Special Report: EQUIPMENT’S BRAVE NEW WORLD

|  March 03, 2011 |

Where we are, how we got here and what happens next.

by Kirk Landers, editor emeritus, Better Roads

 

A recovery is coming for the U.S. construction industry. It will be long and slow. It will be different than other recoveries. And it will require planning. Even in the early stages, it is likely to be marked by shortages of low-hour used equipment, rising prices for fuel and steel, and possibly long lead times for some new machines and replacement parts. This special report addresses those challenges and discusses ways contractors can adjust their equipment acquisition strategies for 2011 to meet long-term as well as short-term needs. In addition, we look at eight major equipment types, detailing market fluctuations and what to expect next.

ALSO IN THIS REPORT

Backhoes: Contractors extend trade-in times, rely on used equipment

page 12

Wheel loaders: New units counted for just one in four machines financed in 2010

page 14

Skid steers: Tracked machines are now getting a larger piece of the pie

page 16

Excavators: Excavators remain solid players

for 2011

page 18

Compact excavators: Manufacturers are starting to see upticks in sales

page 20

Dozers: Overseas buyers snap up used machines, causing prices to rise

page 22

Graders: Used units continue to dominate the financed market

page 24

Double-drum compactors: Technology boosts turnover rates

page 26

 

Charles Dickens might aptly describe the first 11 years of the 21st century as the best of times and the worst of times, and thousands of construction contractors would agree.

The century opened with a mild and short recession, skyrocketed to giddy heights featuring a torrid housing market and the appearance of easy wealth in financial circles, then crashed with a sickening thud when a cyclical recession burst the housing bubble and led to financial market failures that nearly collapsed the economy.

Few contractors and even fewer economists would argue the recession that began in 2008 has been the worst economic period in the United States since the Great Depression. Indeed, many are referring to our times as the Great Recession.

In this difficult period, the traditional annual forecast is of limited value in the construction industry. The economic debate for 2011 is about small degrees of change compared to 2010. For executives who manage their construction businesses and fleets strategically, the bigger questions take a longer-term view: When will this recession end? How will it end? And, what long-term equipment management strategies and tactics does this scenario suggest?

Supplies of new and used iron and components will tend to tighten as the recovery spreads, creating price and lead time pressures

To answer those questions, at least in part, the editors of Equipment World, Better Roads and Aggregates Manager have collaborated with the research analysts of Equipment Data Associates to examine the economic and equipment market trends of our times, from the dawn of the new millennium to today, and what these trends portend for the next several years.

Equipment sales and the economy

Construction equipment sales don’t exactly follow the rise and fall in gross domestic product, but new machine sales in particular dramatically portray the highs and lows in the nation’s economy.

The charts in this special report trace trends in the financed sales of new and used equipment. The data comes from Equipment Data Associates, which maintains a constantly updated database of sales involving financing. While some firms, especially very large ones, do not finance their acquisitions, the EDA data represents anywhere from 30 percent to 80 percent of all new unit sales in any given equipment category, making it a reliable reflection of the market as a whole.

The data for the major construction equipment categories shows that the mild, cyclical recession of the early 2000s resulted in financed sales averaging 56,700 new units from 2000 to 2003. Sales of these machines recovered to 75,000 units in 2004, and topped out at around 91,000 units in the bubble years of 2005 and 2006. As the U.S. economy slowed in 2007, sales receded again, dropping below 51,000 new units in 2008—about what you would expect in a normal, cyclical recession.

But what might have been a normal recession was severely complicated by the crises in the financial and housing markets, and the financed sales of the top 20 categories of new machines dropped to about 17,000 units last year, creating a market about one-sixth the size of the peak market in 2005.

While these numbers may not surprise anyone, they tell a deeper story. Since today’s new machines are the main source of high quality, low hour machines in three to five years, new machine sales are an almost unerring forecaster of the used machine markets of the future. The moribund sales of the past three years portend a weak used equipment market in the offing – most likely during the recovery years which are expected in mid-decade.

Further support for that scenario comes from the data for financed sales of used equipment. Financed sales of used equipment typically outstrip new financed sales by anywhere from 10,000 to 30,000 units a year – the exception being the robust economic growth years of 2004-2007. The high volume of the used market reflects the fact that construction machines have long lifecycles and many are sold multiple times in their service lives.

What has changed in the Great Recession years is the degree of difference between new and used sales. While the financed sales of used machines have declined sharply since 2008, the decline is much less severe than for new machines. Whereas new machine sales are usually 60 percent to 80 percent of used sales, in 2009 used machine sales were more than double new machine sales. And last year, financed sales of used machines were more than three times higher than those for new machines.

The implication of the data – and anecdotal evidence from the field – suggests that the current supply of high quality, low hour used machines is being consumed at a prodigious rate, even in these hard times. Add to that the fact that only a tiny number of new machines are being sold into the market, and the likelihood of a short supply of low-hour used iron in the recovery becomes even stronger.

For contractors in equipment intensive businesses, the distinct possibility of a limited used-machine market during the recovery demands strategic planning for how – and when – to acquire the machine hours necessary to capitalize on new opportunities.

All markets are local

Although national economic and construction trends get the most headlines, the United States economy is a complex tapestry of rural counties and scores of medium and large cities. One result of this is that not all segments of the economy are down or up at any given time. Another is that the economic recovery will occur unevenly, with some areas growing before others.

The graph plotting financed new equipment sales by region on page 7 shows how much variability there can be between regions. During the peak years of 2005 and 2006, the South Atlantic region soared much higher in equipment demand than any of the other regions. Comprised of many of the nation’s fastest growing cities and counties, from Florida to Maryland, South Atlantic consumption of new equipment was actually twice as high as the next largest region in the banner year of 2005. Since housing construction drove many of the region’s construction markets, the South Atlantic was especially hard hit by the collapse of the housing market in 2008 and may lag behind other regions in recovery due to the size of its inventory of unsold houses.

More recently, another aspect of the local/regional nature of markets is the relatively strong demand for compact machinery in America’s north central agricultural regions. The northern plains states that comprise the West North Central region are known more for cold winters and vast expanses of corn, soybeans, wheat and other cash crops than for consumption of construction equipment. But one of the bright spots of the current recession is global demand for those very foods, and agri-companies in the upper Midwest are buying significant numbers of skid steer loaders and other compact machines to sustain their high volume operations.

Similarly, demand for some construction machinery is much higher in the West South Central region – especially Texas – where energy production is stimulating economic growth and jobs.

Equipment demand rises with local economies, so in a recovery, construction companies should anticipate growth in local markets and be aware of trends in other regions. Supplies of new and used iron and components will tend to tighten as the recovery spreads, creating price and lead time pressures. The affects are often felt more in the areas where the recovery comes last than in those that lead the curve.

Employment as indicator

Anticipating an economic recovery is tricky even in a mild recession and the current economic condition presents epic complexities. There is no shortage of doom and gloom forecasts, especially in the popular media, where a constant focus on housing foreclosures, record numbers of unsold homes, weak employment and fears of financial market aftershocks weave a tapestry of fear.

Alternatively, construction economists who forecast general economic and construction market trends take a far more measured – and pragmatic – view of the current situation.

As a practical matter, the U.S. economy is very large and extremely diverse. It can be deeply bruised by economic setbacks as large in scope as the financial and housing crises, but it won’t be broken by them. It will begin a cyclical growth curve eventually – the question is only when, not if.

“Each recession is like a child,” says Ed Sullivan, chief economist for the Portland Cement Association. “They each have their own personality and their own special problems.” Sullivan acknowledges that this downturn is especially severe because of how out of balance we were at the peak when a strong economy was pushed to giddy heights by the housing bubble and the credit binge, among other factors.

Sullivan expects slow growth in the U.S gross domestic product in 2011 and 2012 – 2.5 percent to 3.5 percent – and stronger growth in 2013. His forecast is based on the expectation that the U.S. will add 1.5 million new jobs in 2011, and 2 million more in 2012. If his employment forecast is correct, Sullivan thinks construction markets will begin experiencing modest growth in 2012.

Kenneth Simonson, chief economist for the Associated General Contractors of America, also predicts overall economic growth of about 2.5 percent this year, and 3 percent in 2012.

Simonson expects the recovery to be broad based with gradual growth in many industries and sectors rather than with one or two segments of the economy leading the way.

The AGC economist says the overall construction market should grow about 5 percent in 2011, including a 5 percent to 10 percent increase in residential construction, led by a rebound in the multifamily rental market. He also anticipates growth in hospitals, hotels and warehouse construction this year, with a surge in manufacturing and university construction starting late in the year. Infrastructure work should remain strong through most of 2011, then decline in 2012 as stimulus, base realignment and Gulf Coast restoration funds expire.

Looking at just the transportation building market, Alison Black, vice president of policy and senior economist for the American Road and Transportation Builders Association, estimates that highway and bridge construction declined about 3 percent last year and expects another 4.4 percent decline in 2011. Like AGC’s Simonson, she bases her forecast on the fading influence of federal stimulus dollars, chronic revenue problems at the state and local level, and the lingering uncertainty over the federal transportation program.

Anticipating opportunity

“I expect the recovery to start in the center,” says PCA’s Sullivan, referring to the central United States. “These states didn’t have the huge housing boom we saw on the coasts, and they have strength in agriculture and energy, which are strong markets right now.” Sullivan thinks the two coasts and southwestern states like Arizona and Nevada will lag behind other areas as they work through large housing inventories and other ramifications from the collapse of the bubble economy.

AGC’s Simonson cites Texas as a likely growth area, and Nevada as a state that will struggle with large inventories of available housing and commercial properties. He adds that the metropolitan Washington, D.C., market, which has been outperforming most of the country, is likely to recede to average or even subpar growth in the months to come as federal government spending is expected to decline.

Planning for growth

While mainstream economists see growth ahead for the U.S. economy, no one sees a scorching growth cycle on the horizon.

“I think the United States is in for a long period of slow and variable growth,” says Simonson, echoing a widely held vision in economic circles. “Construction will lag behind the rest of the economy because there will be less demand than last decade for owner-occupied housing, retail or public construction.”

Even with a gradual recovery foreshadowed by rising trends in employment and the general economy, construction firm owners who have successfully downsized for the current market will be wise to contemplate strategies for the recovery.

Recessions, PCA’s Sullivan says, create pent up demand, which fuels growth when a recovery takes place. In equipment-intensive construction vocations, one of the areas of pent up demand in a recovery cycle is new and low-hour used machinery. Inevitably, lead times and prices for new machines rise, demand for rental machines drives higher rental rates, and contractors in strengthening markets scramble to acquire the equipment they need to bid on or fulfill contracts.

The supply of new and high-quality used equipment in the next recovery promises to be tighter than in previous recoveries. In addition to a shortage of quality used iron, lead times for new equipment orders are likely to grow due to spreading global demand for construction machinery.

Economists point out that developing countries like China and India are leading the global recovery with strong growth cycles already under way, while the developed economies of North America, Europe and Japan are expected to begin recovering over the next several years. This means that global demand for construction equipment will be at a high level just as demand is ratcheting upward in U.S. construction markets. Thus, international manufacturers of components and whole machines may have a hard time keeping up with demand.

Knowing that growing markets will present their own unique challenges, construction executives would do well to think about business management strategies to prepare for that reality. For example, as early signs of a recovery begin to appear, a fleet manager might begin projecting machine availability three to five years out as part of machine purchase metrics to make sure the company has the iron it needs when the market is strong. Such consideration could favor the acquisition of a new or premium priced low-hour machine instead of a bargain-priced unit with two or three seasons of life-expectancy left on its major components and systems.

Construction executives should also monitor market indicators beyond contract activity. Signs of a tightening equipment market can occur even in a region with a slow construction market, so firms should closely monitor machine availability and pricing from key distributors and rental dealers whether they are in the market for a machine or not.

In addition to monitoring the usual economic indicators, company leaders need to keep an eye on local and national employment trends, the international trading value of the U.S. dollar, and legislation at the federal and state level that affects transportation funding. While expectations for a new federal transportation program are currently grim, a significant initiative at the state or federal level would create a surge in demand for new and used equipment that would affect prices and availability even for construction firms not engaged in transportation work.

What other strategies U.S. contractors pursue as the economic recovery takes hold in the construction industry remains to be seen. What is clear now is that recovery will come, it will be a far more complex business climate than we have seen in any recovery in the past, and it will reward those who understand and prepare for the challenges it brings.

Gear up for a changing market

Several market forces may affect the recovery:

Equipment buyers from abroad will be shopping North America for high-value used machinery, driving up prices, especially if the U.S. dollar is weak.

Prices for steel, petroleum and other commodities will begin rising rapidly as the world’s major economies enter a period of simultaneous growth. This raises the specter of higher machine prices, fuel and higher transportation costs.

The availability of rental machines is likely to tighten, especially in the early stages of recovery.

U.S. Tier 4 engines are coming on stream and they are bringing sharply higher prices for new iron. Interim emissions being used in 2011 and 2012 are expected to have a modest affect on pricing, but when Tier 4 Final engines become law in 2014, whole machine prices could increase by as much as 10 or 12 percent.

Credit still competitive

One thing that is not likely to be a problem in the foreseeable future is the availability of equipment financing.

The precipitous drop in capital available following the collapse of major financial institutions in 2008 has largely been corrected, says John Crum, national sales manager for Wells Fargo Equipment Finance, the country’s largest non-captive construction equipment financer in 2010.

“I think lenders have instituted more self examination since that time,” says Crum, referring to the financial crisis. “But our credit underwriting standards haven’t changed. We have a better understanding of our borrowers’ businesses now, but our expectations for the customer’s performance have not changed significantly.”

Crum says people who run a good business and pay their bills are still desirable credit customers in financial circles. “We have people pounding the street every day for new customers, and so do our competitors,” he points out.

Perhaps the biggest change in today’s credit market compared to the past two decades actually favors the borrower, says Crum. “The borrower has a much greater ability to compare rates and terms today,” he points out. “It’s a competitive market. I can’t remember the last deal where we didn’t have competition for the business.”

Crum expects an increase of at least 10 percent in financed new and used construction equipment sales this year and something similar in 2012. “I think the weight has shifted to optimism, especially among equipment dealers,” he says. As a part of that, he thinks lead times for new equipment will grow this year, and limited supplies of low-hour used machines will cause prices to rise.

Top 10 Equipment Lenders

Lender Year 2010

Caterpillar Financial Services 13,996

John Deere Industrial Credit 9,563

Wells Fargo Equipment Finance 3,902

CNH Capital America 3,879

GE Capital Commercial 2,957

Komatsu Financial 2,506

1st National Bank 2,305

Farm Credit Services 2,115

Kubota Credit 1,711

Wagner Equipment 1,544

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