An industrial decade with momentum

BE GLAD YOU ARE who you are.

That's the message Eli Lustgarten delivered to his NTEA Economic Outlook Conference audience in his presentation, “Industrial Markets 2004-2006 and Beyond: Managing Through the Mid-Decade Boom.”

“You'd think we were in a recession, listening to conversation and talk,” said Lustgarten, president of ESL Consultants LLC, an industrial consulting firm assisting trade associations and their memberships. “You guys are in the midst of a boom. '04 was terrific. '05 will be good. '06 will be good. Maybe there will be a hiccup in '07. But this is an industrial decade that is going to be great until 2010. There will be fits and starts and problems. But this is a time to be an industrial supplier.”

He said that in September 2004, the concern was whether manufacturing was finally beginning to recover.

“Today, the manufacturing data is consistent with our belief that 2004 was the first year of at least a three-year upturn for this sector, lasting through at least 2006,” he said.

He said a recent ISM manufacturing report on business conditions showed that economic activity in the manufacturing sector grew for the 27th consecutive month. Current ISM data is consistent with GDP growth in the 4% range.

“Many people interpreted the first part of '05 as the end of a cycle, rather than a mini-inventory correction,” he said. “If you look at the data across the board, every index looked good.”

Net cash flow good

Lustgarten said net cash flow in the current cycle is double the increases of the early 1990s and larger than the impressive giants of the early 1980s. During the past three years, the incremental growth in net cash flow has totaled $374 billion, more than three times what occurred in the early-1990s upturn. Improving profits are reflecting exceptional productivity, cost reduction, and wage restraint. He said corporate CEOs still felt the continuing need to emphasize cash generation in light of focus on accounting standards.

He said capital spending will continue to rise, for the following reasons: faster depreciation incentives have expired with minimal negative effect; ongoing postponement of purchases and technological change should help spur spending as the recovery continues; and global markets and US competitiveness overseas should improve, helped by the weakening dollar.

“The war chest of cash flow argues for a long and strong capital expenditures cycle,” he said. “They will continue to strengthen, given factory utilization rates now hovering around 78%-79% in the manufacturing sector, up from 75%-76%. Improving industrial production has raised the overall capacity utilization rate to nearly 80% in July 2005, within the 78%-82% trigger for a major upturn in capital spending.”

He said that although the job recovery has been the weakest on record, the economy still added 2.2 million jobs last year and had added 1.1 million in 2005 as of the end of July; wages and salaries of workers were up 8% this year; and through the second quarter, income from wages and salaries was up 50% (above the average performance of the 1990s boom years).

Even though gasoline briefly pushed above the $3-a-gallon mark, consumers were buying more gasoline, not less. And consumer confidence rose to 106.2 in August from 105.6 in July, with real household spending up 4% and home sales hitting a record.

“Why?” he asked. “Workers were more productive than in past recoveries. Manufacturing productivity is up 5% this decade. Low interest rates help boost household net worth to 12% above the peak stock market bubble, though 70% of the increase is due to rising home equity. Debt service as a percentage of after-tax income is unchanged over the past two years.”

Construction spending strong

He said Wal-Mart's plans for 2006 include opening up to 45 new discount stores and 250 new Supercenters (relocations or expansions of existing discount stores will account for approximately 160 of the Supercenters, while the rest will be built in new locations).

He said this is encouraging because Wal-Mart stores top the private carriers' list, with more than 42,000 trailer fleet — up over 40% from 30,000 two years ago.

Lustgarten said construction spending remains strong, and is going higher.

“It's one of your most important markets,” he said. “It's probably one of the healthiest markets, and there's no reason why it should get worse.”

He said residential construction was expected to decline this year, but may not fall as far as the estimated 5% to about 1.85 million starts as interest rates rise. Non-residential construction is still expected to recover at least 6%-8%. The preliminary residential forecast is about 1.8 million starts for 2006.

This year's demand for equipment has been much stronger than originally anticipated by most manufacturers, led by loader backhoes (up 15% year-to-date, driven by Latin America's 45% increase) and mining equipment (up 10%, with 20%-30% gains everywhere except Europe, which is down 2%). The forecast for 2006 is growth of up to 10%, weighted toward medium/heavy equipment.

In the medium-duty Class 5-7 markets, he said low interest rates and economic strength should continue to drive commercial demand, but rising energy costs and some pullback in consumer discretionary spending is taking its toll on vehicle demand. He said part of the decline in the Class 6-7 markets is attributable to continued growth in the Class 5 segment, which is up 33% year-to-date.

He said the 1997-1999 truck market positives clearly were not sustainable because: strong domestic economic and industrial production/capacity utilization growth was not sustainable; the Union Pacific/UPS strike was followed by Conrail/CSX integration problems; NAFTA benefits of increased Mexican and Canadian trade have waned; and fleet replacement cycle shortened from four to five years to three to four years due to increased utilization and cash flow, driver enticements, flat prices, and guaranteed residual prices.

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