The fact that global demand is rising for commodity minerals and hence the mining activity needed to satisfy it is certainly a tonic to the makers of heavy equipment such as construction, mining and other machinery. But on the flipside of the coin, as their order books refill, they face rising prices for steel. In its first-quarter analyst call, Caterpillar, the large international manufacturer of yellow goods, specifically noted the price of steel as a headwind to profitability.
Mechanical and heavy equipment is the second largest segment of the global market for steel, according to the World Steel Association (see piechart), accounting for 16% of demand. Given that last years global crude steel production was 1.69 billion metric tons, that means about 270.56 million metric tons of steel went into heavy equipment manufacture in 2017.
The segment is a little smaller in the United States: 10% of domestic steel shipments go into the category machinery and equipment there, according to Timothy Gill, chief economist of the American Iron & Steel Institute. That includes mining and agricultural equipment, and also electrical and industrial machinery, and has been at a consistent level over the past few years.
Don Johnson, president of Precision Economics and former chief economist at Caterpillar, sifted through government statistics and noted that there were $17.4 billion worth of shipments from the construction machinery sector in 2016. There was another $3.5 billion worth of small machinery as well as $2.4 billion on parts.
At the same time, US companies spent $30 billion on construction equipment, including imports, Johnson noted. A further $12 billion was spent on mining and oilfield equipment.
Commodity prices peaked in 2011, he said, and machinery investment peaked in 2012. The recovery we are seeing now started last year. Based on sales, he estimates that from peak to trough there was a decline of about 40% in the sector in the US and 60-70% worldwide. It was a huge decline. Even with a strong recovery in sales of 50-60% in first quarter of 2018 over 2017, sales are still well below the peak.
Part of the problem is the long cycle. Large units, especially in mining, tend to have a very long life, said Johnson. Heavy maintenance and field rebuilds make new orders more volatile than construction. Australia is often a good proxy for the global mining sector. Machinery purchases peaked in 2012 and bottomed in 2016 after a 70% decline, he added.
Consolidation and relocation
It may seem surprising that the portion of steel made in the US going into heavy equipment is significantly smaller than the global portion, especially given the ubiquity of American brands such as Caterpillar, Manitowoc, Joy Global and Bucyrus. But Komatsu bought Joy Global in 2017, and Caterpillar acquired Bucyrus in 2011. Both of those big firms have been shifting some of their North American production to Mexico, according to industry sources. Caterpillar is already there, in Monterrey, and Komastu is moving there, one source said. Imported steel from South Korea is also said to feature in some US yellow goods manufacturing.
Caterpillar referred inquiries about its business to its quarterly statements. In the first-quarter call, Bradley M. Halverson, Caterpillars CFO, said: Manufacturing costs were about flat in the quarter on a 31% sales and revenue growth. Lower warranty expense and a favorable impact from cost absorption were about offset by higher material and freight cost as well as higher short-term incentive compensation expense. The increase in material cost was driven largely by steel. We expect steel and other commodity cost to be a headwind all year.
That said, Halverson added: However, at the end of the day, higher commodity cost benefit many of our customers, and they are one of the reasons we have seen several of our end-markets begin to recover. Weve recently received lots of questions from investors about potential impacts from higher commodity prices, especially steel. The revised outlook does reflect an assumption for higher material cost. However, we have also increased our estimate for price realization, partially due to a mid-year price increase. We expect this upward revision to price realization to more than offset material cost increases.
Halverson reiterated: We believe higher commodity prices drive improved market conditions for many of our end markets.
Amy A. Campbell, Caterpillars director of investor relations added: We started off the year expecting material cost to be higher. We started to see some material cost increases in the back half of 2017. For the industry, steel prices, I think, were up about 40% last year. I think they were up about 15% for the industry in the first quarter. We have not seen that type of cost increase flow through to our results, but we have seen material cost increases most notably for steel continue to increase. And as we said, we now expect material cost increases to be higher for the full year than we thought they would be in the fourth-quarter outlook, and that is primarily driven by steel.
She elaborated on the point that the company is still on the positive side of the balance between rising costs for raw materials, and the rising order books that come from the same minerals demand growth.
There are a lot of factors driving those steel cost increases, said Campbell, but we continue to expect price realization to offset those material cost increases. And in fact, from the fourth quarter outlook to this outlook, we now expect the price realization increase was actually larger than the material cost increase so that gap grew a little bit not a significant amount, but it did grow a little bit favorable versus what we had in the fourth quarter outlook.
Since Caterpillar is a giant in the yellow goods sector, with an estimated market share of somewhere between a quarter and a third, the company is a bellwether, especially in terms of sales to China. We started the year expecting industry demand [in China] to be up about 8%, said Campbell. We tend to focus on the 10-ton-and-above excavator as we talk about specific numbers for industry demand. China continues to be stronger than we expected. We now expect the China 10-ton-and-above excavator demand to be up 30% this year. At that level, thats about 88,000 excavators for the industry.
That is about 20% to 25% above where we think normal replacement demand and the macro environment in China support, Campbell elaborated. But we do at this point continue to expect China to be very strong for the rest of the year. That said, we expect normal sales patterns in China. So we expect about 60% of end-user demand to come in the first half of the year and about 40% of end-user demand to be in the back half of the year.
The types and grades of steel generally used in heavy equipment often include small additions of boron to increase toughness and hardenability, said David Anderson, senior director of long products at the Steel Market Development Institute. Typically these long products are in the [ASTM] 1000 type of plain-carbon, induction-hardened, shallow-case steel for torsional strength.
There are also alloys in the ASTM 8620 and 4320 range, he added: Those have more internal toughness for things like gear teeth.
An interesting trend is that the idea of lighter weight that is so prevalent in on-road vehicles is also moving into heavy equipment. It might seem counterintuitive that weight would be a concern in this sector, but in all heavy equipment from common street-legal dump trucks to the monster drag lines for mining performance, reliability and durability are all essential characteristics.
The larger and more expensive the machine, the more critical down-time becomes. The less of its own weight the machine has to move, the more payload in can handle. Several sources noted that end-users and equipment-makers are asking for lighter, stronger grades.
Agricultural applications started to look at fuel efficiency years ago, said Anderson. Operators want more rows for the same amount of fuel. Mining haul trucks are also going to lighter weights. New materials are a lot more power dense, Anderson added. We have done some work with the University of Toledo [Ohio] on improving steelmaking in general, but especially forging. It used to be that the design safety factor used to have to be as much as 70%. In some cases that can be reduced to 10% and still stay well within safety and performance parameters.
Broadly speaking the outlook for the sector is good, said Gill at AISI. Mining as well as oil and gas are benefiting from price rebounds. So far that is strong enough to draw investments into those sectors, but not so strong as to undermine profitability. For US companies there has also been a modest decline in the value of the dollar, which helps exports.
The global recovery in mineral commodities and the incipient recovery in heavy equipment is all the more dramatic given how bad the decline was. The segment just fell off the table in 2012, said Daniel Carroll, national sales manager for JSW Steel USA. At the time he was with ArcelorMittal supplying service centers that concentrated on the heavy-equipment segment.
The timing could not have been worse for all. Caterpillar had spent about $8 billion in 2011 to acquire Bucyrus, maker of huge mining machines. ArcelorMittal, Nucor, and SSAB all made significant additions to their quench-and-temper lines, said Carroll. ArcelorMittal spent $65 million on heat treating, he added. To this day the industry has about twice the quench-and-temper capacity needed, he said.
Carroll also noted that each major equipment manufacturer has its own specific grades, but broadly they are similar to common construction steels. We can produce heavy plate up to six inches, he said. We ship raw plate to our customers, who cut them and supply to the heavy-equipment manufacturers. He added that not much is shipped assembled anymore: The manufacturers engineer, assemble, and test, then disassemble and ship.
As reported by American Metal Market on May 8, Indias JSW Steel Ltd has agreed to buy US flat-rolled steelmaker Acero Junction Inc for $80.85 million. For its own part, JSW USA announced in March that it will build a new electric-arc furnace and upgrade the plate line at its mill complex in Baytown, Texas. The meltshop is expected to be in service in two years.
There has been a quantum leap in the ability to develop better steels, said Carroll. As long ago as the late 1990s the major crane makers like Link-Belt and Manitowoc were moving from 100 KSI steel for booms to 130-140 KSI. Now they are working on 160 and are looking at 180. Anything 130 and higher is quench-and-temper, that is a separate heat treating.
Written By Gregory DL Morris