August 2017

Digging Out of Mid-Decade Hole

Several years of declines brought on by low oil and other commodity prices has dented the heavy equipment market, but the signs point to better days ahead.

By Dan Markham, Senior Editor

Heavy machinery does not turn on a dime. The market for such equipment is experiencing a similar slow course reversal.

The industry has been plagued by three consecutive down years, brought on by across-the-board reduction in commodity prices. The losses should end in 2017, but it will likely be 2018 before the market begins to pick up steam.

“I think you’ll see a flat year, with hopes on the horizon for a little better than that,” says Al Cervero, senior vice president of construction, mining and utility for the Association of Equipment Manufacturers, the Milwaukee-based trade group representing equipment makers.

The recent downturn was pretty much across the board, and global. “You can call it the mid-decade pause, with a modest industrial recession from 2014-16, triggered by the sharp decline in oil,” says Eli Lustgarten, the president of ESL Consultants, St. Louis. “Most markets are seeing it come to an end, or at least becoming stabilized.”

Lustgarten’s forecast for the year is fairly uniform. “When in doubt, pick a market and it will probably be up mid-single digits.”

The 2017 economic performance of the two industry giants reflects both the challenges of the past, and the improving sentiment. “We believe business optimism, which may be contributing to elevated quoting and ordering activity in North America, is partially a reflection of the benefits of pro-business policy in regards to infrastructure and tax reform.

However, we don’t expect to see any meaningful impact from these changes until 2018,” said Caterpillar Inc. CFO and Group President of Finance Services Division Bradley M. Halverson, at the company’s most recent conference call. Cat forecasts sales will be flat to up 5 percent in construction machinery, up 10-15 percent in its resource industries, but flat for its energy and transportation markets.

John Deere’s sales in the first half, which ended May 1, reflect better results globally, but the upturn had yet to hit home. Sales were down 4 percent in North America through the first half.

Still, the two equipment leaders saw strong earnings gains, with Caterpillar’s first-quarter earnings increasing 15 percent to $115 million, while Deere’s first-half gains grew 61.4 percent to $802 million.

“The OEMs have done a good job of belt tightening in a prudent way. And, from a supply and demand perspective, they’ve done a good job restricting their builds,” says Dan DeMare, Western Region sales manager for Heidtman Steel Products, Granite City, Ill.

While the short-term outlook is little more than a reversal of the downturns of the previous three years, the long-term prognosis is much more promising, says Charles Yengst of Yengst Associates, Wilton, Conn. “By the time we hit Conexpo, there was a definite feeling that things were going to get better,” Yengst says of the construction equipment trade show held in March. “I’ve been to that show since the late 1970s, and I’d never seen one so lit up.”

The enthusiasm was driven by numerous factors, including the election of Donald Trump. Anticipated changes in tax policy and regulations, a push toward greater oil exploration and the proposed infrastructure build generated significant goodwill in the sector. Slightly strengthening commodity prices also helped.

“Before 2017, a forecast of flat plus or minus was the optimistic case. With the Trump bump, the change and promise of pro-growth policies, we’ve had a bit of an up-turn industrial markets that has raised the outlook for the year,” says Lustgarten.

However, as the year proceeds and some of the administration’s policy goals remain in limbo, the optimism can waver. Analysts are split on the likelihood the desired changes will be implemented soon.

“Will it all come to pass? I’m pretty sure it will, so I’m holding to what I thought in January and February,” says Yengst.

“Obviously, if we can’t get tax reform through, if we can’t get an infrastructure bill even talked about, then optimism is going to drop. And when optimism drops, the economy drops,” says Cervero.

Though all of the end markets suffered since 2014, agriculture and mining have been the hardest hit. Mining has been soft for the past half-decade, and ag prices trended downward a little after that. Most observers believe the bottom has been hit for both.

“Mining has stabilized and is seeing some improvement in maintenance, repair and overhaul, and we’ve seen some increase in commodity prices, which has helped,” says Lustgarten.

The story is similar for agriculture, though crop levels remain too high to support the pricing improvement that generally spurs spending. “It’s going to take more positive demand on the grain side to get those farmers going again. It usually takes them a while before they’re back into the market for new equipment,” says Yengst.

On the construction side, some increases are expected even if any major infrastructure work isn’t in the cards until 2018 or later. Decent forecasts for residential, nonresidential and some stability on public spending will help.

While heavy equipment was suffering in the mid-decade pause, the same wasn’t true for lighter equipment. “Light equipment you saw holding or expanding. Anything above backhoe loaders, small excavators, wheel loaders, all of it went down,” Yengst says. The smaller equipment market has markedly different drivers than the big stuff, with little reliance on commodity pricing and more driven by replacement and replenishment.

For Heidtman Steel, the strength in the two different markets was evident in the steel they were shipping. “If they’re only consuming the lighter end of the spectrum, ¼-inch stuff, the market strength is in small equipment. When you start seeing 1-inch material orders, that’s when it’s reassuring,” DeMare says. “And we’re starting to see that trend. The OEMS are optimistic about better times ahead.”

A similar story plays out with parts. If Heidtman’s blade manufacturing customers are performing well, it’s a good sign for the light equipment market, while wheel manufacturing strength portends a better outlook for the heavy equipment segment. “That’s how we meter it out,” he says.

The extensive rental segment complicates the market. Yengst says the rental market has also moved toward smaller pieces of equipment, another reason that segment held up well. “We’ve seen the rental side acquiring compact excavators and track loaders instead of backhoe loaders. The equipment is easy to use and easy to transport around, and the contractors like it. They get a lot of mileage out of the small stuff.”

While Trump’s positions are industry-friendly when it comes to taxation and regulations, the heavy equipment market is less aligned with the president on trade. The export market is a strong one for U.S. equipment makers, and threats to NAFTA or retaliatory acts following a significant Section 232 ruling are a significant cause of concern. And, Lustgarten says, changes in trade policy are simply viewed skeptically by most industry players. “There’s a natural fear of trade policies that prevent free trade, because whatever it is, you have to adjust.”

Section 232 could hit the industry hard coming and going, DeMare says. “If you look at the ag segment, 75 percent of their manufactured product is being shipped overseas. They could be impacted by paying a higher price for materials inside the U.S., and face potential trade sanctions for product they’re shipping overseas. It’s a double whammy.”

“I think the big question on a lot of people’s mind is the ‘Buy America’ thing. Our guys have never been supporters of that, because there are a lot of components and specialty things that can’t be sourced very well or very effectively here,” says Cervero. “That will be something to watch.”

On the other hand, many of the largest manufacturers have been moving toward more regional production, serving the North American market from here and Europe from Europe, Lustgarten says. Some of the proposals from the administration are merely pushing the industry in a direction it was already heading.

The industry is also heading toward greater use of telematics and other technologies to drive productivity, with advancements in automation already present in mining and agriculture spreading into other sectors. There is some fear that such a push will result in lower production levels, but that’s not the sense Cervero gets. “Talking to end users, they believe they’ll just be able to do more work. I don’t see it as a negative from the service center perspective.”

“There’s a lot of building uncertainty in an underlying optimistic outlook, with the promise of quite strong gains in 2018 if policy can get its act together,” Lustgarten says.

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Thursday, March 22, 2018