Farm Equipment Market Not All Bad
While it’s certainly not unaffected by the recession, the agriculture market’s fundamentals hold promise for renewed steel sales.
By Myra Pinkham, Contributing Editor
Although demand for agricultural equipment is down somewhat this year, its decline has not been nearly as steep as those in the markets for other types of heavy off-road machinery, such as construction equipment. Good news for steel suppliers, the lion’s share of the farm machinery slump has involved smaller, largely foreign-produced machines (under 100 horsepower two-wheel-drive tractors). Demand for larger, more steel-intensive tractors and combines continues to hold its own compared to record sales levels in 2008. Unfortunately, steel mills are not enjoying the full benefit of this trend yet, as farm equipment makers continue to live off of steel inventories.
According to the Association of Equipment Manufacturers, West Allis, Wis., total U.S. farm tractor sales were down only 22.6 percent year to date through May, compared with the same period a year earlier. Sales of four-wheel drive tractors actually increased 7.7 percent, while sales of self-propelled combines were up 32.7 percent in the same comparison.
Nevertheless, direct shipments to the agricultural machinery sector by U.S. steelmakers were off 71.6 percent in the first quarter of 2009, compared with the first three months of 2008, reports Christopher Plummer, managing director of Metal Strategies Inc., West Chester, Pa. To put this decline in perspective, he notes that it follows a 103.4 percent rise in shipments to that sector in 2008.
Todd Stucke, vice president of professional producers marketing for Agco Corp., Duluth, Ga., says equipment makers stocked up on steel last year as availability tightened at the same time that machine sales reached historical highs. This year, with demand easing by 10 to 20 percent to more normal levels, “we don’t have as much need to buy as much steel, at least in the short term.”
Adding to the weakness in steel demand is a buildup of finished equipment inventories. Rubin McDougal, chief financial officer of CNH Global NV, Burr Ridge, Ill., says he believes it is necessary for both farm and construction equipment makers to reduce their, and their dealers’, inventories before increasing production in the current economic environment. In the first quarter, his company had a 4.3-month supply of tractors in inventory worldwide, up from 3.8 months during the first quarter of 2008. Combine inventories were 4.2 months, compared with 3.5 months a year earlier.
The first quarter has been a transition period, during which the industry has been working on “reducing volumes sufficiently to get our inventories in line so that we are producing closer to retail as we go through the second half,” McDougal says. This is not just true for agriculture equipment, but even more so for construction equipment. “[CNH expects to] under-produce retail by about 8 to 10 percent on the ag side, and by about 45 percent for construction equipment,” he adds.
Equipment makers have scaled back production across the board, but about 80 percent of the layoffs and plant closings have come on the construction side, according to Metal Strategies. “Once inventories are back in line with demand, we will be able to ramp production back up,” Stucke says.
Given the effects of the global recession, credit issues and weak grain exports, makers of tractors and combines are not done adjusting production, says Frank Manfredi, president of Manfredi & Associates, Mundelein, Ill. For example, Agco recently idled one of its tillage factories, while Deere & Co. laid off workers at its Ottumwa and Des Moines Works plants in Iowa.
Sales of farm equipment, especially larger machinery, are clearly outperforming other heavy equipment, says Charles Yengst, president of Yengst Associates, Wilton, Conn. “Construction equipment is in the tank. We will be lucky if it only drops 30 to 40 percent this year.”
Still, agricultural equipment is not immune from the current economic malaise, says Eli Lustgarten, senior vice president of Longbow Securities in Cleveland. Jim Hoffman, senior vice president of operations for Reliance Steel & Aluminum Co. in Los Angeles agrees, noting that with the global financial crisis and the credit crunch “the whole world has frozen up their purchases.”
“Exports, especially to Eastern Europe and Russia, have declined. Credit there has dried up almost completely. That has taken a lot of production out of our North American factories,” Agco’s Stucke adds.
It is unwise to generalize about demand for agricultural equipment, experts warn, as it includes two very different markets, each with very different drivers. “Depending on your niche, you are either going through good times or bad times,” says Greg Embury, vice president of sales and marketing of Kubota Tractor Corp., Torrance, Calif.
By far the biggest category—80 to 90 percent on a unit sales basis—includes small- to medium-sized tractors, two-wheel-drive models under 130 horsepower. Most of these are imported or produced by foreign-owned companies, and are used by homeowners with a few acres, nurseries, garden centers, golf courses and other small businesses rather than large farms.
AEM reports that May sales of under-40-horsepower tractors were down 26.5 percent compared with a year earlier, while sales of 40- to 100-horsepower tractors were down 33.2 percent. According to Embury, these tractors are often purchased by consumers, whose discretionary spending is influenced more by shifts in consumer confidence than capital spending by farmers.
“The American dream is to own 10 acres and a horse. The people who accomplish that are the customers for these tractors,” he says. “This is a cyclical industry. We had a great uptime and now we are having a little downtime, but I think it will start recovering again late in 2010 once the employment situation improves and consumers get past the uncertainty and fear they are feeling right now.”
In contrast, the over-100-horsepower market is driven by the economics of the farm enterprise and is influenced more by shifts in grain prices, which are currently about 50 percent higher than historical levels, Embury says. As a result, 100-plus horsepower two-wheel-drive tractor sales were down only 7.2 percent in May compared with a year earlier. Four-wheel-drive tractor sales were up 21.1 percent, while combine sales were up 43.9 percent, according to AEM figures. Production of these much larger farm machines consumes much more steel per unit than their non-farm counterparts.
“If they expect it will be a good year for corn, farmers will buy tractors and combines, and the last several years have been good years,” Hoffman observes.
But there are signs farm sentiment is moderating. “2009 is a correction year with the market getting back down to a more normal level of activity,” says Agco’s Stucke. “Farmers are conservative by nature, so with all the negative news out there, they are slow to make additional purchases even though most of the farm fundamentals are still strong.”
According to the U.S. Department of Agriculture, net farm income is forecast to be $71.2 billion in 2009, down about 20 percent vs. $89.3 billion in 2008, but still 9 percent above the average $65 billion earned in the previous 10 years.
“Prices of corn, wheat and soybeans went through the roof last year, but this year, due to the recession and other negative news, commodity prices have fallen back a bit,” says Yengst, noting that the price of corn has decreased from around $7 to $3 a bushel and that wheat prices are down as well.
In fact, the USDA says it expects annual receipts from food grains to decline by almost 22 percent in 2009, with much of that decline coming from a 26 percent drop in wheat receipts, including a sizeable drop in U.S. wheat exports. Likewise, corn receipts are expected to fall about 15.6 percent this year, reflecting weaker demand for the grain in ethanol production as well as in export markets.
According to Plummer, there has been a dramatic slowdown in activity and growth rates in the ethanol and biofuels sector since late 2007. Corn used in ethanol and biofuels production in the United States hit approximately 3.7 billion bushels in 2008, an increase of 23 percent vs. 2007. However, the USDA has revised its growth projections for ethanol production in 2009 sharply downward—fully 50 to 100 percent below what was being projected in 2007.
“Ethanol is more of a political than a practical crop,” Lustgarten maintains. “The market has voted that it isn’t interested in it. It is just the politicians that are pushing it.”
Reliance’s Hoffman sees it differently. He says ethanol is a proven commodity. “It works and there is an infrastructure to support it. I would think that the push for ethanol will get hot again as fuel prices increase, as they have started to do in recent weeks.”
Clearly, ethanol continues to be a driving factor in corn production. According to the Renewable Fuels Association’s 2009 Ethanol Industry Outlook Report, the implementation of a new Renewable Fuels Standard calls for the blending of 11.1 billion gallons of ethanol and other biofuels in the U.S. motor fuels market, with the requirement that each gallon of gasoline be 10 percent ethanol. A record 9 billion gallons of ethanol were produced in 2008, and the industry is poised to produce well in excess of 10 billion gallons in 2009, representing nearly 9 percent of America’s gasoline supply.
Calling this a “food for fuel program,” Manfredi is among the many who question the wisdom of promoting ethanol. “It takes a lot of energy to produce ethanol from corn—possibly more energy than you get from the ethanol. With 25 percent of all corn produced being used to produce ethanol, this causes some artificial spikes in demand and in food prices.”
“But in our eyes there is still plenty of corn for food. Farmers will just produce more corn to meet the demand,” Agco’s Stucke maintains. “There also continues to be research on cellulosic (non-grain) biofuels, which could eventually require new types of farm equipment.”
With the recession, and the decline in oil and gasoline prices, much of that research has been put on the backburner, notes Yengst.
Executives at CNH say, while the company anticipates that full-year global agricultural fundamentals will remain solid, “we believe that worldwide industry retail unit sales will continue to be impacted by challenging financial and credit conditions in most regions and that increasing financial uncertainty might cause farmers to further delay or defer purchasing new equipment.”
Banks still are not readily loaning money for tractors and combines, Yengst says. “If farmers aren’t getting loans, they can’t buy equipment. Being conservative by nature, they might be reluctant to make new purchases anyhow. Often they don’t really need new tractors or combines, but might upgrade to more productive equipment if they could get loans to do so.”
Despite all of the stimulus efforts by the federal government, there are few signs that credit is starting to flow more freely,” says John Campo, vice president of sales and marketing for O’Neal Steel Inc., Birmingham, Ala. “There is more willingness on the part of some banks to pay back Troubled Asset Relief Program money earlier, which indicates that they are in better shape than they had been. That’s a positive sign, but it is still tough getting loans, and there are some indications it is even getting tougher. Most of our customers, including some equipment makers, aren’t optimistic that banks will open up their wallets anytime soon. “
However, the credit crunch has had less of an effect on farm machinery than other categories of capital equipment, Manfredi says. “Farmers are largely served by small rural banks that were not involved in the financial maneuvering that led to the financial crisis, so it is a much different lending environment.”
Most farmers have maintained good credit, Embury adds, and major equipment producers have sound and active captive financing arms that are very successful in pushing through equipment loans.
“Long term, the farm market should remain strong given the trend of increased global industrialization and protein consumption,” Manfredi says.
“The world is changing its diet to a more Western diet, including more animal food sources, and the production of animal food sources requires more grain,” Hoffman adds. “As they use more grain, there are more exports of grain and of farm equipment going to the undeveloped and developing world countries. I think this basic structural change will continue to occur.”
While 2009 is shaping up as a down year for farm equipment, Manfredi expects a relatively modest slide, perhaps just 5 to 10 percent. Compared to the 30 to 50 decline projected for construction equipment, makers of ag equipment feel fortunate.
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