Agriculture, Construction, Mining:
The Good, The Bad, The Ugly
For metals producers and distributors that supply heavy equipment manufacturers, the market is a tale of three sectors with distinctly different story lines.
By Myra Pinkham, Contributing Editor
Agricultural Machinery's a Blockbuster
The bright spot in the heavy equipment market is clearly the agricultural sector, which survived last year’s drought with few ill effects. Whether this strength will continue into next year depends on how the cold, wet planting season affects this fall’s harvest, say the experts.
“Agricultural equipment is holding up pretty well thanks to increased prices of farm commodities,” says consultant Charles Yengst, president of Yengst Associates, Wilton, Conn. “It had been thought that last year’s drought would negatively affect sales, but that didn’t happen.”
In fact, the market actually has benefited from the drought, which effectively reduced supply and raised prices on corn and other grains. Likewise, farmers have seen their income grow. The U.S. Department of Agriculture forecasts farm income to reach $128.2 billion this year—its highest level since 1973.
Some farms were unaffected by the drought conditions, yet still reaped the benefit of the market’s high commodity prices, Yengst says. Most of those whose crops suffered due to the extremely hot and dry conditions were protected by crop insurance and other government assistance. Thus, the large corporate farming operations still had the capital to invest in new equipment.
This has translated into strong sales of farm machinery, particularly tractors and planters, says Michael Williams, vice president of government relations for the North American Equipment Dealers Association in Fenton, Mo.
Sales of farm tractors increased 12.6 percent to 83,561 units in the first five months of this year, up from 74,201 in the same period last year, reports the Association of Equipment Manufacturers in Milwaukee. Year-to-date sales of self-propelled combine sales were up 51.5 percent to 3,664 combines versus 2,418 through May 2012.
This is good news for steel suppliers, says analyst Christopher Plummer, managing director of Metal Strategies Inc., West Chester, Pa., who notes that the average tractor contains about nine tons of steel, including plate, hot-roll, bar and tubing. U.S. steel mill-direct shipments to the agricultural equipment market in the first quarter of 2013 grew by 41.1 percent, versus a 7.4 percent increase in first-quarter 2012. The difference was not all due to increase production of farm equipment, however, but also reflects certain supply chain adjustments, Plummer says.
Future forecasts of ag equipment demand are about as predictable as the weather, Williams says. The cool rainy weather this spring damaged some crops and forced the late planting of others. How that will affect the harvest and grain prices, and ultimately the sales of farm equipment, remains to be seen. Farmers traditionally purchase such machinery as combines and harvesters in August, he adds, so the market will speak soon.
Deere & Co., Moline, Ill., which accounts for about 57 percent of all U.S. agricultural equipment assemblies, forecasts that U.S. farmer cash receipts will be about $388 billion in 2013. While down 3.5 percent from last year on expectations of slightly lower grain prices, that number would still be the second highest total on record.
Demand for agricultural equipment outside of the United States is flat, says analyst Eli Lustgarten, senior vice president of Longbow Securities in Cleveland. Export opportunities for farm equipment, like other yellow goods, have been hampered by a combination of the strengthening U.S. dollar and weaker economic growth overseas.
Nevertheless, Marie Ziegler, Deere’s deputy financial officer, says global fundamentals remain positive. “You continue to see rising demand for food and some increases in consumption of meat. Farmers continue to have very strong balance sheets,” she says. “So we continue to feel very positive about the agricultural equipment outlook and the prospects for the global business.”
“Automated farming is the only way to provide the world with enough food, and U.S. manufacturers are doing very well in positioning themselves in overseas markets,” says consultant Frank Manfredi, president of Manfredi & Associates, Mundelein, Ill.
The strongest increase in tractor demand has been in higher horsepower segments, led by farmers chasing greater capacity, says Richard Tobin, president and chief executive officer of equipment maker CNH Global NV, Lake Forest, Ill. “What they are doing is trading in a lower capacity machine for a higher capacity one and extracting the productivity out of it.”
For 2013 as a whole, Manfredi predicts 4-5 percent growth for agricultural equipment sales, although business could be even better if farm receipts exceed expectations.
Construction Machinery's a Mystery
In 2012, makers of construction equipment ramped up production in anticipation of improving demand. Today, they are dealing with bloated inventories and wondering when construction activity will finally take off in earnest.
Production of major construction equipment, including crawlers, wheel loaders, industrial wheel tractors, skid steer loaders, motor graders and excavators, grew by 11.5 percent last year due to perceived strength in the first quarter, reports Metal Strategies.
“All of the construction equipment manufacturers felt very confident about a year ago,” says Yengst. “They felt demand for their products would just continue to go up, even when they should have realized they were sitting on the edge of the fiscal cliff.” When the economy failed to catch fire, exacerbated by the government sequestration cuts and slowdowns in China and Europe, they tried to apply their brakes. “But you can’t just put the brakes on manufacturing. It takes time,” he adds.
The end result was an inventory buildup that the OEMs have been working down for the past nine months, says Lustgarten at Longbow.
The construction equipment industry is still working to align its production capacity with current demand, admits Tobin at CNH Global. “We’re going to have to be very disciplined about how much product we put into the marketplace because of the weak conditions.”
“It’s been a rough road,” says Keith Rohrbacker, product manager for Kubota Tractor Corp., Torrance, Calif., with demand bouncing up and down. “In 2006, contractors had so much work they didn’t know how to schedule it. No wonder there is so much caution out there now.”
“About the only life in the construction equipment industry currently is the energy sector for shale oil and natural gas,” adds Kim Phelan, executive editor and director of programs for the Associated Equipment Distributors, Oak Brook, Ill.
Market fundamentals suggest OEMs can expect at least some improvement next year. The U.S. housing market, while still 40 percent below its peak, is clearly gaining ground, says Plummer at Metal Strategies. Following a 27 percent improvement last year to about 960,000 units, single-family housing starts grew by another 22 percent year-on-year through April. They are expected to top 1.1 million units this year and could reach 1.45 million in 2014, which should fuel demand for some small to medium-sized construction equipment, say the experts.
Given its traditional one- to two-year lag behind the housing market, nonresidential construction should soon begin to follow suit, says Jeff Simons, vice president of marketing and business development for O’Neal Industries Inc., Birmingham, Ala. Commercial and office building has already risen slightly off of the bottom, he adds, which bodes well for construction equipment sales.
Hampering the recovery for construction equipment is weakness in the export markets, which usually account for 40-55 percent of OEMs’ sales. Exports have been hurt by a combination of weakness in major foreign economies, a strengthening U.S. dollar and EPA Tier IV emissions restrictions due to take effect next year. “They can’t export equipment made here to countries that don’t have low sulfur diesel fuels,” explains Manfredi.
“The OEMs expected exports would recover as the year progressed, but we haven’t seen that yet,” says Jim Hoffman, senior vice president of operations for Los Angeles-based Reliance Steel & Aluminum Co., which serves heavy equipment makers and parts suppliers.
The re-shoring of equipment manufacturing has not occurred as quickly has some had hoped, notes Plummer, and not just for construction equipment but for all yellow goods. Moves in that direction are more a realization by the giant equipment makers that their global supply chains had gotten too extended, Lustgarten says. Rather than re-shoring, they have increased capacity at existing domestic plants to make their production more regionalized.
While some predict a pickup in construction equipment demand in the second half, it is more likely to come in the first half next year, which is the typical peak selling season, says Rohrbacker. “What we are seeing now is more of an atmosphere of caution tinted with hope than one of confidence.”
Phelan at AED says the current air of uncertainty has given a boost to rental demand. Contractors who don’t have a sufficient backlog of projects to justify the large capital investment in new equipment are opting to lease machinery instead. Currently, about 35 percent of equipment produced is sold to rental companies, a figure that could grow to 50 percent of sales in the next few years, Manfredi says.
“Once confidence returns, contractors will probably go back to buying equipment,” Rohrbacker adds. “Boys love their toys.”
Metal Strategies forecasts that domestic shipments of major construction equipment will rise about 1 percent this year. Plummer looks for even greater improvement next year, if OEMs manage to work down their inventory overhang. For their metals suppliers, the long-awaited construction rebound cannot come too soon.
Mining Machinery's a Tragedy
Mining companies have put most purchases of capital equipment on hold and, given coal’s embattled status, are not likely to need much new equipment any time soon. “We definitely have been in a period of slower macroeconomic growth and that has caused the mining industry to hit its brakes,” says Michael Sutherlin, chief executive officer and president of Milwaukee-based Joy Global.
Putting it more succinctly is Hoffman at Reliance. “Demand for mining equipment has been dead for the past year and a half.”
With surplus mine capacity for most commodities putting pressure on mining companies’ prices, margins and cash flow, they are proceeding with new projects very selectively, says Sutherlin. As a result, their spending on mining equipment has fallen by 40 to 50 percent.
Mining equipment maker Caterpillar Inc., Peoria, Ill., had expected to see some improvement as 2013 unfolded, “but unfortunately that hasn’t happened,” says Mike DeWalt, the company’s controller and director of investor relations. Caterpillar forecasts a year for mining trucks comparable to demand in the recessionary year of 2009. “It’s pretty dramatic, what we are seeing right now.”
Such a severe decline goes beyond the usual commodity cyclicality, says the experts, and reflects the trends in the coal market. Nearly half of all the mining equipment produced is used to extract coal.
Structural changes are under way in the power generation market, where utilities are converting plants from coal-burning to natural gas. Increased drilling in the nation’s shale formations has produced an abundance of natural gas, driving the price down and making gas an economical alternative to coal, says Manfredi.
The U.S. coal industry has been hard hit by EPA regulations on utilities aimed at reducing greenhouse gas emissions. Federal environmental restrictions could practically shut down the U.S. thermal coal industry, says Yengst.
Globally, about 358 coal-fired power plants are either under construction or in the planning stage to come on line by 2017. However, the majority of these plants will be built in China and India.
Sutherlin sees promise for equipment purchases by copper miners. With the price of copper at over $3.20 per pound, a number of projects are under way. “Some are moving into the equipment selection phase,” he says.
Lustgarten predicts that equipment investments by coal miners will stabilize next year, though at a low level, and that mining in general will continue to be weak for some time. Not a happy ending for the metal suppliers who serve the makers of these behemoth machines.
Prospects for the U.S. coal market turned slightly more positive recently when natural gas prices rose to around $4 per million BTUs, up from about $2 last year. Joy Global’s Sutherlin says this already has caused some switching back from natural gas to coal for power generation. In fact, he predicts that coal demand for power generation will increase by 60 million to 70 million tons this year, with that improved momentum carrying into next year. There will a considerable lag before this results in increased coal production, given the large coal stockpiles at the utilities, and an even greater lag before it translates into increased demand for mining equipment, he adds.
Weaker global economic growth, especially in China and elsewhere in Asia, also has slowed development of new mines for other metals and minerals, including copper and iron ore. “I see that [mine development] staying at a constant level for a number of years, unless China greatly expands its economy, which is not something I expect to happen,” Manfredi says.