Despite a slowing economy and some sluggishness in the
agriculture sector, prospects for heavy equipment production—
and steel demand—remain promising.

By Myra Pinkham,
Contributing Editor

Sidebars and Tables:

• NAFTA Construction and Farm Vehicle Output
• Agricultural Equipment

Production of heavy equipment has been strong for the past two and a half years both in North America and worldwide and is expected to remain robust for some time, promising healthy demand for steel.

“The market could hit a little speed bump later this year, but the expansion still has years to run,” says Ken Mayland, president of ClearView Economics LLC, Pepper Pike, Ohio, calling the sluggishness that could come later this year “more the pause to refresh us” than a downturn in the market.

“Demand for construction and mining equipment in particular has been phenomenal, with most predictions for this year calling for increases in the 20 to 30 percent range,” says Frank Manfredi, president of Manfredi & Associates, Mundelein, Ill., and publisher of the Machinery Outlook newsletter. Demand for material handling equipment has also been quite strong, he adds.

“Agricultural equipment, however, is on a different set of sheet music,” says Charles Yengst, president of Yengst Associates, Wilton, Conn., with sales projected to decline in 2006. He expects ag equipment sales to remain relatively high, however, in historical terms, and to pick up again in the next year or two, fueled by the call for ethanol (which is made from corn) and other biofuels needed to lessen America’s dependence on foreign oil.

Demand for agricultural equipment peaked in 2004 with some slippage in 2005 and a relatively steady decline this year, says Randy Baker, senior vice president of logistics and supply chain for CNH Global NV, Lake Forest, Ill.

Predictions by industry observers for 2006 range from flat sales to declines as high as 8 percent. Much of the slippage is in the high-power cash crop area, he adds.

“[Ag equipment] is still a very positive market for the most part,” says Randy Hoffman, senior vice president of global sales and marketing for Agco Corp., Duluth, Ga., which produces the Challenger line of agricultural equipment. Depending on the specific type of machinery, however, the outlook can be a mixed bag.

The Association of Equipment Manufacturers, West Allis, Wis., expects the overall market for tractors and combines to trend down this year after two years of historically high sales. This despite the fact that during the first five months of 2006, total U.S. tractor unit sales were up 1.6 percent while U.S. sales of self-propelled combines were up 3.6 percent (see chart). At the same time, however, sales of two-wheel-drive tractors with 100 horsepower or more were down 10.9 percent while four-wheel-drive tractors were down 15 percent.

Demand for farm equipment tends to track with commodity prices. The more money farmers make, the more likely they are to invest in new machinery, experts note. The prices of corn, soybeans and wheat have been flat or declined in the past 18 months, and that trend is expected to continue. For the 2006-07 season, the U.S. Department of Agriculture projects wheat production to decrease 11 percent to 1.9 billion bushels, corn production to decline 5 percent to 10.6 billion bushels and soybean production to dip 3.9 percent to 2.9 billion bushels.

Such declines in farm output, while enough to make some nervous, are not that severe, says Hoffman. The ag business remains reasonably strong, especially when compared with production levels three to four years ago. The bigger concern is the increased costs farmers are facing, such as rising prices for fuel and fertilizer.

Farmers have already purchased a lot of equipment in the past few years. Rising interest rates that have increased their cost of acquisition are having a further dampening effect on future purchases, says Eli Lustgarten, senior analyst for Longbow Securities, Independence, Ohio.

Looking long term, prospects for ag equipment production are bullish. “Prosperity in China, India and certain other countries translates into people eating more and better foods, which increases the demand for agricultural products,” Mayland says. That should translate into higher commodity prices and more capital for farmers to invest. As long as gasoline prices stay high, Hoffman adds, there will be increased interest in the use of corn to produce ethanol.

According to the Renewable Fuels Association in Washington, D.C., the U.S. currently has the capacity to produce 4.3 billion gallons of ethanol annually.

Capacity for an additional 2 billion gallons a year is currently under construction. While still a relatively small factor in both the grain and fuel markets, ethanol production could eventually consume a large volume of corn, says Baker at CNH. Biodiesel made from soybean oil also could eventually be very beneficial, but it has been much slower to take off, he adds.

On the other end of the spectrum from the moderating agricultural equipment market is mining equipment, which is booming along with demand for ores, oil and gas, and oil sands exploration, says Mayland. “With copper approaching $4 a pound and oil over $70 a barrel, there will be a tremendous surge of equipment to exploit these big prices.”

“We are in the initial stage of a prolonged boom that some analysts say could last for 10 years,” agrees Kent Henschen, director of marketing and corporate communications for Bucyrus International Inc. in Milwaukee.

James Meil, chief economist for Eaton Corp. in Cleveland, Ohio, says the pickup in demand for mining equipment began about two and a half years ago, and not just for new machinery, but also for parts and components for old equipment. Not only are mined commodity prices high, Meil says, but mining companies are experiencing their best profits in over 20 years. “They are more confident that prices will remain high for at least the next year or year and a half. It seems as if we are in a new age of high commodity prices. If that pricing environment is sustained, then mining machinery will continue to do well.”

Manfredi estimates that demand for mining equipment will increase 30 to 35 percent this year, while demand for other forms of heavy equipment will grow 5 to 10 percent.

Construction equipment is another very strong performer, according to Christopher Plummer, managing director of Metal Strategies Inc., West Chester, Pa. Demand for construction equipment in first-quarter 2006 increased 26 percent vs. first-quarter 2005, following a 46 percent increase for full-year 2005 vs. 2004. Even through residential construction is starting to show some signs of weakness, both nonresidential and public works construction remain quite strong, he adds.

New-home construction was strong until a few months ago, Manfredi notes, and still isn’t doing badly. Annualized housing starts are hovering around 1.8 million nationwide, down only slightly from record levels near 2 million in the past few years.

However modest, this weakening has already had an impact on the compact construction equipment market, reports Keith Rohrbacker, product manager for construction equipment at Kubota Inc., Torrance, Calif. “Our business is about 75 percent residential, so we are very concerned that the residential sector might slow,” he says. Some of the recent softening may reflect equipment dealers working down inventories. “Demand for our product seems to be cooling off some, but it isn’t cold my any means. We are still experiencing double-digit growth,” he adds.

Though light construction may have seen its best days in the first quarter, heavy construction rolls on due to the resurgence of nonresidential projects, the strengthening of highway funding and the rebuilding of the hurricane-damaged Gulf region, says Lustgarten.

“Even now a lot of equipment is being used in the Gulf to clean up the damage,” says Bill Jones, president of O’Neal Steel Inc., Birmingham, Ala. “And there will be need for a lot more equipment when the rebuilding begins.”

With U.S. nonresidential construction in the first quarter increasing about 11.3 percent from the fourth quarter of 2005, that should more than make up for any weakness in residential construction, says Plummer. “The nonresidential sector really started to kick in during the last 12 months or so, and we see growth there continuing possibly for the next couple of years.”

Since a lot more heavy equipment is used for nonresidential construction than in residential projects, this trend holds promise for production of larger, heavier types of machinery—and thus greater demand for steel plate, bar and coil.

Likewise, nonresidential construction has lifted demand for construction cranes, says Steve Khail, director of investor relations and corporate communications for The Manitowoc Co. Inc., Manitowoc, Wis. Thanks to the new federal energy bill, which will fund construction of new nuclear plants, the crane niche is likely to get a further boost.

The newly reauthorized federal highway bill has had a similarly positive effect on cranes as well as most other segments of the construction equipment market, says AEM Chairman Charles Stamp, given that the building and repair of highways, bridges and other public infrastructure is a significant component of overall construction activity. “The challenge now is that individual states might not have the ability to match the modest federal increase, which might limit new contracts and slow down business. With higher oil and gasoline prices, some are calling for money to be diverted away from highway needs into general taxpayer relief,” Stamp notes.

Spending varies widely from state to state, as each apportions the available dollars differently for equipment vs. concrete, asphalt and other materials, depending on the type of projects in the works. Jeff McPherson, vice president of sales for Ranger Steel Supply LP, Houston, notes that road building, and therefore road building equipment investment, is particularly strong in Texas and Florida.

O’Neal’s Jones notes that the material handling sector, including fork trucks, conveyors and overhead cranes, has been strong since 2003. “With demand up, a lot of goods need to be moved,” he says. “Companies are prospering and trying to increase their capacity, and one way to do that is to increase their use of forklifts,” Manfredi agrees. In fact, he says, waning demand for material handling equipment tends to be a leading indicator of a slowdown in the economy, “but we haven’t seen that yet.”

Jeff Allinder, chief operating officer of West Central Steel Inc., Willman, Minn., questions whether certain equipment producers have pulled forward some steel purchasing due to fear of possible shortages of discrete plate and flat-roll and the accompanying price increases. In general, though, most companies don’t seem concerned about raw material availability. “Steel has stabilized. It isn’t the same issue it was 18 to 20 months ago,” Khail says.

Looking forward, heavy equipment makers are at least guardedly optimistic about the next few years. “All in all, conditions are good,” Meil says. “But in the world of rising interest rates and rising commodity prices, there are increased concerns that some headwinds could slow key industrial markets come year end.”

While it is prudent to expect some sluggishness later this year, it doesn’t appear to be the beginning of a prolonged downturn, asserts Mayland, who predicts the market is just taking a little breather before going back into a growth mode. “I think the recovery has a few years yet. It will last into 2008 and possibly into 2010.”