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July 2014
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Big Pickup in Construction Shines Bright for Steel

The long-awaited resurgence of construction activity is a positive development for makers of off-road equipment and their metals suppliers.

By Myra Pinkham, Contributing Editor

Construction equipment is currently the shining star in the off-road heavy equipment sector, forecast to see significant growth this year and next. In sharp contrast, mining equipment is stuck in a black hole it may not emerge from for years.

The strength in demand for construction equipment is directly related to the double-digit surge in homebuilding the past two years. The National Association of Home Builders forecasts an additional 12 percent increase in residential construction in 2014.

Still, the construction market’s recovery has a long way to go, notes Christopher Plummer, managing director at Metal Strategies Inc., West Chester, Pa. Even at 1 million units per year, housing starts remain 40 percent below a normalized level of 1.6 million, a rate not likely until 2016 or 2017.

Nonresidential construction, which has bounced along the bottom for the last several years, is widely expected to gain some traction as the new housing attracts more retail and commercial development. Experts predict a 5 percent improvement in nonresidential projects this year, and even greater growth in 2015 and 2016.

Heavy equipment demand at some OEMs has grown at even greater rates than construction. In its recent conference call, Caterpillar Inc. reported a 20 percent improvement in its first-quarter construction equipment sales worldwide, including a 36 percent gain in North America, compared with first-quarter 2013. Michael DeWalt, vice president of strategic services at Peoria, Ill.-based Caterpillar, notes that the equipment giant’s first-quarter sales increase included a rebuilding of dealer inventories. For 2014 as a whole, the company is predicting growth closer to 10 percent.

This despite the extreme winter weather conditions in many regions that affected durable goods orders early in the year. Mark Eisinger, an economist for IHS Inc.’s pricing and purchasing service, expects spending on construction, and therefore construction equipment, to show further gains once the second-quarter data is tallied.

The U.S. Census Bureau's latest report paints a generally positive picture of the U.S. construction market. Seasonally adjusted put-in-place construction spending was up 8.6 percent year-on-year in April, including a 17 percent increase in private residential spending, a 5.6 percent increase in private nonresidential spending, and a 1.2 percent increase in public construction spending.

The improving economy and surging construction activity have also given a boost to equipment rentals, says Tom Gelston, vice president of investor relations for Terex Corp., Westport, Conn. Large rental companies are broadening their purchases to include even more large earthmoving equipment.

In fact, rental companies are now responsible for at least half of all construction equipment purchases, up from 30-35 percent just a few years ago, says Frank Manfredi, president of Manfredi & Associates, Mundelein, Ill. That suggests many contractors are still hesitant to make major investments in new capital equipment for fear the construction rebound will prove unsustainable.

Ross Conroy, head of direct digital marketing for the Equipment Data Associates division of Randall-Reilly, Tuscaloosa, Ala., says some equipment dealers are offering customers innovative financing options, such as long-term rentals or rent-to-own agreements, to help ease the risk. This contributed to a 27.8 percent increase in financed equipment purchases in the first four months of this year.

Charles Yengst, president of Yengst Associates, Wilton, Conn., doubts renting will be a long-term trend. On the whole, contractors would rather own their own equipment. Ownership has tax benefits and is usually cheaper in the long run. “I think once contractors have more money in their pockets and gain confidence in a sustained recovery, they will look to buy their own equipment once again,” he says.

According to Metal Strategies, production of large construction vehicles in North America will increase about 5 percent this year, to around 156,800 units, followed by another 5 percent gain next year. That should translate into a comparable increase in sales of metal products to the sector, especially steel plate, and cold-roll and galvanized coil.

Demand for construction equipment would be considerably better if the government could agree on how to fund the nation’s much-needed infrastructure improvements, says Jim Hoffman, senior vice president of operations for Reliance Steel & Aluminum Co. in Los Angeles. He is among the many calling for Congress to pass a comprehensive, long-term highway bill. Meanwhile, the debate continues over how to pay for new roads and bridges, as gains in vehicle fuel efficiency continue to shrink proceeds from the federal gasoline tax. The federal highway trust fund is expected to run out of money this summer.

Since the last comprehensive surface transportation bill expired in 2009, funding for infrastructure construction has been allocated through a series of 10 short-term extensions, followed by passage of a two-year bill in June 2012 that is set to expire at the end of September. "Multi-year investment would provide the certainty necessary to allow state departments of transportation to participate in large scale infrastructure construction planning," says Dick Teets, chief operating officer of Steel Dynamics Inc., Fort Wayne, Ind.

Congress currently is considering several proposals for multi-year reauthorization of the highway bill, but without agreement on a new funding mechanism passage is unlikely, says Eli Lustgarten, senior vice president of Longbow Securities in Cleveland. He expects lawmakers to pass another continuing resolution, and borrow money from the general fund, to temporarily replenish the highway trust fund.

Mining equipment's black hole
Demand for equipment used in the mining of oil and natural gas is strong in the shale plays across North America, but the much larger mineral mining sector has seen much better days. “Mining equipment is really taking it under the chin, with mine operators being adversely affected by weak mineral commodity prices,” says Manfredi.

The coal industry, which uses 25-30 percent of all mining equipment, has been especially hard hit by environmental concerns and new EPA rules calling for reductions in emissions from coal-fired power plants. Nearly 70 percent of the nation’s electricity is now produced by burning coal, but that percentage is likely to decline as utilities invest in alternative sources, such as natural gas, wind and solar, say the experts.

The new EPA regulations are a continuation of the already ongoing war on coal and will put even more pressure on the already struggling mining industry, says Lustgarten. Feeling the heat from shareholders as profits decline, CEOs at leading international mining companies are looking for ways to cut costs. As part of these cost reduction moves, not only are companies holding back on expanding their mining capacity but are limiting their purchases of mining equipment.

Slowing growth in China and other emerging markets has contributed to the growing overcapacity in the mining sector, says Eisinger. This has weakened commodity mineral prices since the second quarter of 2013, adding urgency to the mining companies’ focus on cost reduction rather than production.

While global commodity prices remain at multiyear lows, Joy Global President and CEO Ted Doheny is cautiously optimistic that economic recovery around the world will improve heavy-equipment demand in the second half. DeWalt, at Caterpillar, has a similar take. He expects mining equipment orders at his company to be modestly better in the second half.

What does all this mean to the metals industry? Industrial equipment, including heavy machinery and many other types of equipment, accounts for 15-25 percent of all the steel used in the United States each year, making it the third largest consumer of steel behind automotive and construction. In total, production of construction and ag equipment each consume about 1.8 million tons of steel annually, estimates Metal Strategies. If the post-recession construction recovery is finally here, that’s good news for steel producers and distributors.

Bloom's Off Farm Equipment

After what has been a good run, the farm equipment market appears to be taking a breather. Steel suppliers are likely to feel the brunt of the slowdown, particularly as demand for larger tractors and combines is even weaker than that for smaller equipment.

Deere & Co. predicts demand for agricultural equipment will decline 5-10 percent this year in the United States and Canada, 10 percent in South America and 5 percent in the Eurozone. It expects a slight year-on-year improvement in Asia.

While a number of factors are contributing to the anticipated decline in U.S. farm equipment sales this year, perhaps the biggest influence was the “bumper crop” for grains, particularly corn, last year, says John Anton, director of the steel service at IHS Inc.

Not only did that big crop result in lower farm commodity prices, therefore lower farm income, but the expiration of certain tax write-offs last year makes it less economical for farmers to purchase new equipment, says Eli Lustgarten, senior vice president of Longbow Securities in Cleveland.

The long, harsh winter is not a factor, notes Charles Yengst, president of Yengst Associates, Wilton, Conn. While some farmers were a little late with their planting, those crops are now growing well.

“When farmers make money they spend it. When they don’t, they hold off,” says Frank Manfredi, president of Manfredi & Associates, Mundelein, Ill. This year they aren’t expected to make as much money. The U.S. Department of Agriculture’s Economic Research Center forecasts that net farm income will only reach $95.8 billion in 2014. That would be a 26.6 percent decline from last year’s $130.5 billion, and the lowest total since 2010.

Metal Strategies Inc., West Chester, Pa., reports that U.S. farm equipment production through May declined 2.5 percent from the first five months last year. Even more troubling for metals suppliers, the larger, more steel-intensive equipment has seen even greater declines, says Christopher Plummer, Metal Strategies managing director. Combine production, for example, is down 24.2 percent, and four-wheel-drive tractors are off 14.9 percent. The farm equipment turnover rate also has slowed, he adds, indicating that farmers are using equipment longer and being more cautious in their capital investment.

Others are relatively unconcerned, taking a more long-term view. Jim Hoffman, senior vice president of operations for Reliance Steel & Aluminum Co., Los Angeles, believes it is only a matter of time before demand recovers. Global market dynamics, including dietary changes in the developing world, favor greater grain production. People in third-world countries want to eat more meat like Americans, which will require more cattle, and more cattle feed.

When that recovery occurs largely depends on crop yields, Lustgarten says. "That is in the hands of God."



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