CED

October 2013

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Business Outlook 2014: Moderate But Mixed Recovery for Construction Equipment War on coal severely curtails heavy-equipment demand, while rental drives growth in light and medium equipment. Eli Lustgarten Global themes continue to dictate sluggish economic growth both here and abroad for the foreseeable future. Industrial activity peaked globally in the summer of 2012 as global politics froze virtually all major markets. Industrial companies reacted by completing projects underway, deferring the approval of new major programs, and instituting inventory liquidation in the second half of 2012 through the first half of 2013, led by the two sectors that overproduced more than any other – trucks and construction equipment. To date, U.S. markets have been somewhat stronger, Europe has been weaker than expected but clearly showing signs of stabilizing, and emerging markets have been somewhat a disappointment but beginning to improve, though at growth rates below recent norms. Japan has been the country with the most positive surprise for growth, and economists have adjusted to the new China policy of focusing on quality growth that is more muted at around 7.5 percent – that government's priority is to remake its economy to be domestic demanddriven with less reliance on exports and investment in capital-intensive, stateowned companies. In sum, economic growth in 2H13 and into 2014 is likely to be more of the same muddling along that we have been experiencing. The key change is that growth is likely to be led by developed countries such as the U.S., still the best house in a lousy neighborhood; Europe, where the Euro-zone recession looks like it is ending; and Japan. Emerging market growth should improve but at rates well below the norms of 2002-2008. Our forecast for 2013 construction equipment demand remains flat to down 10 percent in North America, and a low-single digit decline in Europe. Latin America is still on track for about a 9 percent gain, underscored by resurgence in government spending across most regions led by civil construction, infrastructure, and energy. China's reviving outlook for 2H2013 continues to support expectations for a moderate improvement, reflecting new government projects possibly in pipeline and private fixed asset investment. We continue to expect further growth in 2014. Construction activity in the U.S. should continue to improve next year, driven by further growth in housing and higher spending in private nonresidential construction markets. We look for double-digit growth for light and medium equipment demand next year, but a 5 to 10 percent decline in larger, heavy equipment reflecting continuing soft mining demand. Besides macroeconomics, the key input into the equipment buying decision making equation in 2014 is Final Tier-4 emissions regulations, which become effective for larger equipment over 174 horsepower in 2014 and all equipment in 2015. Smaller equipment FT4 compliance is being phased in now. Unlike the truck emissions cycle, the good news is that costs for Final Tier-4 are probably only 60 percent of the cost of moving to Interim Tier-4 in 2011-2013. However, that still suggests a midsingle-digit price increase, though less onerous than the double-digit price increases that characterized the move to IT4. Rental companies, which represent more than 50 percent of the market for equipment, seem to be the key to the strength of buying near-term. Most major rental houses are reassessing their planned flat expenditure profile for 2013 and into 2014 due to continued strong utilization rates, improving outlook for construction spending, the need for replacement, and the implementation of FT4 and associated higher prices. We look for a strengthening level of rental expenditures to drive growth in light and medium equipment for the rest of 2013 and into 2014. The only sector with ongoing deterioration of demand is mining. Our surveys show a 45-50 percent or more decline in coal equipment capital spending in North America and midsingle-digit or more weakness abroad. More recently, the Obama administration has renewed its declaration of war against coal power plants with a focus of reducing coal use both domestically and abroad. Further, the five largest global mining companies all have new CEOs with a mandate to improve shareholder returns and reduce capital spending. While the improvement in natural gas prices is off their recent $2 per MCF low to the $3- to $4-level will likely stabilize coal mining related equipment purchases in 2014, noncoal mining capital expenditures are expected to decline at least 15 to 20 percent in 2014. Mining will be troubled well into next year. The super-cycle in commodities is over, and future mining expenditures will depend on global growth, especially in Europe, and how well China manages its transition from exports to domestic consumption. As we said last time, push the politics (and perhaps mining) aside, and the construction industry is poised for at least several years of moderate growth. Eli Lustgarten (elustgarten@aol. com) is president of ESL Consultants, an industrial consulting firm. October 2013 | Construction Equipment Distribution | www.cedmag.com | 49 49_business outlook_KP.indd 49 9/27/13 12:39 PM

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