Ryder System Inc Q2 FY2020 Earnings Call

Good morning, and welcome to the Ryder System Second Quarter 2020 Earnings Release Conference Call. I would now like to introduce Mr. Bob Brunn, Vice President, Investor Relations, Corporate Strategy and Product Strategy for Ryder. Mr. Brunn, you may begin.

Thanks very much. Good morning, and welcome to Ryder's Second Quarter 2020 Earnings Conference Call. I'd like to remind you that during this presentation, you'll hear some forward-looking statements based on management's current expectations and subject to uncertainty and changes in circumstances. Actual results may differ materially due to changes in various factors including economic and regulatory conditions. More detailed information about these factors and a reconciliation of non-GAAP financial measures to the nearest GAAP measure can be found in this morning's earnings release, earnings call presentation, and in Ryder's filings with the Securities and Exchange Commission, available on Ryder's website. Presenting on today's call are Robert Sanchez, Chairman and Chief Executive Officer; and Scott Parker, Executive Vice President and Chief Financial Officer. Additionally, John Diez, President of Global Fleet Management Solutions; and Steve Sensing, President of Global Supply Chain Solutions and Dedicated Transportation are on the call today and available for questions following the presentation. At this time, I'll turn the call over to Robert. Good morning, everyone, and thanks for joining us. Let me start by expressing my hope that you, your family, and friends are safe and healthy during this difficult period. Ryder continues to work closely with our customers to ensure the flow of goods and services throughout the economy, and I am extremely proud of our workforce's performance during this pandemic. On today's call, we'll provide an overview of our second quarter results and the impacts we've seen due to the COVID-19 pandemic. We'll update you on our outlook, our capital allocation priorities, and the actions we're taking to improve returns over time. After our prepared remarks, we'll open the call for questions. Let's now turn to a brief overview of our second quarter results. Operating revenue decreased by 10% to $1.6 billion in the second quarter compared to the prior year, largely due to COVID-related declines in commercial rental and our automotive supply chain business. Comparable earnings per share from continuing operations was a loss of $0.95 in the second quarter, compared to a profit of $1.40 the previous year. Results included $119 million of higher depreciation related to changes in residual value estimates, with $70 million related to previously announced changes, while the remaining impact stemmed from a review of residual value estimates due to COVID-19's projected effect on used vehicle market conditions. This review resulted in increased accelerated end policy depreciation and valuation adjustments totaling $49 million for the quarter, as we now anticipate a delayed recovery of used vehicle market conditions. COVID-19 also had an adverse effect on results of about $45 million, primarily driven by $55 million from lower rental demand and $25 million from decreased automotive customer activity and supply chain, partially offset by COVID-19-related cost savings and lower medical costs totaling $35 million. Additional financial information for the second quarter can be found on page 5. Comparable EBITDA for the quarter was $549 million, down 5% from the prior year, primarily due to lower commercial rental results. The average number of diluted shares outstanding was $52.4 million, down from $52.5 million in the prior year. Excluding pension costs and other items, the comparable tax rate was a benefit of 22.8% in the quarter, compared to an expense of 26.9% in the prior year. The current rate was affected by higher depreciation related to residual value estimate changes and lower expected earnings due to COVID-19. Adjusted return on equity was negative 9.8%, down from a positive 11.9% the previous year, reflecting lower earnings due to higher depreciation and COVID-19 impacts, including reduced rental performance and automotive activity.

I'll turn now to Page 6 to discuss key trends that we saw in each business segment. Fleet Management Solutions operating revenue decreased by 8%, driven by a decline in commercial rental revenue, partially offset by higher choice lease revenue. Rental revenue was down 33% in the quarter, reflecting lower demand due to COVID-19 effects. Rental utilization on power units was 56%, down from 75% in the prior year. Our ending commercial rental fleet declined by 19% compared to the prior year and was down 7% sequentially, reflecting actions to align the rental fleet size with lower expected market demand. ChoiceLease revenue increased 1%, driven by a larger average fleet and higher pricing on new vehicles, partially offset by lower mileage-based revenue. Although our ChoiceLease results have not been materially impacted by COVID-19, we experienced lower sales activity in the quarter, which we expect to continue, reflecting weaker economic conditions. Lower lease sales as well as the redeployment of rental vehicles to fulfill these contracts are expected to result in lower capital expenditures and free cash flow between $1 billion and $1.2 billion in 2020. FMS realized a pretax loss of $104 million, primarily due to $154 million of additional depreciation expense resulting from residual value estimate changes in 2019 and 2020, resulting in a year-over-year earnings impact of $119 million. Rental-related COVID-19 impacts reduced pretax earnings by approximately $55 million. These were partially offset by COVID-related cost savings actions and lower medical costs totaling $20 million. COVID-19 also triggered a review of residual value estimates, resulting in a $49 million additional depreciation and valuation adjustments during the quarter. Based on our view that the recovery in used vehicle pricing will be delayed due to the COVID-19 effects, we primarily extended accelerated depreciation on vehicles expected to be sold by an additional year through mid-2022 and wrote down the values of some inventory held for sale, together resulting in a $31 million impact in the second quarter. In light of COVID-19 effects as well as other factors impacting our longer-term view of used vehicle proceeds, we lowered residual value estimates for trucks and to a much lesser extent, for tractors that we expect to sell after mid-2022. This resulted in $18 million of additional policy depreciation for the quarter.

Thanks, Robert, and good morning. The chart on Page 7 illustrates the level of residual value estimates on trucks for policy depreciation purposes relative to historical sales prices as a percent of their original purchase cost. The anticipated impact of COVID on our outlook for used vehicle market conditions triggered a review of residual value estimates. Based on this review, we lowered estimated residuals for trucks and, to a lesser extent, tractors to reflect our updated outlook. The change in estimated residuals will be recognized through higher depreciation over the remaining life of the vehicles. Based on our revised residuals for policy depreciation purposes, over the next 2 years, we estimate that we need U.S. used vehicle pricing to improve from current levels and achieve an increase of at least approximately 30% for tractors and 10% for trucks in order to maintain current policy depreciation residual estimates. These improved pricing levels are similar to those that we've seen in 2018 and '19 for tractors and are similar to levels seen at the beginning of 2020 for trucks. Moving to the column on the right regarding accelerated depreciation. In the first quarter of 2020, we lowered residual estimates for vehicles we expect to sell by mid-2021 to reflect weaker expected used vehicle conditions as a result of COVID. Residuals for accelerated depreciation purposes were reduced at the time to trough levels and resulted in additional accelerated depreciation. In the second quarter of 2020, we increased accelerated depreciation, primarily by expanding the pool of vehicles requiring accelerated depreciation by 1 year to include vehicles we expect to sell by mid-2022. Management views residual values periodically based on current and expected market conditions. And if management's view of market conditions changes, we may adjust, positively or negatively, residual value estimates. Page 8 details the impact from residual value estimate changes made in the current quarter as well as the combined impact for changes made in the first quarter of 2020 and in 2019 for both policy and accelerated depreciation. As you can see, the estimated earnings headwind is most significant in 2020 and is expected to decline each year thereafter. As shown in the gray box below the chart, the impact from depreciation changes is expected to result in a year-over-year earnings benefit of $250 million in 2021. Please note that if vehicle sales prices come in higher than our new residual values, we would show gains on sale of vehicles on the P&L. I'll hand it back to Robert now to discuss new vehicle sales performance during the quarter.

Thanks, Scott. Page 9 highlights global used vehicle sales results for the quarter. We sold 6,300 used vehicles during the quarter, up 24% versus the prior year and up 15% sequentially. Used vehicle inventory held for sale was 14,000 vehicles at quarter end, up from 8,300 in the prior year and above our target range of 7,000 to 9,000 vehicles. We expect year-end inventory of around 10,000 vehicles. Inventory increased by 2,400 vehicles sequentially, reflecting a greater number of units coming off-lease and downsizing of the rental fleet. Proceeds per vehicle sold were down 33% for tractors and down 9% for trucks compared to a year ago, reflecting continued market weakness. Sequentially, tractor pricing was down 12%, and truck pricing was unchanged. When normalized for age and mileage of the unit, truck pricing in the U.S. was actually up by approximately 9%, which is reflected on the chart in Slide 7, as we sold a higher volume of older trucks in the quarter, which are adjusted for in the calculation on Slide 7. Tractor proceeds in the current quarter were not materially impacted when normalized for age and mileage. Turning to supply chain on Page 10. Operating revenue versus the prior year decreased 16%, primarily reflecting COVID-related volume reductions in the automotive sector. SCS pretax earnings were down 19% due to estimated COVID impacts of $25 million, primarily related to automotive industry production shutdowns, partially offset by COVID-related cost actions and lower medical expense totaling $13 million. Earnings were also negatively impacted by lower residual value estimates on vehicles used in supply chain. These impacts were partially offset by higher pricing and improved operating performance. SCS EBT as a percent of operating revenue was 9.1% for the quarter, consistent with the segment's long-term target of high single digits. Moving to dedicated on Page 11. Operating revenue versus the prior year was down 8%, reflecting lower sales activity. DTS earnings before tax decreased by $6 million, primarily due to a $7 million impact from residual value estimates for vehicles used and dedicated. DTS EBT as a percent of operating revenue was 9.3% for the quarter, consistent with the segment's long-term target of high single digits. I'll turn the call back over to Scott to discuss capital and leverage.

Thanks, Robert. Turning to Page 12. Year-to-date gross capital expenditures were just under $600 million, down nearly $1.7 billion from the prior year. This decrease reflects lower investment in lease and rental vehicles. Weaker economic conditions due to COVID are expected to result in lower lease sales activity and reduced capital spending in 2020. Use of redeployed equipment to fulfill new lease contracts will also result in lower capital expenditures. Our expected range of 2020 gross capital expenditures is now $1 billion to $1.3 billion, below our pre-COVID forecast of $2.1 billion and below prior year of $3.6 billion. We're now expecting free cash flow in 2020 of $1 billion to $1.2 billion, reflecting the countercyclical cash nature of our business model. Proceeds from sales of $218 million were below the prior year, primarily due to a sale of property in 2019 for approximately $40 million. Net capital expenditures decreased by over $1.6 billion to $378 million. Turning to the next page. We generated just over $1.3 billion of total cash for the year, up 1% from the prior year, as higher depreciation and lower working capital needs more than offset lower earnings. Free cash flow was a positive $612 million, up by approximately $1.5 billion from the prior year, reflecting lower capital spending. Debt-to-equity at the end of the second quarter increased to 377% due to lower earnings, reflecting residual value estimate changes and COVID-related impacts. We increased liquidity in response to COVID and are carrying this higher cash balance, which increased the debt-to-equity ratio by approximately 35 percentage points. At this point, I'll turn the call back over to Robert to discuss our outlook as well as provide an update on our actions to increase returns.

Thanks, Scott. Given the uncertainty from COVID-19 and the resulting economic impact, Ryder is not providing financial guidance at this time. We expect to resume issuing guidance when business conditions stabilize. We expect to reduce used vehicle inventory to around 10,000 units at year-end as a result of our initiatives to expand our retail sales capacity and due to fewer rental vehicles expected to be out serviced in the second half of 2020. We will also continue to use the wholesale channel to address used vehicle inventory levels. We were encouraged to see rental utilization improve each month during the quarter from trough levels in April. We expect utilization to continue to improve but remain below typical seasonal levels for the balance of 2020. For every percentage point change in utilization, we estimate a monthly pretax earnings impact of approximately $1 million until the fleet is rightsized to meet market demands. Supply chain activity with automotive customers is expected to be at approximately pre-COVID levels in the third quarter, assuming no additional disruption. The ChoiceLease fleet is expected to be down by approximately 10,000 vehicles in 2020, reflecting customer defleeting and lower sales activity. We've lowered our capital expenditure forecast to $1 billion to $1.3 billion. No material impacts from COVID-19 are expected for ChoiceLease, dedicated or non-automotive supply chain business for the balance of 2020. We continue to expect a comparable tax rate of approximately 20% for full year 2020, reflecting lower earnings due to depreciation and COVID impacts. Slide 16 illustrates our capital allocation strategy. As we discussed, our primary financial focus is on improving returns and reaching our adjusted return on equity target of 15% over the cycle. A disciplined approach to capital allocation plays a critical role in our ability to reach this target. Going forward, our capital allocation strategy is to accelerate growth in our higher return supply chain and dedicated businesses, while moderating growth and improving returns in our capital-intensive FMS business. This strategy is intended to achieve a balance of earnings growth and free cash flow. Increased free cash flow is expected to allow us to pay down debt in order to bring our leverage into our target range, continue to pay our dividend, invest in acquisitions and new innovation initiatives and, over time, allow for discretionary share repurchases. Page 17 shows our primary long-term financial target of 15% ROE over the cycle. Segment operating revenue growth and pretax earnings goals we previously outlined, as they are shown here, are key components to achieving this target. As we've mentioned before, reaching our adjusted ROE of 11% to match our cost of equity is only an interim target. Slide 18 highlights the key drivers for reaching our long-term ROE target of 15%. As illustrated on this chart, we expect to make significant progress towards our ROE target as we anticipate moving past higher levels of depreciation related to residual value estimate changes made in 2019 and 2020. In addition, the cyclical improvement of rental demand and utilization is expected to provide additional support to achieving our target. We expect the diminishing impact from 2019 and 2020 depreciation headwinds combined with the cyclical recovery of rental will increase ROE by between 15 and 18 percentage points over time. The remaining 7 to 10 percentage point improvements needed to reach our ROE target is expected to come primarily from several initiatives, including increasing lease pricing targeted to improve returns; the result of our multiyear maintenance cost initiative, which has been on or ahead of plan since inception; and leveraging secular outsourcing trends to grow our higher return supply chain and dedicated businesses. Turning to Slide 19. While the unprecedented challenges we're currently facing present a setback to earnings in the near term, we're encouraged by the progress we're making on our strategic initiatives to increase returns over time as well as the secular trends that continue to favor logistics and transportation outsourcing. We've taken various actions to support our strategic goals of accelerating growth in our higher return supply chain and dedicated businesses. We're about to launch a national advertising campaign aimed at increasing market awareness of Ryder's broad range of logistics capabilities, including near shoring, e-commerce and transportation services. The campaign will also promote our recently launched visibility and collaboration logistics platform, RyderShare. Our customers are already benefiting from the platform's capabilities to track and manage goods as they move through the supply chain while working together in real time to prevent costly delays and realize efficiency gains. We're encouraged by the continued profitable performance of Ryder Last Mile, which provides home delivery and white glove installation for everything from furniture to large appliances. This business continues to benefit from increasing demand for home delivery. We've increased our outlook for expected pretax earnings as a percent of operating revenue to the high single-digit range for this business, in line with our long-term profitability target for the overall supply chain business. In FMS, we remain focused on actions to increase returns and derisk the business. These initiatives include ChoiceLease price increases resulting in mid-single-digit improvement in revenue per new lease unit compared to the prior year. We are also making important progress on using data analytics to enhance our pricing segmentation and optimize capital allocation. In used vehicle sales, we're on track to expand our retail sales capacity by adding 10 new locations this year. We're also continuing to grow our inside sales capability, including an initiative aimed at getting us closer to used vehicle buyers by leveraging FMS shop locations at customer delivery sites. We're also realizing better leads to sale conversion rates as a result of our digital investment and expansion of our online used vehicle sales capabilities. We're on track to achieve our expected annual savings of $30 million in 2020 from our multiyear maintenance initiative, bringing program-to-date savings to over $50 million. In early April, we took significant action to temporarily furlough employees and reduce discretionary spending. In addition, we incurred lower medical expenses in the quarter. These items resulted in a combined estimated savings of $35 million in the second quarter. We do not anticipate that most of the lower discretionary spending in medical cost benefits will recur going forward. In July, we transitioned from temporary furloughs to permanent headcount reductions, primarily in FMS, which are expected to result in an estimated headcount-related savings of $12 million per quarter. Although we expect the month ahead to be challenging, we believe the pandemic is speeding up trends toward e-commerce fulfillment, final mile delivery of large goods, and the on-shoring and near-shoring of manufacturing and supply chain operations. We see this as a significant opportunity for transportation and logistics outsourcing to Ryder, and we are well-positioned to take advantage of it. That concludes our prepared remarks this morning. Before we proceed to questions, please note that we expect to file our 10-Q later this week. I would also like to mention that based on feedback from our investors, we have added a new disclosure item, selected segment balance sheet items. This is in addition to the segment EBITDA metric we started reporting last quarter. These disclosures aim to provide investors with more transparency regarding segment performance and insights into management's evaluations of such performance. The disclosures and further discussion about them can be found in the appendix of the slide presentation. At this time, I will turn it over to the operator to open the line for questions.

We'll take our first question from Stephanie Benjamin with SunTrust.

I wanted to, I guess, I'm back on to Slide 7 here. And I wanted to clarify just on the depreciation changes. Clearly, there's a lot of positive tailwinds going and strategies in place right now for you guys to improve your ROE. Whether it’s cost savings or a greater focus on your supply chain solutions, but a big part of that step-up does assume that improvement in depreciation. I guess maybe just help us with, I guess, it's the footnote talking about expectations would be for a 30% improvement in tractor and 10% improvement in truck pricing. So what kind of gives you confidence? Why did you choose these levels in 2Q? This is kind of it from a depreciation reduction. Why should we be comfortable, like, going forward we're not going to see another step down? So maybe just through kind of your thought process when making these decisions for 2Q, that would be helpful.

Yes, Stephanie, thank you. I'll let Scott provide more details. Just keep in mind that the policy of residual estimate represents our best prediction of what we believe the long-term sales proceeds will be for these vehicles. It reflects our expectations for their resale value. As you can see on the chart on Page 7, it shows a 22-year historical view of proceeds as a percentage of operating investments, indexed to 1999. Currently, our long-term policy is set close to the low levels we experienced back in 2009. This indicates that we are establishing expectations at historically low levels. I’ll let Scott expand on this.

Yes, Stephanie. Thanks, Robert. What Robert mentioned was that when we project our long-term policy levels, we must consider both historical and prospective data. In the current policy for the second quarter, we incorporated an extended recovery period into 2022 for our sales. This indicates that we expect conditions to remain at levels below the trough. For trucks, the trough occurred in 2009, and our accelerated policy is at or below that level. For tractors, as we noted in the third quarter, the trough was in 2002, and we're also at or below that for tractors. By considering these factors and analyzing the sensitivities, we aimed to provide context around the expected improvement levels. As Robert pointed out, for tractors, we’re looking at levels similar to those of 2018 and 2019. For trucks, we're referring to levels observed at the beginning of the year. This gives you a better understanding of our policy expectations for the next couple of years.

Right. For us to avoid any further policy changes, pricing would need to revert to levels we observed in the past couple of years, particularly for trucks and tractors. It's not a significant shift, but the substantial drop we've seen due to COVID and other factors would need to be addressed for this to occur.

Moving on, we'll go to Todd Fowler with KeyBanc Capital Markets.

Great. So I want to ask a very similar question on Slide 7, but I'm going to ask on the accelerated depreciation side. Understanding that you're accelerating depreciation on vehicles coming off of lease by an extra year into mid-2022, what is your assumption for where those vehicles are being depreciated to? Is that at today's used truck value? Or is there any assumption that used truck pricing is going to improve from where we're at today over the next 1.5 years? And Robert, to your last comment to Stephanie, it's kind of a similar question. What would we need to see to make sure there isn't additional accelerated depreciation going forward?

Okay. Well, Todd, just to be clear, the accelerated is for those vehicles you mentioned that are going to be sold between now and middle of 2022. So we really extended it out. It's basically a 2-year window. Those residuals are set to, I would say, at or below historical trough levels. So we haven't given exactly where that is, but it's lower than where the policy is. So we're assuming that we're going to stay at kind of the levels that we're at now, we're going to stay at those for the next 2 years. If there's any type of recovery, you'll start to see gains, but that's what we've set those at. Scott, is there anything else that you'd add?

No, I think that's clear.

Next, we'll go to Ben Hartford with Baird.

Robert, just interested in your perspective on rental utilization. The improvement through the quarter makes sense. But if we look at some broader spot trucking data points, I mean, the market's firmed up quite a bit. Utilization is still below historical levels, as you said, and you expect it to remain as such in the back half of the year. So with regard to rental utilization, do you think it's more of a demand or a supply issue? And to what extent can you defleet to get back to targeted levels here over the next several quarters, if the demand environment does remain as firm as it has been from a spot perspective?

Yes, that's a good question. Rental serves as our leading indicator of the transportation market. It's the first trucks that return when things slow down and usually the first ones picked up when things pick up again. There have been many idle assets during the COVID-19 shutdown, so getting the essential units of most of our customers operational has been the first step. After that, you'll start to see an increase in rental activity. There is a bit of a lag, which is why utilization is not meeting target levels. John can provide more details about what we observed during the quarter. We did see an increase, but it's starting to level off now. John will give you more insights on that.

Okay. Ben, just to give you a little bit of color of what happened during the quarter. I think your question on demand, specifically what we're seeing in the tractor class, we did see the tractor class similar to the trucks, kind of behaved about the same in April and May. And that with the lockdown, there was not much moving from a rental point of view. So we saw March utilization in the low-60s. April, as we mentioned, was 51%, so low-50s. In May, it ticked up a little bit to 54%. And then when we finished June, we were just above 60%. A good portion of that, you are seeing the tractors come on up. So similar to what you're seeing in the spot market. But I would tell you, we're in July, we're in the mid- to high 60s, and we expect that to level off because that's seasonally what we expect in the third quarter. So we have seen a pickup. We have seen a pickup on the tractor side, driving some of that improvement that I just called out on the utilization front, but we expect that to kind of level off here over the next couple of months.

Yes. I think, Ben, if you see things really pick up in the economy, we don't have any more of these shutdowns as we had, you could get some benefit there more than we expect. It's just difficult to say right now based on what's going on in some parts of the country where you're seeing things begin to slow down a little bit.

That's helpful. And if I could get a quick just follow-up related to that, Robert. There's a lot of ifs around the demand side. What can you do from a supply perspective within that rental fleet to work the denominator down to help improve utilization above and beyond? Any hope on demand remaining stable or even improving from here?

Yes. A key focus has been reallocating vehicles from our rental fleet to lease applications. John and his team performed well this quarter, reducing the fleet by 7%. This was impressive given the overall challenges this quarter with limited activity. Year-over-year, the fleet is down 19%. Continuing to lease from our rental fleet has been a significant factor in this reduction. John, is there anything else you would like to add?

No, I think that's right. I think we're going to continue with our redeployment efforts. We've seen a good amount of acceptance on the part of our lease customers that are looking for a shorter-term flexible equipment. So we've been able to redeploy on-ground equipment for shorter terms at good rates, and we expect that to continue.

I think it's important to note that we believe the worst is behind us in sectors like rental and automotive, as we have seen significant improvement since April, which was particularly challenging. We anticipate this trend of improvement to persist, provided there are no further disruptions and we don't regress. However, it's difficult to predict the exact pace of this improvement, which makes it challenging for us to provide guidance.

And next, we'll go to Scott Group with Wolfe Research.

Can we revisit Slide 7? I'm still feeling quite confused about it. The black line, which I believed represented current used prices, seems to be rising and is above the policy assumptions. Is that correct? I just want to clarify if I'm interpreting this black line correctly.

Yes, Scott, you're right on that one. That's the second quarter, where Robert mentioned the second quarter, we had seen a decline. And in the second quarter, I think John mentioned in the last call that the wholesale market in kind of April and May was very low. So we had a higher than normal level of retail sales in the quarter, which led to the pickup there. And our expectation for the remainder of the year as we kind of go back to normalized levels of retail wholesale mix, given the inventories that we have. That's the assumption.

No. Yes, the black line did increase in the quarter, as Scott mentioned, but this was mainly because the retail wholesale mix for trucks was higher than usual. The wholesale market effectively shut down in April, leading to an increase in retail sales. The good news overall at UBS is that our volumes have been strong, which is a positive sign and could result in potential price increases over time. However, we are not assuming that this trend will continue in our analysis. If pricing were to maintain this trajectory, we would see gains in these figures, although residuals would be lower. What we have done is set our projections lower, assuming that over the next several quarters, pricing will continue this trend but eventually come back down.

I just want to clarify where you would consider the underlying used prices in relation to the blue X. Are you saying that current used prices are approximately 30% below that blue X?

No, not 30%. No, we're saying current used prices are going to be somewhat below that blue X, not 30%.

Okay. Okay. And sorry just...

And when I say current used prices, normalized for normal rental and for normal retail wholesale mix.

Right. Okay. And then just last thing. So let's say, hypothetically, used truck pricing gets 10% better. So it doesn't get 30% better, but it gets 10% better. Will you start reporting gains on sales?

Yes.

I guess how much does used need to improve to start reporting gains on sales?

In order to report gain on sales, Scott, if you're currently looking at, that would be the accelerated pool, like the assets that we're expecting to sell in the next couple of quarters. That level is below the blue X that's on this page. So our residuals that we're setting for accelerated at trough levels. So if pricing came up in the short term, you would see gains on those assets that we're selling currently, if they're up from current levels.

So if we see any improvement in used truck pricing from here, we'll start reporting gains on sales?

Yes, the answer is yes. It's mainly a timing issue related to some of the depreciation. Generally, the answer would be yes.

Next, we'll hear from Brian Ossenbeck with JPMorgan.

I have a follow-up regarding the residual index. I want to clarify that there seems to be a mixed effect not only related to the class and type of trucks but also based on your sales approach. You experienced some shifts in wholesale retail for trucks last quarter, which have now stabilized. As you mentioned earlier, you are increasing your focus on retail channels. I want to know if the projected increases of 10% and 30% mentioned on Slide 7 account for a greater shift toward retail, which could provide a slight advantage, or if that shift is not being factored into your assumptions for the coming years.

Yes. We're not making any assumptions either way. What we're saying is that the overall proceeds will be helped if we sell more vehicles through the retail channel, as that will help us reach our targets more quickly. If we can increase the percentage of vehicles sold through retail, then we wouldn't need to raise retail prices as much because the blended figures would be higher. To clarify, the sensitivity we provided of 30% to 10% is for the long term, specifically over the next two years, where we expect it to increase that much. In the short term, our residual values are currently very close to our pricing and what we are observing in the market. If prices rise, we should start to see gains. However, we are uncertain about this because we have a significant amount of inventory, 14,000 units. We need to sell a lot of vehicles for the remainder of the year, and overall, there are many vehicles in the market. Therefore, we will have to wholesale additional units, which could put pressure on pricing. This is why we have made these assumptions. If market conditions improve, and we continue to see strong volume, we could potentially experience gains.

The other clarification I'd like to make on the chart is that it is normalized for age and mileage. When assessing the impact on the profit and loss statement on a quarterly basis, we need to consider the mix between retail and wholesale, as well as the age and mileage of the units we're selling. This is intended to provide a directional index on market performance. However, quarter-to-quarter results will be influenced by the age and mileage of the units sold, which is factored into our accelerated depreciation.

Got it. Just a quick follow-up for you, Scott, regarding the chart for tractors. It's a bit outdated now, but could you provide some context on its current status? Your understanding is that accelerated depreciation is below residual, which may not have changed much. I'm curious if you've noticed anything that might give more confidence despite last quarter being a bit soft, particularly regarding realized value per tractor. What trends are you observing that support the idea of not needing a significant adjustment on the tractor side?

Yes. I think it's a little bit about what John mentioned. So the second quarter action was predominantly on the truck side. And so on the tractor side, when we picked the action in the third quarter, we mentioned that we were kind of tracking kind of close to the assumptions we made there. So the change really was on the accelerated side. We did do a slight modification on the policy side for tractors. But they have been kind of stable the last couple of quarters.

Our next question comes from Jeff Kauffman with Loop Capital Markets.

I just wanted to ask a detailed question and more of a kind of longer-term outlook question. You mentioned that at the end of the year, you would look to get the ChoiceLease fleet down by 10,000 vehicles. Where are you on the progress of that so far? And can you give us kind of a view of where you think the commercial rental fleet needs to be as we approach year-end? Just trying to get an idea for vehicle accounts through 3Q and 4Q.

Yes. I'll let John give you some color on that. We do expect the ChoiceLease fleet to be down 10,000 units. That's primarily a reflection of our customers defleeting during the softer economic period, and there's definitely been slower sales activity as companies have been kind of holding off to make those types of investments. So that's really the natural flow down of vehicles. And I'll let John give you a little more color. As I mentioned, our rental fleet is already down 19% year-over-year. But I'll let him give you a little more color on the balance of the year. John?

Yes. So looking at the rental fleet, we're down 19%, as we highlighted in the remarks, I would expect that to continue to decline 1 to 2 percentage points sequentially each of the next couple of quarters. So you're probably looking at another 1,000 to 2,000 units in that range as the potential adjustment that we need to make. Obviously, we're going to continue to monitor demand side. And if the demand comes back as we approach the fourth quarter, we may pull back on that. But that's kind of the range that we're looking at right now that's needed.

All right. I want to switch gears. There was an announcement that you had reached an agreement to bring some Workhorse electric step vans into the fleet. I know there's a company, Nikola, that's made a big splash coming public, and you were going to provide maintenance exclusively for those vehicles and then not exclusively. Hey, can we take a step back and kind of give us your view on this emerging alternative power technology and kind of where Ryder's strategy is and what your expectations are for customer demand in those areas?

Sure. I believe we are uniquely positioned to assess the direction of that technology. Moving forward, we can continue to play a key role in supplying our customers with those types of vehicles, thanks to our extensive network and presence in North America. We have been early adopters, engaging with various vehicles and establishing relationships with both start-ups and traditional OEMs. We are seeing progress, and there is significant global investment in research and technology in this area. We have been collaborating with several customers, including Workhorse, which is about to launch a smaller, lighter-duty step van. We think this is where we will first see significant advancements in technology. We are pleased with the progress made, particularly with Workhorse, as we already have some of their vehicles with a leasing customer and are adding newer models to our rental fleet. However, this transition won’t happen overnight; it will be a gradual process, likely starting with lighter-duty vehicles where the technology is more developed.

And next, we'll go to David Ross with Stifel.

I wanted to follow-up on the rental fleet. And with the fleet coming down significantly, utilization is still only being in the 60s. What percentage of your rental business is typically what I would call trade show conference event business because there are no conferences, there are no concerts, there are no stadium events probably happening the rest of this year. So if 10% to 15% of your normal business just doesn't exist until 2021, is that really what we have to prepare for?

Yes. I'll let John provide some insights. While it hasn't been the main factor, it is one of the reasons. John, can you elaborate on the decline by industry type and customer?

Yes. So David, just to address your question. With regards to the event rentals, you're absolutely right. That group or that segment of our customer base has felt the impact and continues to feel the impact. That specific category represents mid-single digits for us in the rental portfolio. I would tell you, I think we have seen the impact across both food and service customers as well as van rental customers, and they're coming back online. The foodservice folks have figured out a way to kind of reinvent themselves and they're coming back online now. And certainly, we expect that to continue to progress. It's going to be a gradual improvement, whereas the events folks, I think it's going to be longer term, as you suggested in your remarks.

And then just quickly on the Ryder Last Mile business. You mentioned that, I guess, maybe due to increased demand, the outlook was raised to a high single-digit margin business. Why the, I guess, more optimistic outlook on profitability, better pricing, change in operations, other?

Yes, David. So we went through some cost control measures back earlier in the year. So I think we're certainly benefiting from that at this point. As Robert said, pipeline is very, very strong. Sales team is really hitting it on all cylinders. So we've got a lot of new business coming into the pipeline and then volume here over the last 3 or 4 months. So this business is all about density. And as we continue to build that density and optimize each one of these trucks, we continue to see that profitability grow. So operations team is executing as well. So just really in a good spot now.

What I would add is that if you look beyond Ryder Last Mile to our entire supply chain business and even our ChoiceLease business, the performance level has remained very high, even during this exceptionally challenging quarter. This highlights the resilience of our contractual business, especially since the headwinds were primarily related to rental and the automotive industry, which experienced a total shutdown—something that was unexpected for an entire industry. These were truly extraordinary circumstances. Additionally, we are still facing challenges with used vehicle values and depreciation. However, if you examine our data, we've adopted a cautious approach regarding residual values, especially considering the impacts of COVID-19. A significant portion of these issues will be resolved this year, with more coming next year, leading to a return to more normalized earnings from this segment of the business. Overall, one should appreciate how well the business performed when excluding those COVID-related factors.

And next, we'll go to Justin Long with Stephens.

Robert, I wanted to take a step back and ask you a bigger picture question. If I think about Ryder, historically, it's been a countercyclical cash flow model. We can see big swings based on where we are in the cycle. Is there a focus on managing the business differently going forward? And instead of having this focus historically that's been on growth, shifting to a strategy that's more focused on maintaining positive cash flow through the cycle? And if the answer to that is yes, would love to know some of the changes you're implementing to incentivize that.

Yes, that's a great question. We included a slide in our presentation discussing our adjustments to the capital allocation strategy, which is our primary focus. Our main objective is to reach a 15% return on equity, and we are concentrating on that goal. Achieving this will require growth, as simply cutting costs won't suffice. We are looking to drive more growth from our supply chain and dedicated businesses, which typically offer a higher return. In our lease business, which requires more capital, we aim to improve returns through price increases, reducing maintenance costs, and finding other efficiencies. This may involve limiting some growth. In recent years, we have had significant capital expenditures and negative free cash flow, which poses challenges for investors. Therefore, we plan to moderate our growth. We are expecting some growth, but certainly not at the levels of 10,000 or 11,000 units that we experienced in previous years. By doing so, we expect to achieve the 15% return on equity while also generating positive free cash flow throughout the cycle. While not every year will necessarily be positive, we are aiming for most to be positive and to avoid the large negative cash flow years we've seen. We have a clear plan to reach these goals, as illustrated in our waterfall chart, and we are making good progress with our initiatives. At the start of this quarter, even before COVID, we believed we could reach our cost of capital by 2022. I still believe, even post-COVID, that we can achieve an 11% cost of capital by that year and potentially even exceed it if conditions are favorable. However, there is still uncertainty ahead. We are focused on resolving much of the depreciation we've been dealing with over the past several quarters to pave the way towards achieving our target return on equity of 15%.

Great. And just a quick follow-up on that. That 15% target, is that a 3-year target, 5-year target? Is there any kind of time frame you can put around it?

No, it's our long-term target over the cycle. Depending on how the economy evolves, we could reach that target sooner or later. However, I believe that by 2022, we should achieve our cost of capital. From that point on, we aim to move into the 15% range. There are many uncertainties between now and then, but considering the depreciation we will overcome this year and next, we expect to make significant progress starting in 2022.

We'll go to David Mack with J. Goldman.

I just want to clarify a few things because the whole discussion about the risk of additional charges has to factor into pricing and then into your 15% returns. What I think I've heard so far is on trucks that you're selling for the next few years, if use values go up, you're going to recognize gains. The confusion seems to be, though, for trucks that you'd be selling beyond that time frame, you need a significant improvement from here in use values in order to not take any charges. One, is that correct? And then if that is correct, how does that factor into your 15% targets? Because if you have to take further charges, I would assume that's going to impact your returns. And additionally, how are you pricing long-term leases with this great uncertainty that you need a 30% move up in use values? I would think that, that has to create a greater residual risk when you're going out into the market pricing leases.

Yes, David, currently used values are at historically low levels. For trucks and tractors, we're seeing values similar to those in 2009 and 2002, respectively. We're anticipating that these values will remain low for the next two years. After that, we expect a modest improvement of about 10% for trucks, which reflects the pricing we saw at the beginning of this year. For tractors, we expect them to stabilize at these low levels for two years before gradually returning to the pricing seen in 2018 and 2019, which was moderate, not peak pricing. In terms of our lease pricing, we are currently at or below those expectations. Just to clarify, we do not believe that these low prices will persist indefinitely; it would be unrealistic to think that. We expect the market to remain cyclical, and after hitting these lows, we anticipate a gradual increase over the next few years.

So just so I understand the volatility news because, really, we've been talking about decline in use values for a number of years now. I'm guessing like 5 years or so. First, it was the ones with the new engines, I guess, the 2012s, and it's it hasn't gotten any better. So is there any risk in your mind that we are in a just a deflationary environment for trucks due to how many trucks were built and potentially greater fuel economy and technological advances that are shortening the period of obsolescence on older equipment?

Yes. If you examine the buyers of the vehicles we sell, such as tractors, we're dealing with vehicles that are typically 7 to 8 years old. The buyers of these vehicles are willing to pay between $20,000 and $25,000 in the current market. This is not the same consumer who can afford a new vehicle priced at $120,000 or a 3-year-old vehicle at $60,000. The buyers for our type of vehicle are usually owner-operators. While fuel efficiency is a consideration, the primary factor is their budget for purchasing a vehicle. Over the past few years, it’s not just the older vehicles that have seen price declines; there has been a decrease in prices for used equipment across the board, which has remained consistent. It reflects the dynamics of any market, governed by supply and demand. When demand increases, often due to a large number of vehicles being sold seven years prior, it creates pressure on pricing. Similarly, an economic downturn also exerts pressure. Conversely, if the economy improves or if supply contracts, we can expect prices to rise. This situation is more about supply and demand than a long-term technological issue.

And just to put a finer point on it. So if we get to a point in 2 years where values haven't gone up and really, if you're saying 30% from $25,000, it's really not a lot of dollars we're talking about here. But if that doesn't happen, is there then risk to that 15%? Or are there offsetting variables that would still allow you to reach that 15%?

Yes. There are always offsetting variables at play. That's what we've been discussing with our various initiatives. We're making significant progress on the $100 million in maintenance initiatives aimed at cost-cutting. There are always other factors within the business that can balance this out, and that’s our focus. If we need to take more actions, we will keep looking for ways to improve and enhance efficiencies in our operations. That’s the core of these initiatives. If you consider the chart we presented during the third quarter call, you might think that with trucks, pricing, and decreasing used vehicle values, there should be pressure on that chart. There is some pressure, but it is countered by better maintenance performance. All our maintenance initiatives are positively influencing that figure. Consequently, the chart remains largely consistent with what we observed in the third quarter. It’s not just a single variable affecting the equation; multiple factors are involved. Used vehicle prices are one variable, but certainly not the only one.

Okay. And this is my last one. And just to hammer this, for the next two years, if use values, and I know there's a mix issue, but for the next two years, if use values do not decline further, you should start recognizing gains. So this discussion that we're going to have and we're going to have again and again over what's going to happen in two years, that's about two years. Anything that you're selling now, if we see any kind of noticeable uptick in use values you should start reporting gains on those units?

Yes, yes. Again, the only other variable is the retail wholesale mix, but as long as there's not a big move there, you're exactly right. Actually, the retail mix moves more towards retail, you can actually get there even without a lot of improvement. But yes, that's a fair assessment.

And our final question will be a follow-up from Stephanie Benjamin with SunTrust.

I wanted to ask if you are experiencing any increased demand for your supply chain or dedicated services due to COVID. Are there customers who have faced significant disruptions in their supply chain? I’m curious if any positive developments have emerged for those specific segments.

Yes. I'll let Steve provide more details on that. However, what is very encouraging for us is that with COVID, there is a renewed focus on supply chains due to the disruptions that occurred in April. I believe that the combination of last year's tariff changes and the current situation with COVID will lead to increased on-shoring and near-shoring activities, and Ryder is primarily focused in North America. Our expertise is concentrated here, which is promising for onshoring and near-shoring, particularly considering our capabilities in Mexico, as well as in the U.S. and Canada. E-commerce is also showing growth, and I think our initiatives related to e-fulfillment and Ryder Last Mile will benefit from this trend. Now, I'll let Steve share what he's hearing and observing from customers in real time.

Yes, Stephanie, it's Steve. Yes, I think just to kind of dig a little bit deeper on the areas that Robert highlighted. Certainly, e-comm is up significantly over the last 2 or 3 months, sequentially quarter-over-quarter and over last year. So seeing a lot of good mix of opportunities there, and volumes continue to increase. So a lot of interest from new and existing customers on that front. We talked a little bit earlier about Last Mile. We expect that to continue to grow and saw quarter-over-quarter versus last year, we were up mid-double digits. So I think that's a good sign. And then with the marketing campaign that Robert talked about that will launch here in the next week or so, we expect that to help build the pipeline. And our pipeline on supply chain is at historical record levels. So that's only going to be more on top and new opportunities that we can grow in. So our team is very excited and focused.

That's why we're launching this national ad campaign as we think it's really a great opportunity for us to get the word out on the capabilities that we have in supply chain and how we can help companies.

I'd like to turn the call back over to Mr. Robert Sanchez for closing remarks.

All right. Thank you. We're a little bit past the top of the hour. So thank you all for joining. And hopefully, you all continue to stay safe, and we look forward to seeing you, if not in person, we'll see you virtually at some of the conferences. Thank you.

That concludes today's conference. Thank you all for your participation.