EXPERT SPEAKERS laid out a bad news/good news scenario at the National Truck Equipment Association's Business and Market Planning Summit at the Embassy Suites in Rosemont, Illinois.
The bad news: Largely because of the pre-buy in advance of the Environmental Protection Agency's new emissions standards, 2007 will be a down year for the industry.
The good news: It won't last long.
“The expansion in truck equipment sales is over,” said NTEA market data and research director Stephen Latin-Kasper in the Truck Equipment Market Outlook. “2007 is not going to be a good time for this industry. But it's just that year; 2008 and 2009 look very good again.”
Latin-Kasper gave the following pros for 2007: moderate interest rates and core inflation, low unemployment, and increasing capital expenditures, trade, and state and local revenues. His forecast cons: terrorism/confidence, federal budget deficits, volatile energy prices, yield curve, and low productivity growth.
“None of these cons are long-term, especially federal budget deficits,” he said. “So there's really nothing to be worried about beyond 2007. Growth has been slowing since 2005 and we'll have a recession in this industry in 2007. But that should be it. At some point later on in 2007, the bad times should be over and we'll be looking forward to 2008 and 2009.”
He said total transportation and truck-equipment shipments accounted for $131.1 billion in 2006, up nearly $8 billion from 2005. Truck-equipment shipments accounted for $43.6 billion and grew nearly three times faster than chassis shipments, largely because Class 1-2 are in chassis shipments and include passenger vehicles.
Growth rate declining
In medium-duty trucks, the rate of growth has been steadily declining since the end of 2004 — from 42% to less than 5% in the middle of 2006.
In heavy-duty trucks, the rate of growth hit 55% early in 2005 and was running at less than 20% in the middle of 2006.
“We expected the pre-buy to be a little more significant for the heavy duty than the medium duty — and it was,” Latin-Kasper said. “But we didn't expect it to be that much more significant, because of the price of the medium-duty engines, which didn't increase that much in the first phase of the diesel-emission regulations.”
For 10 years, the graphs for trailer production and American Trucking Associations (ATA) freight shipments have nearly mirrored each other. Both peaked at the beginning of 2003 and 2005 and troughed at the beginning of 2004.
“Right now, we're not sure where the next trough is,” Latin-Kasper said. “It hasn't happened, but we're approaching it.” Both had dipped below 1% by the middle of 2006, the last time statistics were available.
Likewise, the graphs for medium truck sales and medium truck production have nearly mirrored each other, although production growth topped 40% near the end of 2004 and sales peaked nearly a year later at 30% growth.
“Sales were a bit ahead of production, so we didn't have a lot of inventory building up in medium through July,” he said. “But the reports I'm hearing are that it may have changed radically for Classes 3-5 in August and September. I suspect the gap closed in a hurry.”
In heavy duty, production was running about 10% ahead of sales at the beginning of 2006, but the gap is closing and Latin-Kasper said inventory has been sold off.
In application markets for truck equipment, construction occupied 22.6%, compared to transportation (16.7%), rental (10.6%), and government (10%).
“What we know from our survey of NTEA members is that for some products within the truck equipment industry — dump bodies — the construction industry accounts for 15% all of sales,” he said. “We have guys who are focused on particular product segments within the NTEA membership that are almost completely dependent on what's going on in the construction industry.”
Look to utilities
While production of business trucks has flattened to nearly zero growth, electric utility production was showing 7% growth in the latest statistics.
“The utilities industry is a good place to look for new sales because the build rate is going to keep going and as utilities get bigger and more and more energy in the form of electricity and natural gas gets demanded, they're going to need more trucks,” he said. “That is a very long-run trend in terms of adding capacity.”
Similarly, state and local government spending on equipment (minus computers) showed a steady increase from 2004 through 2006.
“The story here is very simple: They're about a year behind reality in terms of the business cycle,” he said. “So when the rest of the economy slows down in 2007, we slow down a lot, and one of the good places to look for new business will be state and local and municipal governments, because they're still going to be living off 2006 taxes.”
Talking about total private construction spending — which “far outweighs all public construction spending” — he said the growth rate had declined to about 8% and figured to take at least another year to reach zero growth. And it might flatten out at 4-5% and starting coming back in '08 and '09 along with the rest of the economy.
Latin-Kasper said there is very little concern over steel prices, noting that hot rolled sheet and strip (up 14%) and carbon steel scrap (up 12.3%) were the only products that experienced a double-digit price increase in the second quarter of 2006.
“Things are really calming down,” he said.
Likewise, the Producer Price Indexes for trucks, buses, trailers, truck equipment, and selected materials were very stable in the last statistical period. Up were trucks, truck tractors, and truck chassis of 14,001 to 33,000 lb (0.5%) and 33,001 lb and over (1.8%), truck and bus bodies (1.8%), truck trailers and chassis 10,000 lb per axle and over (2.1%) and those under (2%), and hardwood plywood (0.7%). Down were trucks, truck tractors, and truck chassis 14,000 lbs and under (2.1%) and completed vehicles produced on purchased chassis (0.2%).
“The pricing environment in terms of our costs looks good,” he said. “It'll be a lot easier to control than in the past few years.”
He said that despite the rise of the Canadian dollar against the US dollar, Canada's exports to the US were expected to grow by over $400,000 in 2006.
“That tells you that trade between Canada and the US is not really dependent on the value of the Canadian dollar compared to the value of the US dollar,” he said. “Many of the companies in North America have operations so integrated that the comparison between the Canadian and US dollars doesn't affect our trade that much. Of all the trading partners in the world, I doubt that there are two others' economies that are so well integrated.”
However, he said that truck and trailer sales in 2007 to Canada and Mexico are going to decline due to the pre-buy. He encouraged attendees to tap into the overseas markets. Sales this year to Russia were up 94.7% to $203 million and to Brazil were up 90.9% to $196 million. Sales to Australia were up 42.9%, but the increase in dollars ($228 million) dwarfed the total sales in Russia and Brazil.
“If you're looking for some way to diversify, start looking now at some foreign markets,” he said.
Truck Industry Market Forecast
Presenter: Kenneth Kremar, principal of the Industry Forecast Practices Group for Global Insight, Eddystone, Pennsylvania.
Kremar predicts a rough road ahead for 2007, with the US truck market seeing a payback for the 2006 pre-buy, deteriorating economic and end-use market conditions, and continuing high diesel and gasoline prices.
“We're not going to use the ‘R’ word,” he said, “but we'll have a bit more pronounced of a slowdown. We've already seen the weakness.
“There will be a payback. You always have to pay the piper. Buying was distorted in 2006. That has to be a payback for that pre-buy. How much? It's going to be significant.
“The worst may be over (regarding fuel prices) but we're not going back to a situation where we're going to see cheap gas or diesel fuel — or cheap energy prices in general.”
Retail sales of Class 1-3 commercial trucks declined 15.2% in the first half of 2006, compared with the same period in 2005. Class 4-7 saw a 5.1% increase, while the pre-buy boosted Class 8 by 14.4%.
“Next year's going to look pretty ugly (for Class 8),” he said.
He said the US economy has slowed, with GDP growth likely to average just over 2% over the next four quarters after being between 3% and 4% for three straight years — “and that ripples through to the markets that buy trucks and truck equipment,” he said.
He said the keys to the slowdown are a downturn in the housing market and a more cautious consumer. Oil prices slipped below $70 a barrel, but “we are skeptical that they will remain there.”
“We expect capital spending and exports to support growth, but they will not fully offset the consumer and housing slowdowns,” he said. “The Fed paused in August. Our forecast assumes one more hike in the federal funds rate to 5.5%, followed by rate cuts in 2007.”
The Purchasing Managers Index for Manufacturing & Nonmanufacturing peaked at 64% in 2004, but has been steadily declining and appears headed below 50% — which would mean the markets are not expanding. The same thing has happened in wholesale and retail trade, with Kremar adding that “the consumer is beginning to pull in his horns and become much more cautious in 2007.”
In truckload carrier performance, loads are down 1%, revenue is up 7%, mileage is down 2%, revenue per mile is up 8%, and rates are up 4%.
“In volume terms, the weakness is mainly in the truckload sector,” he said. “There's a driver shortage, and that's not going away soon.”
The picture is better in Less-than-Truckload (LTL) carrier performance, with shipments up 4%, tonnage 5%, revenue 10%, revenue per ton 5%, and rates 7%.
Kremar said economic conditions point to a sluggish traffic performance in 2007, but better days are ahead.
“The movement from 2006 to 2007 would seem to suggest 2007 is not going to be a gangbuster year,” he said. “And after spending the kind of money they're spending this year for new equipment, it's not likely they're going to be aggressive in 2007. It just seems to lend credence that big trucking is going to be conservative in 2007.”
The Index of Small Business Optimism fell to 96 after peaking at 109 in 2004, prompting Kremar to conclude: “It's unlikely they'll become happy campers anytime soon. They'll be cautious in capital spending for the next year at least. The opportunity to sell trucks and truck equipment into small markets is going to be constrained by the general conditions we're facing.”
He said activity in key truck-buying markets will be slower or experience outright declines in 11 of 12 outlets, with only oil and gas exploration increasing (3%).
Looking ahead, Kremar predicted that economic and end-use market conditions would improve in 2008-2009 and that energy prices would ease. He also said that the pre-buy caused by 2010 Environmental Protection Agency (EPA) diesel engine regulations would provide added support in 2009 and that favorable conditions should lift sales in 2011.
State GovernmentFleet Forecast
Presenter: Joe O'Neill, vice president of Chanticleer Inc, Litchfield Park, Arizona.
O'Neill predicted that state and local governments would do well in 2007.
“Increased tax revenues and funds for internal service will lead to a larger number of trucks being purchased by state fleets in 2007,” he said.
Based on a survey of state fleet managers conducted by Chanticleer, O'Neill predicted that state fleets would buy 96,709 work trucks in 2007. Of that total, roughly 66,500 would be Classes 1 and 2, 20,000 would be Classes 3-5, 6800 would be Classes 6 and 7, and 3100 would be Class 8. Total projected expenditures: $2.2 billion.
He said positive factors impacting state fleet funding are increased tax revenue, internal service fund, and excellent communication; neutral factors are other budget priorities, fuel, and legislative assistance (flat-line funding, internal service fund fundraising, privatization); negative factors are decreased tax revenue; bad publicity; legislator or executive branch manager with a “bone to pick”, and bad fleet management/communications.
A survey of fleet managers and agencies indicated that 78% expect the same funding for next year, 12% expect a better outlook, and 10% expect a worse outlook. Asked to assess the past five years, 49% of those same fleet managers say that funding has been static, 46% say it's increasing and 5% say it's decreasing.
He said decision drivers in state fleet purchasing are conformance to specifications, this year's cost, life cycle cost, quality, and previous practices; and current restraints on state fleets are the fact that the Department of Energy is not a serious factor in AFV requirements, money (fleets requiring annual budgeting versus service fund fleets are at a severe disadvantage), self-inflicted problems, and homeland security.
The data includes departments of transportation, departments of general services, departments of game and fish (interior), state police, and departments of economic security (welfare, child protective services, etc). The data does not include school districts, municipal and county government entities, jail and prison systems, “cat and dog” fleets (lottery, blood banks, cemeteries, hospitals, etc), colleges and universities, and federal fleets.
End-use Market Review
Presenter: Eli Lustgarten, senior vice president of Longbow Research, Cleveland, Ohio, and principal of ESL Consultants, St Louis, Missouri.
Lustgarten said the truck boom of 2004-2006 was driven by normal cyclical economic recovery, assuming sustained 3% domestic GDP growth.
“It was exacerbated by the fear of 2007 emissions, causing rational truck owners to dramatically reduce fleet age as much as possible by January 1, 2007,” he said. “2007 engines are 2002 engines with added filtration. The engines that fleets hate in 2007 will be loved in 2008 and 2009. 2010 emissions standards are very stringent and difficult, causing material engine and truck re-design.”
He said demand for Class 8 trucks and tractors will range between 283,000-360,000 for 2006 and will return to normal levels for 2007: 187,000-205,000. Medium truck production also will fall from an estimated 262,000 in 2006 to 200,000 in 2007.
He predicted that the US economy will continue to grow, saying that real gross domestic product (GDP) growth remains strong, capital spending continues to strengthen, manufacturing output is improving, inflation remains under control, and corporate profits are strong.
“The industrial sector will still be a good place to be in 2006 and likely 2007,” said Lustgarten. “This year will become that mid-cycle year where top-line growth falls from above normal, double-digit levels to mid-single digits. Meeting the goal of most industrial business models of 8%-10% top-line growth likely requires enhancement to normal volume leverage, either through additive acquisitions, and/or margin improvement from better pricing and lower input costs, and/or new products, and/or market-share gains.
“The economy's slowing at the close of 2006 is typical of a mid-business cycle pause (as in 1966, 1986, and 1995). The 2006 global economic conditions are likely to be average — and average is good!”
He said there's no need to worry about the economy in the short term because: the consumer sector is resilient; job recovery remains inconsistent; consumers can handle gasoline at $2.50 to $3 a gallon, and are buying more, not less; strong productivity helped unit labor costs to rise only 1.3% in 2005, following a more than 3% gain in 2004 after three years of being almost flat.
He said a slowing of the domestic economy was inevitable. First-quarter GDP growth of 5.6% in 2006 made the US one of the fastest-growing advanced economies (second behind Greece), but was not sustainable. It benefited from a smaller US trade deficit (higher exports and lower oil imports). Business inventories were slowly being rebuilt. Job creation has waned. And higher energy costs and rising interest rates will take a toll.
“Construction activity will slow, particularly home building,” he said. “There are higher interest rates. The inventory of single-family homes was at 6.5 months in July, the highest level since 1995. And 37% of construction equipment rental companies are currently building inventory. Their fleet refurbishment as measured by the average age of equipment appears to be almost completed.”
He said the industrial sector kept rolling through 2006. He said most investors and companies underestimated the strength of the industrial sector in the first half of 2006.
“Business conditions in most markets remain very solid, with strong positive momentum, particularly in the construction equipment and fluid power sectors,” he said. “Capacity utilization in manufacturing has moved up to 81% since June, or a rate more than 1% above its 1972-2005 average of 79.8%. Right now, with inventory not totally out of whack and money readily available, you don't have the conditions for a recession. That's why most of us are optimistic that this is a slowdown, not a recession.”
North American Economic Forecast
Presenter: James Meil, chief economist for Eaton Corporation, Cleveland, Ohio.
He said GDP will grow 3.3% in 2006 and 2.6% in 2007. He forecast the following segments to grow in 2007, but at a slower rate than in 2006: consumer spending 2.4%, down from 3%; capital spending 6.9%, down from 7.8%; industrial production 3%, down from 5%; and housing starts 1.67 million, down from 1.84 million. He forecasts government spending to grow 2.2%, up from 1.9 in 2006.
“The economy started strong in 2006, running into housing headwinds,” he said. “The fear is both of the inflation threat and the possible overreaction by the Federal Reserve, European Central Bank, and others. Volatility is up, commodity prices in retreat. The indicators are mixed, rather than uniformly strong. As central banks raise rates, the likelihood of a slowdown persisting into 2007 increases.”
Meil also spoke about U.S. retail sales of Class 8 trucks/tractors, predicting sales of 360,000 units for 2006 and 205,000 units for 2007. However, he noted that there is still plenty of time for the ongoing pre-buy to affect the current trend.
US Construction Market Forecast
Presenter: Don Johnson, chief economist of Caterpillar Inc, Peoria, Illinois.
He noted that while residential construction is likely to decline in 2007, nonresidential (especially highway and street construction) is likely to have a good year.
“Housing starts are not likely to fall as steeply in 2007 as they did in 2001 since the ratio of housing cost to personal income has actually improved since then — from 46.3 to 45.5," he said.
His views on housing:
Home prices are moderating.
Mortgage rates have softened.
Incomes and employment are growing.
Affordability should improve, eventually slowing the decline in new starts.
Look for starts to decline from 1.9 million in 2006 to about 1.8 million in 2007.