interested in more information, please contact your RBC representative directly or visit our website at www.rbccm.com/industriesinmotion. Thank you very much for listening.
Speaker 3:
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