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Construction Industry Insight | 2017

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This document focuses on a number of topics that affect the construction industry as a whole, including the decline in infrastructure borrowing, the downgraded construction forecast stemming from moderating economic growth, the shortage of construction workers, the bounce back in the construction equipment markets, keys to maintaining equipment resale value, and the rise in construction stock prices caused by the recent hurricanes. It also includes a brief summary of trends in used equipment values.

Hot Topics

Infrastructure Borrowing Declines as U.S. States Await Details of Trump Plan: President Donald Trump took office having promised a bold 10-year $1 trillion infrastructure investment plan to address deteriorating roads, bridges, airports and transit systems across the U.S. Earlier this year, the American Society of Civil Engineers assigned a D+ grade to the U.S. infrastructure.  Now, more than half a year since the inauguration, details on the future of federal infrastructure funding are still unclear. This is one reason state and municipal governments have issued fewer bonds to improve roads, water systems and other projects thus far in 2017. Moreover, they have been put off by the overall rise in interest rates. According to an analysis of Thomson Reuters data, through July, municipal bonds issued to fund transportation, utilities and power projects totaled $50.7 billion, down 19.4% from the same period last year.

The Trump administration has announced that the infrastructure plan is to be financed through $200 billion in government funding, supported by private investment. While states and cities build most of the country’s public infrastructure, they generally rely on stable and predictable funding from the federal government to help complete those projects. Historically, the U.S. has financed the vast majority of its infrastructure through the tax-exempt, low-cost channel of the $3.8 trillion U.S. municipal bond market. According to James Grabovac, a managing director at McDonnell Investment Management, Trump’s plan to utilize private financing to spur the bulk of his infrastructure program is “unrealistic”. Until the details on the federal funding of the infrastructure plan are made clear, it is likely that both state and local governments will be reluctant to independently engage in long-term infrastructure financing of any significance.

Moderating Economic Growth Triggers Downgrade in Construction Forecast for 2017/2018: Entering 2017, construction forecasters were quite optimistic about the near-term outlook for the industry. That optimism reflected a 6% increase in construction spending across the entire nonresidential building sector for 2016, paced by more than a 10% increase in the commercial sector. On top of that, 2017 was to be the year that federal fiscal policy would provide even more momentum for this market. Tax reform and financial deregulation were going to unleash investment capital, and the repeal and replacement of the Affordable Care Act was going to reduce financial burdens on small businesses. Additionally, a 10-year $1 trillion infrastructure program would directly support construction growth for the foreseeable future. However, little progress has been made on these key elements of the Trump administration’s legislative agenda, and optimism regarding the outlook for the industry is waning. The U.S. economy has seen only about 2% annualized growth over the first half of this year and that is weighing heavily on consumer sentiment and business confidence. Construction spending so far in 2017 has been fairly disappointing. Commercial/industrial construction spending has increased just under 7% through the first five months relative to the same period in 2016, compared to more than 10% growth for 2016 overall. Although some slowdown was anticipated for 2017, it was expected to be offset by the institutional sector. However, year-to date spending for institutional buildings has grown only 3%. While that is up from 1.6% in 2016, it is well below expectations when the year began.

Considering the above factors, in July the American Institute of Architects (AIA) Consensus Construction Forecast panel predicted slower growth for the construction industry for the remainder of 2017 and through 2018. They project that overall spending for nonresidential buildings in 2017 will be just under 4%, compared to the 5.6% forecast at the end of 2016. The commercial market is expected to perform largely as anticipated; however, both the industrial and institutional sectors have been marked down considerably. For 2018, overall spending growth is projected at 3.6%, down modestly from the forecast entering this year.

The recent slowdown in construction spending activity, and the scaled-back forecasts for the next 18 months, are a result of several factors including: (a) a potential slowdown in the U.S. economy, (b) rising interest rates, (c) the rising cost of materials, and (d) the potential shortage of labor stemming from the decrease in unemployment rate in the construction industry and the recent focus on immigration. However, one key factor that is not considered in the scaled-back forecasts is the anticipated increase in construction that is likely to result from the destruction caused by recent hurricanes. See the discussion below entitled “Hurricanes Lift Construction Stocks & ETFs”.

Shortage of Construction Workers Continues to Raise Concerns: In many parts of the country, construction activity isn’t growing as fast as it could be, due to a lack of workers. The construction industry’s unemployment rate is at a record low. It was at 5.3% in May — the second-lowest rate since May 2000. In some states, it’s significantly lower. In Iowa, Idaho, Colorado, Indiana and North Dakota it’s between 2.2% and 2.5%. While that’s great news for workers, it makes new buildings more expensive to construct and has the potential to slow down the creation of new housing just as the need for it increases. Part of the shortage of construction workers stems from the Great Recession that followed the 2007 housing crash. During the financial crisis, the construction industry shed about 2 million jobs. Many of those workers left the field permanently. According to Reuters, an estimated 30% went into other industries. While there’s not much evidence that the White House’s anti-immigration rhetoric has had an impact on the industry, it does not bode well for the worker pipeline. Almost one-third of the construction workforce is foreign-born; according to the Pew Research Center undocumented immigrants make up about 14% of the industry. Moreover, many more people will be needed to replace those leaving, particularly given the devastation caused by recent hurricanes. Meanwhile, with fewer workers to build houses, existing homes are practically flying off the lot, with the typical house going under contract in less than a month.

Construction Equipment Markets Bounce Back: Global construction equipment sales are expected to increase 16% this year, according to Off-Highway Research, a specialist consultant.  In 2017, worldwide sales are expected to exceed 810,000 units, with a value of more than $80 billion. Most major regional equipment markets are expected to see growth this year, but the key driver will be China where crawler excavator sales have more than doubled in the first half of 2017, compared to the same period last year. Elsewhere in the world, the Indian market remains strong, with 10% sales growth forecast for this year, following the 36% surge seen in 2016. As a result, the Indian market will surpass the previous record high of 54,065 machine sales in 2011.  In Europe, sales of construction equipment are expected to grow 2% to almost 145,000 units.  This moderate rise follows an 11% surge in 2016, which was driven by booming demand from the German residential construction sector. The North American market is expected to climb 8% to over 170,000 units. This would take it back to levels seen in 2014 and 2015, before market growth was disrupted by last year’s presidential election. Similarly, in Japan, a 4% increase in equipment sales is expected, following a slump in demand last year. The 2016 correction in Japan was preceded by three years of unusually high sales in response to the government’s stimulus policies and the demand for equipment needed for reconstruction work following the 2011 earthquake and Tsunami. Over the longer term, Off-Highway Research expects global construction equipment sales to rise to close to 900,000 units by 2021, with a value of more than $90 billion in today’s terms.

Keys to Maintaining the Resale Value of Heavy Construction Equipment: The resale market value of heavy construction equipment totally depends on how the equipment has been used over the years. Because they understand the durability of the equipment, many contractors tend to use it in extremely rough and hard conditions without bothering to service or repair it. If the equipment is to work properly for a long period of time, some effort needs to be put into getting it serviced or repaired on a regular basis. It may be easy to get resale value for a heavy construction machine, but to get the desired resale price it must be properly maintained. To get a good price, the seller should clearly describe all the specs, as well as the defect details. This is important to maintain credibility and to avoid accusations by the purchaser subsequent to the sale. If the heavy construction equipment is not up to the mark, avoid writing good things about it.  Those who are conscientious about maintaining the resale value of their equipment generally follow two main practices; they hire qualified operators who know how to handle the equipment on different types of terrains and they have the equipment serviced at least once every two months to preserve its longevity.

Hurricanes Lift Construction Stocks & ETFs: The devastation caused by hurricane Harvey in the Houston area and hurricane Irma throughout various parts of Florida will—in all likelihood—lead to billions of dollars’ worth of damage to homes, buildings, and infrastructure. Still, despite the seemingly distasteful nature, these storms have caused construction stocks to rise. Shares of construction equipment giant Caterpillar CAT gained 0.45% on Friday, September 8. Other companies in the industry also saw their stock prices rise before Irma made landfall in Florida.  Gibraltar Industries ROCK stock jumped over 1.50%, while shares of United Rentals URI and NCI Building Systems NCS both climbed over 3.50%. Construction and infrastructure Exchange Traded Funds (ETFs) saw gains as well.  Shares of the SPDR S&P Homebuilders ETF XHB, the PowerShares Dynamic Building & Const ETF PKB, and the iShares U.S. Home Construction ETF ITB all leapt higher.

The rise in construction stock prices certainly reflects an anticipated increase in construction activity. As a result, economists predict that heighted competition for construction workers could result in higher wages. In addition, an uptick in construction activity is likely to have a positive impact on the prices of both new and used equipment.

Trends in Used Equipment Values

Private industry feedback recently obtained by Thompson Research Group shows that prices for used equipment saw improvement in the beginning of the year, but subsequently stabilized.  Used equipment prices were largely unchanged across equipment types, with the exception of rough terrain cranes that trended lower. Contributing to the weakness in this category is a recent bankruptcy by a crane rental company that has added to the industry supply. The weakness in crane demand is also consistent with Thompson’s feedback from H&E Equipment, one of the largest integrated equipment companies in the nation, where new crane sales have fallen off dramatically. During the first quarter of 2017, new crane sales at H&E were down 73.5% year-over-year due to reduced demand caused by lower-levels of oil & gas activity.

The prices of used equipment are now on an upswing as contractors and rental companies continue to utilize their equipment rather than sell it. The reduced supply of late-model low-hour used equipment is due in part to continuing deregulation which has caused pipeline projects to boom in areas of the country where the oil and gas infrastructure is still limited. The large players in this business are renting large quantities of certain excavators and crawler tractors and many of the manufacturers are months out in filling new equipment orders. Also, many end users are still reluctant to purchase new equipment, thus fueling the demand for rental equipment. As indicated in the preceding section, it is likely that the values of both new and used equipment will benefit from the anticipated increase in construction activity resulting from the destruction caused by the recent hurricanes. Specifically, it is probable that we will see an immediate run on skid steers, wheel loaders and wheeled excavators as the cleanup begins.