High Hopes for Heavy Equipment
Weak demand and excessive destocking created a difficult environment for heavy machinery manufacturers and their suppliers in 2009. But inventory replenishment and an improving economy promise modest gains in consumption of metals by equipment makers in the coming year.
By Dan Markham, Senior Editor
The three major sectors of heavy equipment— agriculture, construction and mining—are in various stages of recovery, but all are starting to benefit from a slowly improving economy. The inventory drawdowns of last year have set the stage for some significant buildup in second-half 2010 and 2011, say the experts.
|While small machinery remains impacted by the residential market, larger farm equipment is in heavy demand as most commodity prices have been strong. (Photo courtesy Massey Ferguson/Agco.)
Equipment buyers were cautious in 2009 in the face of the ongoing recession, tight credit and paltry housing starts, among other economic factors. Many of the leading equipment makers made the tough decision to dramatically curtail production. As a result, supply is no longer far outpacing demand.
“There was a major inventory reduction across all three of the big sectors,” says analyst Christopher Plummer, managing director of Metal Strategies Inc., West Chester, Pa. “Inventory was a major factor going down last year and going up in the first half of this year.”
In late 2008, Caterpillar had a three-year backlog of orders for new mining trucks. Rather than produce unneeded equipment after the economy crashed, it allowed skittish customers and dealers to cancel their orders. The company’s willingness to bite the bullet last year is already starting to pay off, says Frank Manfredi of Manfredi and Associates, Mundelein, Ill., who publishes Machinery Outlook newsletter. “They were aggressive about reducing the flow of goods into the market and maintaining the health of their dealer network,” he says. “Through the first quarter, their results look pretty good. A lot of that was due to inventory rebuilding.”
The same rebuilding is going on in the construction machinery field, says analyst Eli Lustgarten of Longbow Research, Cleveland. “The bullwhip effect is most evident in the construction equipment industry.”
Equipment manufacturers slashed production in 2009 by as much as 50 percent and shipments to dealers by 75 percent. So far this year, end-market sales are up in the single digits, but production is up 15 to 25 percent and purchases from suppliers are up 40 to 50 percent, he says, as vendors rebuild finished-goods inventories ahead of the economic recovery.
While most are in an inventory-replenishment mode, equipment makers face much different markets for the rest of 2010 and into 2011.
Agriculture: modest gains
For the agricultural machinery industry, gains may be modest this year, experts say, in part because its losses were the most moderate in the past year.
“Ag, relative to construction and mining, has been stable the last four to five years, with whipsawing more muted,” says James Meil, economist for the Eaton Corp., Cleveland. “The percent changes and the sense of turnaround are not as profound as in construction because the recession wasn’t as bad for agriculture.”
Through the first four months of 2010, farm equipment production has increased at about a 10 percent clip and is expected to continue to increase at a single-digit rate for the balance of the year, Manfredi says. Of course, there will be some greater fluctuation within the individual markets.
Small horsepower tractors, those most closely tied to the residential market, are unlikely to enjoy much gain this year. Larger farm equipment is in a far better position.
“We’ve found the industry is virtually on the verge of being sold out for the year on big equipment,” says Lustgarten. “It’s a combination of somewhat better prices and a lot of chatter about the impact of the emissions [regulations] in the off-the-road sector driving up prices.”
Todd Stucke, general marketing manager of Agco, Duluth, Ga., says his company has seen positive demand for its larger tractors and combines, a byproduct of the good prices farmers are receiving for most commodities. The exception is for its commercial hay equipment, where potential purchasers are suffering from soft dairy prices.
Whatever short-term issues face the agriculture industry, the longer-term outlook is exceedingly positive, for three reasons, Stucke says. He points to worldwide population growth and the need to feed it. On top of that, arable land continues to be taken out of production, requiring greater and greater yields from the land still in use.
The other factor is agriculture’s increasing role in not just feeding the world, but fueling it. Existing ethanol production and biomass fuel technologies in development are creating new opportunities for machinery makers.
Stucke says his company is following the advancements and beginning to engage in R&D, but must wait to see which direction the market takes. “We don’t know which way biomass is going to go. In the Midwest, it’s corn, corn cobs and corn fodder. In the South, it’s switchgrass. We’re kind of dabbling in all of them.”
There is one sizable concern on the horizon for the ag industry: Interim Tier 4 emissions regulations due to take effect at year’s end. Under Tier 4 regulations, companies must produce new engines with advanced emission-control technologies similar to those for trucks and buses, decreasing exhaust emissions by more than 90 percent. Such technology is more costly.
While equipment makers may see some additional late-year demand ahead of the new air-quality regs, as customers seek to buy the cheaper engines, the long-term effect on sales is uncertain. “It has taken a lot of our engineering and resource dollars to meet our emissions compliance, but there are worries the industry may fall flat on its face. Is the retail customer going to buy into it?” Stucke asks.
Construction: more disappointment
Unlike the ag market, the residential and commercial construction markets are coming off a dismal 2009 and continue to face a strong economic headwind. Public spending propped up the market, though the impact of the American Recovery and Reinvestment Act was disappointing to most.
Housing starts are expected to increase in 2010, though not in line with earlier optimism. Some forecasts originally called for as many as one million new home starts this year, a number later revised to 800,000, and more recently to 700,000. “The market remains in a challenged position when you don’t have a new-home-buyers program motivating demand,” says Meil. “The housing sector will probably remain weak for the next four to six quarters, and that translates into a tough story for light construction equipment.”
While 700,000 housing starts represents a substantial improvement, especially compared to year’s past, it’s a far cry from nearly 1.8 million homes at the market’s peak in 2006. “We’re seeing home sales improve, and permits are up quite a bit. There are a lot of positive signs. But we’re so far in the hole, it’s going to take awhile,” Manfredi says.
The hole may be even deeper for nonresidential construction, which entered its downturn long after the residential market began to slide and is still searching for the bottom. “There’s still some distress to be felt there by the mortgage market,” Manfredi says. “A lot of these projects were funded, but don’t have permanent financing.”
Lustgarten forecasts single-digit declines in the nonresidential market for 2010, with expectations for a modest recovery in 2011.
Offsetting the nonresidential sector’s struggles will be the public sector, which figures to benefit more from ARRA money than it did in 2010. While some public works projects were completed in 2009, many were just repavings of road surfaces, which require less heavy machinery. This year, more ambitious infrastructure projects such as road building and airport development are likely to spur the need for heavy equipment.
Yet whatever effect the stimulus has, many in the sector are unsatisfied with the federal government’s commitment to the nation’s infrastructure. “Especially critical for the construction equipment industry is timely passage of multiyear federal transportation legislation,” says Dennis Slater, president of the Association of Equipment Manufacturers, Milwaukee, Wis. “The stimulus package of last year is a short-term fix and doesn’t tackle the underlying problem. A fully funded, long-term bill will significantly increase highway and transit investment and result in real and long-lasting stimulus.”
Mining: greater stability
The mining sector is looking considerably healthier, as the unpredictability of 2008 fades further in the rearview mirror. Two years ago, prices for virtually every raw material took a wild ride, with most moving from a normal price range at the start of the year, spiking to record highs in the summer, then falling precipitously.
Even as pricing stabilized in the fall of 2009, the larger mining companies remained cautious on their equipment buys, determined to see if the commodity markets were truly over their dangerous volatility.
“It’s fair to say that investment did not explode out of the blocks even when pricing recovered in the fall of 2009,” Meil says. “Delaying operators from rolling out their capital spending plans were memories of prices all over the map in 2008. They didn’t want to put a lot of equipment in place and all of a sudden see copper go down to $1.75 per pound.”
That attitude has changed, particularly as the economies of developing countries have begun to recover at quicker rates than those of Western Europe and the United States.
“The fundamentals in global mining remain very strong,” said Joy Global President and CEO Mike Sutherland during the Milwaukee-based equipment company’s quarterly report last month. “Mines are running at a high level of capacity utilization, and the economic and inventory cycles in the industrialized countries are progressing, padding high levels of demand from the emerging markets.”
Unlike some other industries, those in emerging economies must turn to North America to satisfy their appetites for crucial raw materials. Strong demand for metallurgical coal from China, India and other countries is helping U.S. producers find new customers, Sutherland said.
Crude steel production worldwide is expected to increase by 15 percent this year, with China up 10 percent and the rest of the world improving by 25 percent. “That’s helping the U.S. and Canada, which are significant coal exporters,” Plummer says.
The domestic mining industry is facing some concerns, however. The recent deaths of mineworkers in West Virginia and safety issues in other North American mines, coupled with uncertainty over the general direction of the nation’s energy policy, may curtail growth in mining, Lustgarten says.
But the makers of mining and other types of equipment are not reliant on domestic demand alone. The export market comprises a significant percentage of the customer base for all large equipment companies. The technological advantages of U.S. companies, combined with a still-weak U.S. dollar, makes American-made equipment a competitive choice on the world market.
Europe’s recent economic calamities and the corresponding weakening of the euro do threaten some of that U.S. advantage. “[The exchange rate] will stimulate the export competitiveness of European suppliers to some degree, at the expense of domestic suppliers,” Lustgarten says. “It’s not going to be a dramatic shift, but it does help the Germans, the UK and the French.”
Meil says domestic manufacturers shouldn’t be too worried about customers suddenly fleeing U.S. companies for European manufacturers. It takes time to change major supply agreements. “Businesses don’t move on that kind of production location decision overnight.”
On the other hand, America’s leading heavy equipment manufacturer is demonstrating its faith in the long-term competitiveness of U.S. industry with two recent announcements. Caterpillar will invest $700 million, initially at its Aurora, Ill., facility, to produce a full range of mining shovels. The company is also contemplating the shift of excavator production from Japan to the United States.
“Companies across the board in all markets are showing they are willing and able to make investments here,” Plummer says. “It shows the U.S. is still viewed as a competitive market.”