The good, the bad, and the ugly

Give Dave Fulghum credit for creativity. He patterned his portion of Heavy Duty Aftermarket Week's Aftermarket Forum after The Good, The Bad, and The Ugly, a 1966 spaghetti western starring Clint Eastwood.

“When I started putting together the presentation on the aftermarket, I was thinking about good things and bad things, and more I got into it, it got to be pretty ugly,” said Fulghum, vice president of Mackay & Company. “That's the kind of market I think we're in today.”

And that's exactly what he named his presentation.

The good: 2008 was not that bad of a year for some companies; 2009 may be only slightly worse than 2008; and there were a lot of people in the room listening to him, so they probably were doing better than the ones who couldn't afford to attend.

The bad: The first half of 2009 will be similar to the fourth quarter of 2008, and we should plan on more of the same for quite some time.

The ugly: If your business was falling behind, you need to make changes — the economy will not save your business; and if the second half of 2009 doesn't show improvement, then 2009 will be truly ugly.

Breaking down 2008 using his theme:

The good: Average vehicle age increased last year. “We didn't sell any new trucks so parts out there got old.”

The bad: Vehicle population was down; average annual mileage was down; vehicle utilization was down and end users were “cannibalizing parts out of vehicles that are parked in order to make sure the vehicles that were being used can keep running”; even with more aggressive pricing in 2008, margins were down; all channels pulled their inventories down; component quality continues to improve, reducing parts demand.

The ugly: New truck sales were dismal; there were steep increases and subsequent declines in raw materials pricing; diesel fuel prices skyrocketed; and freight demand declined.

Population down

He said the overall population in Classes 6-8 and trailers was down 0.9%, going from 8,115,500 to 8,035,200. Class 8 was down 2.2%, “one of the few times in last 20 or 30 years that's happened. We almost always make enough trucks to replace what gets scrapped or goes out of service.”

In Class 8, the average vehicle age will go up from 8.2 years in 2008 to 8.5 in 2009. US replacement demand for Class 6-8 and trailers will be down 4%.

He said MacKay & Company surveys hundreds of fleets every quarter to determine the utilization of their vehicles. They ask, “During the last month, how much of your equipment was operating near to or at full utilization?” and “Looking ahead, how much of your equipment do you expect to operate near to or at full utilization?”

In the fourth quarter of 2008, utilization was 85.8 overall, as opposed to 88.3 in 2006. For trailers, it was 83.7 after hitting an all-time high of 89.1 in 2005. Construction, mining, and refuse were hit with a 16.2% decline to 58.4. Class 6-7 vehicles fell by just 0.2% in all of 2008, with owner-operators experiencing the biggest decline (5.7%).

His 2009 outlook: component quality will continue to improve, reducing parts demand; vehicle population will not increase, but the vehicles on average will be older; average annual miles and utilization will be close to 2008 levels; and the 2009 aftermarket will be down slightly from 2008.

The 2009 US vehicle population for Class 8 is expected to be down 0.7%. Replacement demand will be down 0.4% for Class 6-8 trucks and trailers.

According to MacKay's 2008 parts distribution study — which included input from 309 aftermarket parts and service providers, including truck dealers, heavy-duty distributors, specialists, independent garages, and others — 47% of all channels experienced a decline in parts sales, 32% an increase, and 21% no change. In labor, 48% experienced a decline, 25% an increase, and 27% no change.

For truck dealers, 49% showed an increase in average gross margin on parts sales, 36% a decrease, and 15% no change. In labor, 45% had an increase, 30% a decrease, and 25% no change.

For HD distributors and product specialists, 75% showed a decrease in average gross margin on parts sales, 15% an increase, and 10% no change. In labor, 65% had an increase, 22% a decrease, and 13% no change.

For independent garages, 50% showed a decrease in average gross margin on parts sales, 14% an increase, and 36% no change. In labor, 47% showed a decrease, 19% an increase, and 34% no change.

In terms of overall parts, 53% of truck dealers increased prices and 64% of HD distributors and specialists increased prices. Average parts prices increased 2.4% in all channels, compared to 1.5% in 2007.

Fulghum's conclusion: “Don't expect the economy to help you out.”

Building share

In introducing Fulghum, Mackay & Company president Stu MacKay had said he was more of a chiropractor, “pulling apart what happened in 2008 and putting together what's forecasted for 2009, laying out where the independent aftermarket stands today.” By the time Fulghum had finished his grim presentation — with the bad and the ugly dominating — Stu MacKay joked that perhaps he should be compared to a funeral director.

So how does the independent distribution channel build its share of the heavy-duty aftermarket?

MacKay said there is no one-size-fits-all recommendation.

“In terms of basic assumptions, we're looking at modest overall aftermarket growth,” he said. “The economy will recover. Truck activity will recover. Parts demand will increase.

“Near term, we're looking at relative cost and price stability. I think we're looking at a probable competitive distribution shakeout — restructuring in the channel of distribution, maybe not in terms of total entities, but how those entities are controlled.”

He said growth options for consideration include: adding or expanding service; building the parts business customer by customer; and niche positioning.

He said the 2008 service labor market had 500 million service labor hours, with vehicle operators accounting for 75%, truck dealers 7%, independent paint and body shops 7%, and independent garages 9%.

He said that in terms of truck dealer service-bay utilization, only 41% was customer-pay service and repairs, while 59% was used truck or warranty service, recall campaigns, or new pre-truck delivery.

“In 2009, there will be much more focus on customer-pay service because there isn't much in warranty and there isn't much of consequence in the new-field delivery,” MacKay said.

He said that 75% of the service labor market was vehicle operator, followed by 9% independent garage, 7% truck dealer, 7% independent paint and body, and 2% all others.

He projects that the 2015 service labor market will include 600 million hours, with vehicle operators losing 10% and accounting for 65%. Truck dealers will pick up an additional 5%, independent paint and body 1%, independent garages 3%, and all others 1%.

He said service labor provides a significant opportunity, because 1% of market share is worth about $600 million in revenue.

Shifting dynamics

The second growth option — building the parts business customer by customer — assumes modest overall aftermarket growth, near-term cost/price stability, and probable competitive distribution shakeout.

The 2008 HD aftermarket accounted for $15.6 billion, but the 2015 HD aftermarket should grow to $20.3 billion, with major dealer groups going from $800 million to $4.5 billion, automotive parts doubling from $950 million to $1.8 billion, single-franchise and affiliated independents going from $1.2 to $1.6 billion, and independents and others going from $2.8 billion down to $1.3 billion.

“We think we're looking at some fairly significant restructuring and consolidation, not only on your own side of the business but on the truck dealer side of the business as well,” he said.

He said the sales and marketing reality is that the easiest prospects are current customers, the easiest sales are current products, the easiest competitors are old ones, and the easiest goals are to keep the business and add incrementally.

MacKay said the key issues to consider are:

  • How much of my current customer's business do I really have?

  • Who's getting the balance?

  • Who are the prospects that I'm not reaching at all?

  • How much business do these prospects represent?

He said the key steps include a market analysis involving customer/prospect identification, fleet size, composition, and location, current sales versus potential volume, target products and/or services, and target timetable.

He used an example from a business in Chicago that had 50% of its parts business within 10 miles and 68% within 15 miles. In parts sales per square mile, $16,000 came from the area within five miles, while $5000 came from the area between five and 10 miles.

“The bottom line is that this business sells nearly eight times as many parts to a customer that is less than five miles from the dealership location as it does to a customer that is over 10 miles away,” he said. “Every market is different. Geography considerations have to be taken into account. Taking a hard look and identifying it on a customer-by-customer basis is probably the soundest way to add value in your respective territory.”

Economic breakdown

MacKay introduced economist Robert Dieli, president of RDLB Inc, comparing him to an industry proctologist, “taking a hard look at things that are not all that obvious.”

But Dieli used a farming analogy to describe what companies will face during the rest of 2009: “All of us every day essentially go out and harvest the corn we've planted and think about how we're going to plant the next crop. As we go forward and do exactly that, we will be laying the foundation for the recovery we think is ahead, the strength of which we will finally be able to judge as we get to the end of the year.”

He said there are five indicators: the Aggregate Spread, non-farm payroll employment the one-month treasury bill rate, Gross Domestic Product (GDP), and Truckable Economic Activity (TEA).

He said the Aggregate Spread is RDLB's leading indicator of business-cycle turning points: “20/20 hindsight nine months in advance.”

Non-farm payroll employment, he said, is a coincident indicator of economic activity that can also be a leading indicator of cycle turning points. The declines were much worse in 2008 than had been first reported, and benchmark revisions told a compelling story. And the job loss of 2.53% in January was the fourth-largest in the past 50 years, following May 1958 (4.18% during the steel strike), 2.65% in June 1975, and 2.71% in October 1982.

In 1980, it took five months to regain the jobs that were lost between the peak and trough of the cycle, but in 2001, it took more than three years to regain jobs that had been lost in eight months.

“This raises the possibility that if we start to see a repeat of this type of formation, we are going to have to look at things other than just job creation,” he said.

Dieli said real GDP was minus-0.5% in the third quarter of 2008, then minus-3.8% in the fourth.

“Net exports have been, and continue to be, a major contributor as to how the economy was performing,” he said. “The domestic economy stopped in the third quarter of 2007 and the real GDP number was not the right place to look to see how the economy was performing. If you look at imports, the picture gets even worse. If we don't import the Lexus, the person who's supposed to take the Lexus from the dock to the dealership doesn't have a loading haul. The guy at the Lexus dealer doesn't have a car to sell, so he doesn't get a commission. The city doesn't get the sales tax and the dealership doesn't get the service agreement. If you take imports out of the equation in the fourth quarter of 2008, GDP was declining at 6.8% instead of 3.8%.”

TEA an indicator of demand

He said MacKay & Company developed TEA as an indicator of trucking demand based on the GDP statistics, because the company found that GDP doesn't really work when trying to figure out what's going on in the trucking business.

TEA includes only those components of real GDP that can move by truck: consumer goods, investment goods, export and import goods, and government purchases of goods. TEA also differs from GDP in that it counts imports as a positive (they have to get from the port to their final destination). Dieli said TEA is more sensitive than GDP to the cyclical swings in aggregate activity and is a better predictor for trucking activity.

TEA in the fourth quarter of 2008 was $7.7 trillion, with consumption accounting for 47%, investments 22%, exports 13%, imports 10%, and government 8%.

On a year-over-year basis, TEA was down much more in the fourth quarter of 2008 (5.5%) than GDP was (0.2%), matching the deep decline of 1973.

TEA declined for two quarters after the 1973 recession ended, and the Aggregate Spread paralleled TEA downturn. In 2007, the TEA remained positive two quarters into the recession, then dropped in the final two quarters of 2008.

TEA and the Aggregate Spread mirrored each other in the first two quarters of the recession in 2008, but in the third quarter, the Aggregate Spread actually went up while TEA declined by 0.5%. And in the fourth quarter, the Aggregate Spread went down by less than 2% while TEA plummeted 6%.

“The Aggregate Spread suggests that the turn in TEA will happen in the second half of 2009,” Dieli said. “We will be watching both the composition and the size of the changes. Consumer spending will look better.”

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