2013: Slow, Steady Growth for Construction and Equipment Rental

While the U.S. economy continues to improve gradually, short-term uncertainty on multiple fronts stifles larger capital investment. Slow improvement will continue as unemployment remains around 8 percent for a prolonged period.

Speaking collectively for CEOs, money managers, banks, and consumers, the economy doesn’t like uncertainty. As if the serious international debt problems were not enough, the long U.S. election year has added uncertainty, rather than reducing it. No matter who becomes the next president, expect the doubt to continue at least into the beginning of 2013. Politics aside, the economy is slowly rebuilding and de-leveraging debt, and we are experiencing a slow, ragged recovery.

Some construction markets have recovered faster than others, which is going to be the case for the foreseeable future. This has made it difficult for most contractors to plan growth strategies as they continue to chase the next project, often bidding below expected profit levels. Deciding to buy new equipment is harder when growth is hard to predict.

That uncertainty has translated into improved equipment rentals, as contractor backlogs remain low and uncertain. If contractors and suppliers aren’t going to lose money, everyone associated with construction must deliver more for less cost. In construction, that means more productivity through greater use of technologies like BIM, GPS, and communication devices.

The need for productivity and delivery of quality projects for lower total cost is also driving more prefabrication and modular construction. That could change the mix of talent on the jobsite, as well as the types of equipment needed.

While forecasters predict that GDP will likely remain between 2 and 2.5% for the next several years, we are seeing improvements and increased demand in the home-building market, which has traditionally been a harbinger of improvements in all other areas of construction. Current GDP sits at just 1.7%. If GDP makes it to a sustained 2% or more, it will look like a boom from where we have been lately.

Despite the uncertainties of the economic growth rate, some long-term positive trends prevail.

• The United States remains a relatively stable investment and financial safe haven with strong consumption.
• Long-term foreign investment in the United States will continue and increase as worries discussed above resolve. This will drive real estate investment as well as further business investments and acquisitions.
• Increased foreign investment will bolster our economy. We continue to distance ourselves from the Great Recession, work through the overhang of excess homes, and burn through the residential bubble from five years ago. With construction unemployment currently around 11%, this increase in demand will have a positive effect across the economy. Ongoing demographic changes stemming from baby-boomer retirement support construction of more multifamily projects, multi-use and assisted-living complexes as Americans move closer to cities and out of suburbia.

Construction improving slowly

If 2012 does become the turning point for construction, it will be a long, slow turn. That may prove to be a safer road to recovery than a sharp V or U curve. At this point, we expect construction put in place to grow between 5% (to $826 billion) and 7% (to $882.4 billion) in 2013.

That improving growth rate includes a solid recovery in housing, especially multifamily units, and strong growth in power construction. Other areas, like commercial construction, will awaken from a long slumber to resume slower-than-traditional growth rates but somewhat ahead of national GDP growth. Healthcare, after slowing to near zero in 2011 and recovering to 3 % growth in 2012, will gain steam to almost 75% in 2013. This is a factor of baby-boomer demographics more than an economic boom, and the national health care law, reaffirmed by the Supreme Court, will continue to be the elephant in the room that could add millions of new insured needing health care, depending on what the next Congress does after the elections.

During the Great Recession, construction industry firms refocused on efficiencies, cost reduction, and improved strategies. These adaptions will bear fruit as demand increases over the next few years. As construction markets gradually improve, equipment rental, acquisition, and utilization will follow. Major sectors involved in this slow recovery include:

Infrastructure

After a multi-year wrangle, Congress passed a new $109-billion, two-year transportation bill. FMI forecasts that transportation construction will grow 3% in 2012 and 5% through 2015. State revenues are returning to more normal levels; next, they will need a clear picture of funding from the federal government. Private investment may also play a bigger role as institutional investors look for a steady revenue stream.

Trends
• The passage of a new transportation bill will add some stability as well as funds to the transportation sector.
• FAA authorization passes after 23 extensions over a five-year period, but flat Airport Improvement Funding may ground hopes for significant reinvestment.
• High-speed rail is slow to get projects off of the ground, due to state funding and political resistance.
• Growth in container ports is recovering from the recession.
• Intermodal transportation will be the focus of new projects.

While the need for infrastructure projects remains strong, current funding plans are limited only to critical projects. Sewer and water upgrades and EPA mandates require work that remains expensive and unfunded. As of this writing, Congress passed an immediate funding bill that supports only a small fraction of the need. While still slow to materialize, public/private financing may yet play a larger role in funding infrastructure.

Highway and street

The new $109-billion transportation bill will finally help states fund badly needed construction projects. One project was going ahead anyway—the new Tappan Zee Bridge project in New York, where Gov. Cuomo just struck a deal in the PLA agreement with the unions to save $452 million over the course of the project. Currently, FMI projects that CPIP for highway construction will drop 2% in 2012 and grow just 1% in 2013 to reach $77.7 billion, or near- 2007 levels. The new bill may help raise the FMI forecast next quarter after the details start to work their way down to the state level.

Trends
• Funding uncertainty persists as ARRA money dries up, and the new transportation bill goes into effect. Highway investment from ARRA peaked in fiscal year 2010 at $11.5 billion. The disappearance of this source of funding creates a significant head wind for new projects.
• Many state and local governments are not in a position to advance transportation programs without federal support and funding certainty.
• Public-private partnerships continue to generate more talk than action, although six projects, totaling $8.6 billion, appear ready to reach financial close in 2012.
• National Surface Transportation Policy and Revenue Study Commission report calls for more than $225 billion annually “for the next 50 years to upgrade our surface transportation system to a state of good repair and create a more advanced system.” (Bill H.R. 402)
• Funding—not need—will continue to be the big question for highway and street construction.

Manufacturing

Manufacturing construction is demonstrating sound growth after a sharp drop of 33% in 2010 and a weak 2011. Manufacturing construction is forecast to rise 3% in 2012 and show steady increases to 2015. Although growth has been uneven, manufacturing production, led by automotive production, has been on the rise.

At 79.2% in April, capacity utilization is returning to normal levels. Production for utilities has also seen gains, especially for natural gas. Lower natural gas prices will also help manufacturing energy inputs. The ISM manufacturing activity index rose to 53.5% in May but fell to 49.6% in August. Growth spurts have been difficult to sustain, so manufacturers will be cautious before adding capacity and employees.

Water supply

Construction related to water supply is beginning to grow but will gain only 2% in 2012 and 3% in 2013 to reach $14.7 billion. Federal funding for water projects was cut in fiscal year 2012, with further cuts likely in fiscal year 2013.

Power

Power construction has been one of the stronger areas throughout the recession. It will continue to grow faster than any segment other than residential construction over the next five years. In part, that growth will come from an anticipated gain in residential construction fueled by population growth and a growing need for power.

Even though homes and industrial needs are becoming more efficient, an increasing numbers of devices, such as electric vehicles, will drive the need to generate more electricity. FMI forecasts a 10% rise in construction for 2012 and another 10 percent in 2013, to $108 billion.

Although overall power generation will grow, the kind of fuel that power plants will use is in flux, with the rise of shale-gas mining and the demise of outdated coal plants. Nuclear energy’s comeback is slow because of concerns about safety and cost. The growth of alternative energy will slow as subsidies are removed.

Trends
• Emergence of shale gas supply fundamentally alters the U.S. energy landscape.
• U.S. Environmental Protection Agency regulations are expected to halt new coal construction, drive premature retirement of existing coal-generating capacity, and support the shift to natural gas as fuel for power generation.
• The U.S. nuclear renaissance is on hold outside of regulated markets, as the low price of natural gas redirects investment. The renaissance is now limited to two new reactors each at Southern Company’s Vogtle plant in Georgia and South Carolina Electric & Gas Co.’s Summer plant near Jenkinsville, S.C. Industry experts expect nuclear power to hold its near 20% share of generation going forward, which will spur future investment.
• The power transmission and distribution market remains robust.
• Renewable energy is likely to stall, as incentives are set to disappear. Extension of the Federal Production Tax Credit (PTC), which makes economics of renewable energy favorable for producers, is uncertain. The credit is set to expire at the end of the year. As of April 3, 2012, the Senate had voted four times in 2012 not to extend the PTC.

Infrastructure in the broad definition is likely to be a central focus for construction for the next decade and beyond. The American Society of Civil Engineers (ASCE) is stepping up its call for fixing America’s infrastructure and failing roads, bridges, and water and wastewater management systems. No one has yet solved the issue of paying for it, and the longer the problems continue, the higher the price.

This begs for solutions. Some ways to solve the problems include learning to build bridges more quickly, more safely, and for lower cost—such as using more prefabrication and simpler designs that are only as strong as needed. For power construction, although subsidies for alternative power sources, like solar and wind, are due to run out, expect larger projects to continue to be planned and built.

Meantime, the focus on natural gas from shale will continue to drive out coal. Although it takes a long time to plan and build large infrastructure projects, all still rely on shifting economic sands.

Ultimately, infrastructure projects depend more on funding than need. As state and local governments struggle to rebuild their tax bases, we expect to see fewer large-scale projects. There are always exceptions, and cities like New York have a number of larger projects in the works and planned. Corporations that can self-fund with cash flow and reserves will also plan larger projects. Meanwhile, others will continue to update and rebuild projects to be more efficient and attractive.

Trends influencing equipment use

The positive forecasts for the industry sectors above will yield a steady demand on equipment acquisition, rental, and leasing for the next five years.

Overseas demand

Backlog for new construction equipment remains strong, with some manufacturers reporting a multi-year waiting period for new construction equipment. It is expected that, as massive populations in China and India gravitate towards the middle class (1 billion expected by 2020), there will be a continuous demand for lifts to support vertical construction needs in large megapolitan areas.

Used equipment resale

The Great Recession and construction downturn resulted in fleets liquidating used equipment in order to raise capital for continued operation. Coupled with restrictions on capital for leasing, the initial wave of excess supply in the market following the downturn has ceased, resulting in improved pricing for most used equipment.

Demand for used equipment (secondary market) will continue to overpower the demand for new equipment through 2014. Ritchie Bros.’ auction volume is up across the globe, with lower inventory and improved prices. We expect this trend to continue as the construction markets improve slightly.

United Rentals, RSC, and H&E Equipment Services saw rental revenue increase at a double-digit pace through the first three quarters of 2012, with utilization rates as high as 70%. We expect this trend to moderate slightly in 2013.

Impact of operation recognition of true cost

After purging excess equipment, many companies improved their awareness of cost. If they were not already recognizing equipment costs at a project level (internal rental rate), the identification of the true costs to own and operate allowed them to make apples-to-apples comparisons with external rental rates.

Many companies recognized they didn’t use equipment enough to justify owning it, and renting equipment allowed the most effective use of time and energy. Rental appears to remain an ongoing trend for low-utilization equipment.

Over the next five years, aging equipment will need to be replaced. Purchases that were sidelined by decreased backlogs and lower margins have now created a built-up demand. In an effort to win work in competitive sectors, many equipment owners cut overhead by delaying preventive maintenance. These factors will increase the demand for new equipment in order to perform work effectively. More than 50% of equipment dealers believe equipment sales will increase by more than 3% in the next 12 months.

Engineering impact

Regulations that demand low-emission engines and better energy efficiency brought dramatic engineering adaptions, including low-diesel emissions, Tier 4 engines, and significant improvement in fuel economy. As natural gas engines become accepted in on-road vehicles, major manufacturers have begun developing natural gas-burning off-road applications.

The market, regulation, and future technological breakthroughs will determine how rapidly this trend grows. The decision will depend on the tradeoff between higher initial equipment costs and savings of up to 70 percent in operating costs offered by some natural gas engines. While concern persists about the power of such engines on heavy earthmoving and crane applications, lift- and access-based equipment should have sufficient power.

GPS and telematics continue to improve operations and equipment management. Collecting “real time” data regarding equipment location, operation, and maintenance needs for rented and owned equipment can reduce paperwork and increase efficiency.

Many critical components of heavy equipment are becoming more complex and computerized. This requires extensive in-house training and specialized equipment or external service teams to perform even common tasks. There are benefits and challenges to these changes. Smart companies will take advantage of the outsourcing opportunity despite the higher cost and focus on the work they perform best.

Enter the certified equipment manager

For many companies, equipment management is the largest capital budget, and the one under sharpest scrutiny. Balancing financial demands, maximum uptime, and equipment life with an aging workforce is just the beginning of the challenge.

Other demands include:
• Increasingly complex systems
• Ever-evolving components
• Parts inventory control and management
• Acquisition and negotiation
• Labor outsourcing
• Compliance with ongoing regulatory changes

While senior technicians are in high demand, many companies are turning to an equipment business manager to focus on strategies to manage these challenges effectively. Additionally, continued integration of manufacturers, dealers, and equipment operating should improve operations and efficiencies for all three entities.

Forward-looking

Companies would do well to develop contingency plans for:
• Uncertainty around government regulation (EPA) and policy
• Fuel costs and Middle East turmoil
• European financial stability

Despite the constant confusion of news from Europe and uncertainty and inaction in the U.S. Congress, there are positive signs in the economy. Improving housing construction, especially multifamily housing, is helping lead the way. Power construction is strong, and commercial construction will show signs of waking up. Nonetheless, slow growth may be even more challenging than large market drops or boom times because it requires improved management, precision market research, and creative business development.