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Times may get tougher for heavy equipment manufacturers

Keywords: Tags  heavy equipment manufacturers, O’Neal Industries Inc., Jeff Simons, Deere & Co., Caterpillar Inc., Douglas R. Oberhelman, Mike DeWalt, Terex Corp. Dean Barley

A combination of declining export opportunities and excessive inventories could result in somewhat lower growth in 2013 than in the past few years for U.S. heavy equipment manufacturers. Just how much lower, however, depends on the type of equipment, with agricultural holding up well despite last year’s drought but construction and mining experiencing difficulty.

Such an outlook follows a somewhat schizophrenic 2012--one that Jeff Simons, vice president of marketing and business development at Birmingham, Ala.-based O’Neal Industries Inc., called “a tale of two halves,” with manufacturers of all types of yellow goods “hitting it out of the park” early in the year. While shipment levels didn’t quite match those prior to the recession, they were quite strong.

“After a great first half, the economies around the world began to slow around mid-year, and as a result dealer sales to end-users began to flatten out,” Mike DeWalt, corporate controller and director of investor relations at Peoria, Ill.-based Caterpillar Inc., recently told investors. “We found ourselves with inventory that was too high, and our dealers also found themselves with too much inventory. As a result, dealers slowed orders, and in the third quarter we began the process of scaling back production.”

Caterpillar was not alone in seeing a buildup in heavy equipment inventory. Marie Ziegler, deputy financial officer at Deere & Co., Moline, Ill., told investors that Deere also has been “really tweaking” its inventories, especially on the construction side.

This isn’t surprising. “Whenever there’s economic uncertainty, it can have a negative impact on the market,” Dean Barley, vice president and general manager of the construction Americas and global aftermarket division of Terex Corp., Westport, Conn., told AMM. He said this is especially true when the economy is stabilizing and in a fragile recovery mode after digging itself out of a deep recession.

The fourth quarter of last year was especially tough for the heavy equipment sector, with some of that weakness spilling over into the first part of 2013, according to Eli S. Lustgarten, senior vice president of Longbow Securities LLC, Cleveland. While an inventory liquidation continues, the current market is an improvement over the fourth quarter of 2012, with some strength in sales but a lag in production, he said. “On the whole, 2013 will be a transition year, with the performance in the heavy goods sector likely to be flat to modestly down, partly because of slower economic growth but also because of global politics.”

Exports have a major impact on how well the heavy equipment sector performs because about 45 percent of all North American heavy equipment was exported in the last couple of years, Christopher Plummer, managing director of Metal Strategies Inc., West Chester, Pa., said. “That is one reason why (heavy equipment manufacturers’) inventories had built up so much. It is the worldwide effect--the slowing of economic growth in China, the European recession, and the weak economies in Brazil and India, as well as the softening of economic activity in the United States.”

Because of continued destocking, Plummer said that overall the first half of 2013 could be weaker than the first half of 2012 for yellow goods, both in North America and worldwide. “But as I believe that the inventory problem will largely be cleared out by the second quarter, growth should accelerate in the second half, resulting in an average of 5-percent year-on-year growth in 2013,” he said.

Agricultural equipment is holding up especially well due to high commodity prices, according to Charles Yengst, president of Yengst Associates Inc., Wilton, Conn. “These are the type of times that farmers love.”

Deere has estimated that the price of corn will be $7 per bushel in 2012-13, up from $6.22 in 2011-12, while wheat will increase to $8 per bushel from $7.24 and soybeans to $14 per bushel from $12.50.

Yengst said this has resulted in stronger income for farmers, which is a big factor in their decision to purchase tractors and combines. And while it was expected that last year’s drought would hurt farmers, it hasn’t been the case. He said that some farms were unaffected by the drought, so they benefited from the resulting crop shortage which forced prices up, and those farmers who were affected received insurance payments or other help from the government and still managed.

Certain demographics--specifically, the growing middle class in many developing nations--continue to be factors in the sale of agricultural equipment: The more meat they eat, the more feed that is needed for livestock.

On the flip side, Plummer said that of all the heavy equipment sectors, mining equipment has been the most affected by what is happening elsewhere in the world, especially in China and Europe.

“We had very large orders for mining equipment throughout much of 2011 and through almost the entire first half of 2012. But that’s when the sentiment changed,” Caterpillar chairman and chief executive officer Douglas R. Oberhelman said. While orders on hand remained quite significant, the softening of the Chinese economy over the past six months has led to customers easing off on orders, he said. “It did start to pick up a little bit late in the fourth quarter, but it’s not what we’d consider to be at a sustainable level.”

Overall, coal mining--and, to a lesser degree, iron ore mining--has been extremely soft in North America, Lustgarten said, with certain companies holding off on a number of projects as the mining industry enters a transition period.

Simons said that demand for thermal coal in particular has been hit hard by environmental concerns, as well as the Obama administration’s push for alternative energy sources.

Michael W. Sutherlin, president and chief executive officer of Joy Global Inc. and chief executive officer of Joy Mining Machinery, said at a recent industry conference that a lot of thermal coal production has already been taken out, with most of the switch having occurred last April, when natural gas prices were below $2 per million British thermal units. “Right now, we see it stabilizing,” he said, with much of the thermal coal that’s still being produced in central Appalachia finding a home in export markets.

Despite its recent sharp but temporary dropoff, mining has the strongest potential for long-term growth for the heavy equipment sector, Plummer said.

Construction equipment was hit hard by economic woes over the past four years, during which some equipment markets dropped by as much as 90 percent, according to Barley. However, replacing aging fleets and increasing building permits have combined to result in a resurgence in many types of construction equipment sales. For Terex, Barley said, this includes its front-discharge mixer truck line, articulated trucks, compact track loaders, wheel loaders, skid steers and crawler excavators.

It isn’t that the construction market is booming, however. Building permits were up 28.8 percent year on year in December, according to the U.S. Department of Housing and Urban Development, which isn’t all that strong. Yengst noted that U.S. housing starts had fallen 75 percent to 500,000 in 2009, down from a peak of 2 million in 2007. While they have since risen to 750,000 to 850,000 units and could increase further to slightly above 900,000 this year due to low interest rates and pent-up demand, they will remain about 55 percent below peak levels.

Nonresidential construction, despite having already bottomed out, is seeing just modest gains, which Plummer said is to be expected, given that the sector historically trails housing recoveries by about 18 to 24 months.

Equipment sales also have been trailing positive economic trends, for several reasons. One is a weakening in exports, especially to China, Europe and Japan. This has a big effect, Plummer said, noting that China accounts for about 50 percent of the construction equipment consumed worldwide.

And while the domestic market is growing, it is primarily seen at equipment rental companies. “Without that business, the equipment manufacturers would be losing money,” Yengst said, explaining that contractors don’t have a long-term vision of where their market is going so they don’t want to risk buying new equipment, even though they might have sold some of their older equipment during the downturn. “They no longer have three or four jobs lined up in a row, but only have one going at a time, and they don’t want to have equipment just sit in their yards,” he said.

Yengst said he doesn’t see the mix shifting back to direct sales until there is a more significant pickup in commercial and infrastructure construction.

“We expect the construction equipment market to continue to stabilize and rebound” as it slowly rises from its long, deep recession, Barley said, with 2013 being a setup year for 2014 and beyond, when a full recovery should start to take shape.

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