Trucking Industry: Investing Essentials

"Without trucks, America stops." -- American Trucking Association

That precisely sums up how significant the trucking industry is to the U.S. economy. Trucking is considered an excellent barometer of the economy's health, simply because trucks carry the bulk of the tonnage moved in the U.S. every year. So when the economy is booming and you want to play the upturn, trucking stocks certainly belong in your portfolio. 

But is the trucking industry only about companies that build trucks? What drives the industry, and how does it work? How big is the industry, and what is its growth potential? Read on for the answers to these critical questions before taking the plunge.

What is the trucking industry?

Put simply, trucks are large motor vehicles designed to carry cargo over long distances. Trucks are broadly classified into three classes, depending on their gross vehicle weight, as shown in the following table:

So while most of us use the generic names, industry experts refer to trucks according to their classes.

While the U.S. boasts some of the biggest truck brands in the world -- think PACCAR's (PCAR +4.91%) Peterbilt and Kenworth, and Navistar International's (NAV +0.00%) International Truck -- European brands, especially Freightliner Trucks (a subsidiary of Daimler AG) and Volvo, have made huge headway in recent years.  For perspective, Daimler and Volvo together dominated nearly 55% of the North American heavy-duty truck market last year according to a Bloomberg report. 

Interestingly, none of these companies rule the global truck market today; in actuality, Chinese manufacturers take the lead. China is currently the world's largest truck market, accounting for nearly half of the heavy-duty trucks sold worldwide.

Now that you know who the biggest truck makers in the world are, you must also understand that trucking is much more than just companies that manufacture and sell trucks.   

Truck manufacturing is only one of the components of the trucking industry. Source: PACCAR

Trucking is a hugely diversified industry, and freight trucking is an even bigger part of the equation than truck manufacturing. Think of companies like United Parcel Service (UPS +2.84%), YRC Worldwide (YRCW 81.82%), and XPO Logistics (XPO +7.14%). The amount of freight that these fleets move around is among the biggest determinants of truck demand. I'll soon tell you how big this part of the industry is -- you'll be amazed.

Another key aspect of the trucking industry is the supply side. After all, trucks can't run without engines, fuel systems, axles, and other critical parts. While companies such as Cummins (CMI +6.64%) and Eaton (ETN +4.43%) supply a wide range of engines and components, Westport Innovations (WPRT 1.04%) and others focus on specific technologies such as natural gas engine platforms.

In a nutshell, you can view the trucking industry from three angles: manufacturing, supply, and services.

How big is the trucking industry?

While that's a difficult question to answer given the diversity of the industry, some facts should help you gauge its size:

• Nearly 2.76 million units of medium- and heavy-duty trucks were sold worldwide in 2013. Frost & Sullivan projects global medium- and heavy-duty truck sales to jump 70% between 2012 and 2022.
• Heavy vehicles are the primary end users of diesel engines. According to Freedonia Group research, the global diesel engine market, now worth $171.5 billion, is pegged to grow at an annual rate of 7.7% through 2017.
• Trucks moved 9.7 billion tons of freight in the U.S. last year. That's a whopping 69.1% of the total freight carried by all modes of transportation. The American Trucking Associations forecasts trucking's share in total freight tonnage to expand to 71.5% by 2025.
• Trucking freight in 2013 generated $682 billion in revenue, or 81% of the total freight revenue in the U.S. last year.

How does the trucking industry work?

While truck and engine manufacturing are capital-intensive industries, transportation companies are service-based and hence more labor-intensive.

Truck and engine companies spend huge amounts of money across their value chains, from research and development to manufacturing to distribution of products. Companies rely heavily on dealership networks for sales, and seasonality isn't much of a concern since demand is primarily driven by economic conditions.

The trucking industry witnessed a phase of consolidation over the past two decades, with big players acquiring rivals to outgrow the competition. Thanks to cyclicality and stiff competition, truck producers have branched out, both geographically and operationally. So nearly every truck manufacturer today offers parts, value-added services like maintenance, and lease financing. In fact, truck rental and leasing is a big market today.

Interestingly, the line between truck and engine manufacturers is also blurring, with most truck manufacturers having vertically integrated to produce their own engines.  That has compelled engine specialists like Cummins to focus more on niche areas such as alternative-fuel engines.

Manpower is a key asset for logistics companies. Source: XPO Logistics.

Services are relatively non-asset-based businesses, as the key to sustainability lies in efficient execution and delivery of customer orders or packages. Logistics and transportation companies operate a mix of leased and purchased vehicles to transport goods.

Some, like XPO Logistics, act only as intermediaries and subcontract transportation services to independent carriers. Therefore manpower is their biggest asset. The level of economic activity directly impacts the service side, and hence the trucking industry.

What are the drivers of the trucking industry?

The trucking industry is highly sensitive to business cycles. It's a simple equation: When the economy grows, and consumer spending and manufacturing activity gather steam, there's a greater need to move goods and haul freight. That means brisk business for logistics companies, and thus greater demand for trucks. That explains why the recession year of 2008 counts among the worst years for the U.S. trucking industry.

Trucking is also one of the most regulated industries: From weight rules and emission standards for vehicles to safety and work hour policies for drivers, companies must comply with strict government rules throughout the value chain.

Emission regulations, in particular, hold great significance. Every time a new emission standard comes into force, truck and engine manufacturers have to upgrade their products accordingly. That's costly, but also mandatory. Likewise, transportation companies scramble to upgrade their fleets to meet emission standards, which is why a new environmental regulation generally means greater business for truck and engine manufacturers.

Cyclicality and its associated volatility may put an investor off trucking stocks, but an industry that virtually runs the economy doesn't stay under the weather for long. And with emission regulations becoming more stringent, this industry looks like a great place for investments.