Demand for heavy equipment is expected to grow more than 15 percent this year, driving orders for steel and other metals.

By Myra Pinkam,
Contributing Editor

Thanks to a generally strong economy and an even stronger capital goods sector, demand remains healthy for just about every type of heavy equipment—from construction to mining to agricultural—though the growth rate has slowed from last year.

“The economy is the ultimate driver of heavy equipment, and we are just in the middle innings of the economic expansion. The middle innings tend to last for a long time,” says analyst Ken Mayland, president of ClearView Economics LLC, Pepper Pike, Ohio. “Every once in awhile, talk arises that we are in a soft patch, but the economy never moves in a straight line. I think this is just the beginning,” he adds.

More importantly, the investment sectors of the economy are faring better than the consumer sectors, notes Jim Owens, chairman and chief executive officer of Caterpillar Inc., Peoria, Ill. “Business profits in many countries are at, or near, record shares of national incomes, and companies are using profits to boost productivity. Low interest rates are encouraging companies to upgrade and expand aged capital equipment and, more recently, structures,” he says.

Describing it as a “stealth boom,” Mayland notes that capital spending is rising twice as fast as the general economy. “Capital spending is up about 8.5 percent, while overall GDP growth is 3.5 percent. I expect that kind of ratio to persist into 2006.”

So does Robert McCarthy of Robert W. Baird & Co., Chicago. “If growth peters out now, it will be the shortest capital goods recovery in history, and I don’t expect that to happen. Currently, capacity utilization is high, at a range that can support continued levels of investment.”

The unusual length and depth of the last manufacturing recession, which created significant pent-up demand, is still contributing to the rebound in all the different heavy equipment sectors, says Jim Meil, chief economist for Eaton Corp. in Cleveland.

Most construction and agricultural equipment has not been replaced for at least six to 10 years. Companies that held off buying new equipment during the lean years are now eager to spend, he says.

Not only did mining companies decline to invest in new equipment during the past decade, many of them just parked existing equipment as commodity prices headed down, says Kent Henschen, director of marketing and corporate communications for Bucyrus International Inc., Milwaukee.

Overall, demand for heavy equipment is likely to rise 15 to 20 percent this year—healthy growth, though below the 20 to 30 percent realized in 2004, says consultant Frank Manfredi, president of Manfredi & Associates, Mundelein, Ill. By product segment, Manfredi estimates demand for construction equipment will increase 15 to 20 percent this year; farm equipment will grow 8 to 10 percent; and mining equipment, especially big trucks and big shovels, will rise by 20 to 30 percent. Growth in all three segments will be pushed not only by domestic sales, but also by exports and overseas production, he says.

Pushed by the weak U.S. dollar vs. most other currencies, exports of heavy equipment have been on the rise. According to the Association of Equipment Manufacturers in Milwaukee, U.S. exports of agriculture-related machinery increased almost 19 percent in 2004, and exports of construction equipment increased almost 30 percent.

Baird’s McCarthy adds there’s been a significant increase in exports of mining equipment, too, though he could not quantify it. A large portion of the world’s mining equipment is made in the United States.

While current exchange rates give U.S. manufacturers an advantage over European and Japanese equipment suppliers, the Chinese continue to maintain a trade advantage by pegging their yuan to the U.S. dollar—much to the chagrin of many U.S. manufacturers, trade groups and politicians who argue that the policy violates free-trade rules.

Meanwhile, the lines continue to blur as equipment makers in the West move manufacturing operations to low-cost labor markets in Asia and elsewhere.

“They are opening plants in such countries as India and China to supply those countries’ internal needs,” Mayland notes.

Though they have been inching up in recent months, interest rates are still reasonable for buyers looking to finance equipment, says Jim McCullough, president of CNH Construction Equipment North America, Racine, Wis. If rates continue to rise, however, they will eventually dampen demand.

Interest rates are still low by historical standards, Mayland notes. “While the Fed has lifted interest rates eight times so far, they are just where they started at the bottom of the last cycle in 1994,” and do not represent a significant constraint on business. “It is still cheap money,” he maintains. He expects regulators to bump rates up again in July and August, “but after that, the Fed is likely to go to the sidelines. Inflation numbers should start to moderate.”

Heavy equipment sales are doing well in most sectors, though for different reasons, experts explain. For example, construction equipment is in demand due to the boom in residential housing and infrastructure funding. Agricultural and mining equipment are benefiting from improved commodity prices in their respective markets.

“We are encouraged by the fundamental strength of the key markets we serve,” says Caterpillar’s Owens. “Mining companies will continue to add capacity to meet anticipated growth in demand for the next several years. Global demand for energy, including coal, as well as oil and gas, is growing. Likewise commercial construction and housing in most countries will create even further demand.”

Demand for light equipment, generally used to support residential construction, is up 12.5 percent this year, while heavy equipment, used in road building, is up 9.3 percent, says McCullough. “Construction equipment is very, very strong for both light and heavy equipment. The pace of demand during the last two years is quicker than anyone thought it would be,” he adds, due to the surprisingly strong housing market, rebounding nonresidential construction, and in anticipation of a new, expanded federal transportation infrastructure bill.

In 2004, purchases of some capital equipment spiked by over 50 percent, largely due to federal tax incentives that expired at the end of last year. While that level of growth is unlikely to continue, demand should remain strong in light of the stable economy and consumer confidence, says Charles Yengst, president of Yengst Associates, Wilton, Conn.

Housing, commercial building trends
“Housing starts are continuing to set records,” despite all the predictions that the bubble is about to burst, observes Keith Rohrbacker, product manager for construction equipment at Kubota Tractor Corp., Torrance, Calif.

Statistics from the U.S. Commerce Department show that sales of newly built single-family homes hit a seasonally adjusted 2.009 million units in May—a new record. “The drive for home ownership is as strong, or stronger, than ever and builders don’t see this demand diminishing anytime soon,” states David Wilson, president of the National Association of Home Builders.

McCullough notes that this trend has been helped along by growth in “sunshine state” construction, as baby boomers build retirement homes in the South and Southwest.

Meanwhile, the long-awaited rebound in nonresidential construction has finally begun, with commercial construction up 3.8 percent, office construction up 1.8 percent and manufacturing construction up 1.3 percent in April.

“The hardest hit area of the economy during the past four years has been nonresidential construction. It has been the last to recover, but it’s now showing some clear signs of coming back to life,” Mayland says.

Analyst Christopher Plummer, managing director of Metal Strategies Inc., West Chester, Pa., estimates that nonresidential construction demand will increase 5 to 7 percent this year, and be even stronger next year.

Given how far it has declined, nonresidential construction has a long way to go to recover, adds Mayland. “As it does, it should breathe a second wind into the economic recovery.”

Public construction of buildings and highways is also accelerating as state and local government budgets feel the benefits of the country’s economic expansion.

On the federal level, industry is anxiously waiting for Congress to reauthorize the infrastructure spending bill. The $219 billion TEA-21 (Transportation Equity Act for the 21st Century) expired Sept. 3, 2003, but current project funding has been kept alive by a series of extensions. Congress is reportedly very close to passing its successor legislation, TEA-LU (Transportation Equity Act: A Legacy for Users), which is expected to provide between $284 billion and $295 billion in highway funding over a six-year period. The House and the Senate have passed separate versions of the legislation, which is in conference committee.

One question remaining is whether President Bush will veto the legislation, as he has threatened, if the spending level is higher than $284 billion. Congress was expected to pass a final bill last month, as the seventh and final extension to TEA-21 was due to expire June 30.

McCullough predicts the legislation will not have immediate impact, as much of the work for the season has already been contracted. Yengst maintains that the highway bill really hasn’t affected machinery sales much in the past. Mayland, however, feels it could add “new lifeblood to highway construction.”

Mining, oil & gas
With every sector of the mining and oil exploration industries strong due to high commodity prices, production of mining equipment is at its best level in years. Producers of mining equipment are not only building new equipment, but selling more parts and maintenance products as well, says Henschen of Bucyrus International. “Companies are not just bringing back parked equipment, but improving the machinery.”

Due to extended lead times—some stretching out to 2007—much of the new mining equipment is not in the field yet. At Bucyrus, for example, lead times are extended 15 to 20 percent. The equipment maker expects its sales to top $550 million this year, up from $454 million last year and $337 million in 2003.

“It appears [the market] will stay strong for a while,” Henschen says. “It doesn’t seem as if demand from China and India is going to ease any time soon, although it might stabilize some.”

Demand for agricultural equipment has been holding steady this year, up 5 to 7 percent from the strong gains made last year, says Jim Sharp, president of the North American agricultural business of CNH North America. Ag equipment shipments increased 16 percent last year, according to Metal Strategies.

“Farmers had an excellent year last year as far as income, due to crop prices and government support,” says Sharp. “This year won’t be quite as good, but it will be close. Crop prices have come down 20 to 25 percent in many cases, but government support should be continuing.”

Agricultural equipment shipments are already quite high. Plummer notes that last year the industry shipped about 165,000 units, which is an all-time record, so any increase means the industry will see another record year.

Molly Dye, vice president of corporate communications for Agco Corp., Duluth, Ga., explains that the agricultural equipment market tends to run in seven-year cycles with the current uptick starting late in 2001. “So we can expect a few more years of flat to slightly positive growth in North America.”

The market has been bolstered further by a number of economic and social factors, McCarthy notes, such as growing global economies, more protein consumption in third-world countries, and increased mechanization and commercialization in emerging markets.

Some clouds are visible on the horizon, however, most notably issues surrounding the new farm bill due in 2007, Sharp says. In particular, the Bush administration would like a reduction in subsidies. “It isn’t by any means settled or final, but the uncertainty is weighing on people’s minds.”

The irony in iron ore
As all heavy equipment tends to be very steel intensive, questions about the cost and availability of steel are of concern among equipment makers. Last year, when the steel supply was particularly tight, mining equipment producers faced a Catch-22, Henschen observes.

“We build equipment to get iron ore out of the ground; meanwhile we weren’t able to get enough of the steel that iron ore was used to make.” Some heavy equipment makers still report occasional difficulty getting steel and other raw materials.

Perhaps the larger issue has been increased raw material costs cutting into profit margins. Luckily, Mayland says, companies have been able to raise their prices a bit in the current business environment, unlike in the 1990s when their margins were cut “razor thin.” Still, Sharp notes, margins declined last year “and now everyone is playing catch-up to get paid for costs.”

He remains hopeful that equipment makers’ margins will stabilize or even improve a little for the remainder of this year, making 2005 another positive year for heavy equipment sales.

“Revenues are up, and profit margins should be up as well due to price increases,” McCarthy says. “I’m assuming that the market won’t peak until sometime in 2006.”