Construction Activity Up in 2017: Residential Upsurge Makes Up for Declines in Infrastructure Spending
by John Crum November/December 2017
Red tape may have put public construction projects on hold this year, but a surge in private spending drove an overall increase in construction activity. Wells Fargo’s John Crum examines this and other key industry observations including the rental market, new equipment sales, used equipment prices and the effects of hurricane season. Looking ahead to 2018, he predicts it could be another great year for construction if this year’s pattern holds.
The U.S. construction industry started the year with high hopes and expectations. Our stakeholders strongly anticipated increased work, lower regulations and a friendlier business environment. It didn’t matter who was speaking, the buzz was overwhelmingly positive.
Much of this feedback was based on talk of a federally funded infrastructure package that would help spur growth and keep the construction industry busy throughout 2017 and beyond. While that talk began almost every conversation, more often than not the rest of the conversation moderated these expectations based on gridlock at the congressional level, lack of specifics of the talked-about infrastructure plan and the fact that, even if passed, a comprehensive plan would take 12 months or more to materialize in the field.
Summarizing the mood in Q4/16 and Q1/17, even though industry participants highly anticipated a long-term plan, most were cautious, or even reluctant, to believe one was coming soon. Our own Construction Industry Forecast, completed after the November presidential election, showed the overwhelming majority of industry executives believed 2017 would be better than 2016 and their optimism extended into 2018. Before we dive into the 2017 industry review and potential 2018 outlook, let’s look at a few key industry observations.
Significant research exists on the long-term prospects for rental and the segments that serve it. The consensus of the research shows that the market, while subject to periodic fluctuations due to economic conditions, will grow in the coming five years. How much it will grow is subject to debate but many reports put the rate in the 5% to 10% range. This research, supplemented with conversations with executives in the market, has confirmed that our previous observations of the rental market remain intact.
There has been a long-shift in contractors/end-users’ habits regarding rental as a permanent component of fleet management driven by a continued abundance of equipment for rent, general affordability of rental equipment used to supplement permanent owned equipment fleets and a desire to transfer risk from the contractor to the rental provider. This year has produced strong results in the rental market for independent and dealer-owned rental fleets.
Publically available information on rental company results shows that revenues, profits and utilization rates are up. HERC Holdings (formerly Hertz Equipment Rental Company) reported first half results ending June 30, 2017 showing total revenue up 9.3% and rental revenue up 7%. For its first quarter ending July 31, Sunbelt Rentals reported revenue and profitability increases of 15.2% and 17.4%, respectively.
For the first nine months of 2017, United Rentals reported rental revenue increased by 11.7% on a year-over-year basis. Taking into account its acquisition of NES in April, pro forma rental revenues are up 6.5% and both actual equipment on rent and time utilization are up significantly. M&A activity has been robust with both large and small acquisitions happening at a brisk pace, another sign that the rental market continues to be attractive.
New demand caused by recent natural disasters will only add to the positive environment for participants on the supply side of the rental market.
New Equipment Sales
Major equipment manufacturers have fared well so far in 2017. For the third quarter ending July 31, 2017, John Deere reported sales in its Construction and Forestry segment increased worldwide by 29% compared to Q3/16. In third quarter results ending September 30, 2017, Caterpillar indicated overall sales improved 27% in North America, with the Construction segment leading the way at a 31% increase. Komatsu reported North American sales of seven major products increased 8% year over year.
Other manufacturers have reported robust sales in North America. Volvo CE reported first half sales increases in North America of 16%, while Case Construction reported a Q2/17 global sales increase of 13.6% in North America and Asia as drivers of growth. These sharp increases will be difficult to repeat, particularly because the comparison periods to 2016 in many cases were from declining inventory levels. However, the industry appears to be set for continued increases in new unit sales going into 2018.
Used Equipment Prices
For used equipment, the accessibility of online auction and bidding, coupled with increased transparency of machine condition and warranties has lowered the margin between retail prices and auction prices of construction equipment. This is a trend that will likely continue. In many ways, it makes the evaluation of used equipment easier for industry participants. With that backdrop, used equipment prices have stabilized in 2017 while certain asset types have increased in value, notably wheel loaders, articulated trucks and hydraulic excavators. Given the increase in demand anticipated for other asset types needed for storm clean up, this is a trend that will carry over to additional asset types for the next several months.
Impacts of the Hurricane Season
Devastating hurricanes swept through Houston and parts of Florida this year. While it is difficult to find specific information about the overall impact of a major storm on a specific industry segment, a few resources relevant to H2/17 and 2018 are available and worth discussing. The first is the producer price impact for construction materials. Damage from the hurricanes has affected the price of multiple segments of construction materials. From September 2016 to September 2017 building material prices increased as a result of greater demand and scarcity of supply for multiple products. According to AGC, the price of gypsum — used to make drywall — has increased 8%. Cement has increased 4.5%, lumber and plywood prices have risen 6.8% and asphalt is up 30.2%. These are more dramatic examples, and the percentage increases might not hold throughout 2018. But with rebuilding efforts forecasted to last months, if not years, certain materials will experience long-term increases in pricing.
Without any measurement of activity related to the storms yet available, overall construction activity for 2017 is up. According to the U.S. Census Bureau, the total value of construction put in place, seasonally adjusted, was up 2.5% from August 2016 to August 2017. The overall increase has been led by a strong 11.3% upsurge in residential construction. For parts of the industry related to residential construction, 2017 is shaping up to be a very good year. On the opposite side of the coin is an overall 3.4% decline in non-residential construction. Looking at it another way, the value of all private construction is up 4.7% in the same period while public construction is down 5.1%.
Multiple reasons can be cited for the decline in infrastructure spending and the overall decrease in public construction spending. Industry participants point to a lack of appointments to key permitting boards and agencies that approve large-scale projects. This issue, coupled with vacancies in strategic agencies, has caused significant delays in new work permits. Some of the openings have been filled in the last few months, but the openings and delays affected many key, large-scale projects.
Other factors contributing to the decrease include shortfalls in a few large-population state budgets. In these states, projects have been approved — and often awarded — but put on hold or delayed due to lack of funding.
This doesn’t mean the news is all bad or that the industry is down. In fact, three key stakeholder levels — contractors, dealers/rental companies and manufacturers — remain optimistic and anticipate continued improvement in the industry.
Predicting the future is impossible. The best we can do is look for trends and make educated assessments of what might happen. The Dodge Momentum Index fell by 9.4% in September, marking the fourth consecutive month of decline. This index is typically an indicator for non-residential building activity for the next 12 months. Does this mean we are likely to see continued declines in non-residential building activity? Not necessarily according to Ken Simonson, chief economist for the Associated General Contractors of America. In the October 6 edition of Data DIGest, Simonson noted similar index declines were seen prior to the 2008 industry peak. The index rebounded in the following months to be more in line with general economic growth.
In September, the Architectural Billing Index turned negative for the first time in seven months, but the decline was concentrated in the West with the Northeast, Midwest and South remaining positive. In addition, commercial, industrial and mixed billings remained in growth territory. In October, the U.S. Homebuilder Confidence Index rebounded after a storm affected decline in September. With single family housing starts typically following the Homebuilder Confidence Index and a continued low inventory of new homes for sale, conditions are present for continued increases in residential construction activity, which typically stimulates other private construction activity.
Here’s the bottom line: If this year’s pattern holds, private spending could take the lead again with an upside coming from a public construction increase. If both of these occur, the good of 2017 could easily carry into next year for all parts of the construction industry.
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