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Current Environment.............................................................................................. 1
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STANDARD & POORS INDUSTRY SURVEYS is published weekly. Annual subscription: $10,500. Please call for special pricing: 1-800-852-1641, option 2. Reproduction in whole or in part (including inputting into a computer) prohibited except by permission of Standard & Poors. Executive and Editorial Office: Standard & Poors, 55 Water Street, New York, NY 10041. Standard & Poors Financial Services LLC is a wholly-owned subsidiary of The McGraw-Hill Companies. Officers of The McGraw-Hill Companies, Inc.: Harold McGraw III, Chairman, President, and Chief Executive Officer; Kenneth M. Vittor, Executive Vice President and General Counsel; Robert J. Bahash, Executive Vice President and Chief Financial Officer; John Weisenseel, Senior Vice President, Treasury Operations. Periodicals postage paid at New York, NY 10004 and additional mailing offices. Postmaster: Send address changes to Standard & Poors, Industry Surveys, Attn: Mail Prep, 55 Water Street, New York, NY 10041. Information has been obtained by Standard & Poors INDUSTRY SURVEYS from sources believed to be reliable. However, because of the possibility of human or mechanical error by our sources, INDUSTRY SURVEYS, or others, INDUSTRY SURVEYS does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. Volume 177, No. 15, Section 1. This issue of Industry Surveys includes 2 sections.
CURRENT ENVIRONMENT
What is down must go up
The US economy has been in recession since December 2007, according to the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER), an organization that provides economic research. Standard & Poors Economics believes that this will be the longest recession in post-war history. In 2008, payrolls registered 12 consecutive months of declines. Job losses totaled 2.589 million, just below the record of 2.75 million set in 1945. The unemployment rate reached 7.2%, the highest in 16 years. The US housing and auto markets have been among the worst affected areas of the economy during this period. Business and consumer confidence readings have also been weak, with the University of Michigans US consumer sentiment index plunging to a low of 55.3 in November, the lowest reading in 28 years. The index moved up to 61.2 in January 2009, but then fell to 56.2 in mid-February 2009. All of the industrial companies in the heavy equipment sectors have felt the chill of the recessionary headwinds. In 2008, they struggled with negative economic growth in the US in combination with surging manufacturing input costs from raw materials, labor, and energy. Caterpillar Inc., a major bellwether for the heavy equipment sector, noted recessionary conditions in the US in the first quarter of 2008, but saw continued pockets of strength, notably in emerging markets and in mining and energy demand. By year-end 2008, however, the perfect economic storm had formed. Arriving all at once were a sharp pullback in energy and mining commodity prices, the global credit crunch, the European Union in recession, and a slowing of growth in the previously strong emerging markets of the BRIC countries (Brazil, Russia, India, and China), and other emerging market economies. According to data released by the US Department of Agriculture (USDA) in its 2009 Farm Sector Income Forecast, record-high agricultural commodity prices allowed farmers in the US to build the strongest balance sheets ever recorded, with farm equity of $2.134 trillion in 2008, up from $1.998 trillion in 2007. Farm equity is forecast to rise further in 2009 to $2.171 trillion. This created unprecedented demand for farm equipment globally, and manufacturers such as Deere & Co., CNH Global NV, and AGCO Corp. had record earnings in 2008. However, in the final quarter of 2008, we saw a sharp pullback in agriculture commodities prices and, subsequently, weakening demand for agricultural equipment, which we expect to continue through 2009. We do not believe that this drop in demand will be as severe as construction equipment manufacturers will experience, since we have a more positive outlook for the farming industry. Although manufacturers of heavy trucks saw anemic sales in the US, they benefited from exposure to emerging markets in 2008; however, by year end, even this market had experienced a pullback in demand. Chinas heavy truck market continued to maintain its global No. 1 position (as measured by unit sales), with 540,448 units sold in 2008 (up 27.2% year-on-year), compared with a slow North American market with 207,199 units sold. Chinas market is very difficult for foreign manufacturers to compete in, since Chinese manufacturers enjoy a price advantage of almost 66% over US manufacturers. By year-end 2008, emerging market demand had also waned significantly. A further pullback in global demand is expected in 2009 as the global downturn gains momentum. Both the Chinese and North American heavy truck industry are simultaneously undergoing a sharp pullback in demand. Comparing January 2009 with the same month of 2008, sales in China dropped by 72%, to 10,851 units, while North American sales dropped 23% to 13,669 units. However, we expect an uptick in activity in late 2009 from the replacement of aging fleets and a pre-buy of trucks before the revised US emission standards take effect in 2010. Although heavy equipment manufacturers are currently in a recessionary global economic environment, it is important to remember that the industry is coming off several years of strong results. During the economic expansion of the past several years, many heavy machinery companies experienced improved sales and profits as a result of increased demand. In the five years through 2008, sales at three bellwether heavy equipment
INDUSTRY SURVEYS
companiesCaterpillar Inc., Deere & Co., and Paccar Inc.grew at an average compound annual growth rate (CAGR) of 14%. During the same period, earnings grew at an average CAGR of 20%, reflecting the significant manufacturing operating leverage inherent in these companies business models.
INDUSTRY SURVEYS
packages passed by governments worldwidea major beneficiary of which will be infrastructure projects will greatly assist the construction industry to regain growth. Against this backdrop, McGraw-Hill Construction has forecast, in its annual Construction Outlook 2009, that the overall level of construction starts in 2009 will slide another 7% to $515 billion, after a 12% decline in 2008. For the 12 months ended January 2009, total construction declined 9.1%: residential construction declined 27.4%, but was offset slightly by growth of 2.1% in nonresidential construction. We expect these conditions to continue through late 2009, as the economy struggles with a very weak employment market and the credit freeze. Funding continues to be difficult, as construction loans and commercial mortgages become pricier and harder to get. Declining US payrolls are reducing demand for offices.
CONSTRUCTION PUT IN PLACE IN THE UNITED STATES (Annual value, in millions of current dollars)
TYPE OF CONSTRUCTION 1995 2000 2005 2006 2007 2008
TOTAL CONSTRUCTION Total private construction Residential Lodging Office Commercial Health care Educational Religious Public safety Amusement and recreation Transportation Communication Power Sewage and waste disposal Water supply Manufacturing
548,666
802,756
1,102,703 868,543 611,899 12,666 37,276 66,584 28,495 12,788 7,715 408 7,507 7,124 18,846 26,304 240 326 29,886
1,167,554 912,169 613,731 17,624 45,680 73,368 32,016 13,839 7,740 419 9,326 8,654 22,187 31,164 305 477 35,086 255,385
1,137,152 850,009 492,499 27,503 53,377 84,999 34,776 17,071 7,429 495 10,352 9,444 26,947 41,481 383 460 42,229 287,143
1,078,858 770,392 358,351 36,663 57,911 82,272 37,827 18,771 7,107 686 11,041 10,208 24,726 59,432 605 712 63,817 308,465
408,655 621,431 228,121 346,138 7,131 16,304 22,996 52,407 TABLE B01 44,096 64,055 CONSTRUCTION 15,259 19,455 PUT IN PLACE IN 5,699 11,683 4,348 8,030 185 423 5,886 8,768 4,759 6,879 11,112 18,799 22,006 29,344 576 508 670 714 35,364 37,583
Total public construction 140,011 181,325 234,160 Note: All data revised. Figures may not add to totals due to rounding. Source: US Department of Commerce.
Private residential construction, which typically represents roughly half of total construction outlays, came in at $291.5 billion (SAAR) in January 2009a decline of 28% from the $404.9 billion in January 2008. Public construction outlaysgenerally about 30% of total construction spendingshowed a gain in January 2009; at $303.7 billion (SAAR), this total was 4.4% higher than the year-earlier level. The yearover-year increase reflected increased government spending on infrastructure projects such as bridges, highways, and water supply projects. However, on a monthly basis, spending declined 2.3%. We expect public construction outlays to grow substantially as a result of the stimulus packagethe American Recovery and Reinvestment Act of 2009with its focus on public infrastructure projects. Nonresidential private construction (roughly 40% of total construction outlays) rose to an annualized rate of $391.0 billion in January 2009. This represented a 4.3% decrease from December 2008, and a 0.3% increase from January 2008. Additionally, we see slowing equipment spending as companies delay fleet additions due to an economy in recession and hard-to-obtain and expensive financing. Capital equipment spending will fall 14.8% in 2009, after rising 1.5% in 2007, according to Standard & Poors forecasts. While the balance sheets of many large US corporations are pretty sound, with low debt and record cash levels, smaller companies are less well positioned, with higher debt levels.
INDUSTRY SURVEYS
Medium-duty trucks, total 16,00119,500 lbs. 19,50133,000 lbs. Heavy-duty trucks (over 33,000 lbs.) Total North American Med. & heavy truck sales Source: ACT Research.
148,994 169,117 184,454 148,874 119,133 TRUCKS, BY WEIGHT CLASS 40,053 49,845 53,200 50,245 47,556 108,941 119,272 131,254 98,629 71,577 260,553 409,547 326,211 495,328 368,791 553,245 237,614 386,488 207,070 326,203
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Pre-buying occurs for two main reasons: cost and uncertainty. The newer engines tend to be more expensive (Paccar estimates from $5,000 to $10,000 more, depending on horsepower and application) than the ones they replace: manufacturers need to recoup the incremental engineering, development, and production costs associated with the new emissions-compliant engines. Additionally, because users have not extensively tested the new engines, the information available regarding fuel efficiency, maintenance costs, and reliability is usually limited. Much of the expected price increase will result from the cost of the new emissionsreduction components. Fuel economy has a big impact on truck operators purchasing decisions, since fuel represents approximately 25% to 30% of business costs. Maintenance costs are also a large portion of a vehicles total cost of ownership. However, truck operators also increasingly value vehicle reliability: businesses that have moved toward a just-in-time (JIT) inventory model (which aims to minimize inventory costs by shipping parts or products when they are needed) increase the pressure on truckers to meet tight shipping deadlines. The number and length of carriers tests of new engines and the results of those tests will also have a large influence on pre-buying activity. The more time that truckers have to test the engines, the less uncertainty there is likely to be with respect to incremental fuel and maintenance costs associated with the new engines. The results of the tests will also influence how much pre-buying activity occurs: if the new engines exhibit unappealing aspects such as reduced fuel efficiency and/or higher maintenance costs, more operators would be expected to pre-buy trucks ahead of the introduction of the new EPA emission standards in 2010. These factors lead us to expect pre-buying of Class 8 trucks in 2009 before the new emissions standards take effect with the 2010 model engines. While it is difficult to estimate the exact portion of purchases that will be related to pre-buying, with some purchase activity that is expected as a result of replacement demand and expectations of an economic pick-up in 2009, we think that pre-buy activity will represent a significant portion of demand. Updated budget from the DOT In 2005, President Bush signed the Safe, Accountable, Flexible, and Efficient Transportation Equity Act: A Legacy for Users (SAFETEA-LU), a $286.4 billion, six-year highway bill. It provides funding for states through September 30, 2009, and represents about a 31% increase over the $218 billion in funding provided by the Transportation Equity Act for the 21st Century (TEA-21). As a result of SAFETEA-LU, we expect state spending to increase through 2009, as federal funding will likely allow highway-related projects to move forward. The fiscal 2009 budget request proposes $41.9 billion in federal highway funding for that year (up slightly from $41.2 billion in 2008), the amount called for under the 2005 highway law (PL 109-59). However, the Administrations fiscal 2008 budget proposal had decreased funding for certain parts of SAFETEA-LU. Transit funding, as part of SAFETEA-LU, set spending at $9.7 billion, but the DOT budget provides only $9.4 billion for transit programs. SAFETEA-LU established the Revenue Aligned Budget Authority (RABA) funding program, which allowed highway funding to exceed the authorization if gas tax revenues surpassed projections. Based on these gas tax revenues, the states were guaranteed an additional $631 million RABA adjustment in fiscal 2008, but this amount was not part of the presidents budget.
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regard to water infrastructure, 12 cents of every dollar spent on sewer and drinking water projects is for construction equipment.
Cash expenses 226.0 261.1 250.1 250.2 Net cash income 87.4 90.5 81.0 82.9 Total production expenses 254.4 290.9 281.0 282.9 Net farm income 86.8 89.3 71.2 78.1 E-Estimated. F-Forecast. Source: Food and Agricultural Policy Research Institute.
YEAR
2009F 324.1 71.2 4.9 4.3 Table B02: 5.0 FARM INCOME 2008E 354.3 89.3 4.4 AND FARM EQUIPMENT 2007 313.4 86.8 5.0 3.6 EXPENDITURES 3.6 2006 274.1 58.5 4.7 2005 281.5 79.3 5.1 4.3 2004 267.4 85.8 6.0 4.5 2003 249.5 60.5 5.0 4.2 2002 221.0 39.6 4.0 3.9 2001 235.6 54.9 3.7 4.0 2000 228.6 50.6 3.3 3.7 1999 224.0 47.7 3.3 3.5 1998 222.5 47.1 3.5 3.9 1997 227.5 51.3 3.3 3.7 E-Estimate. F-Forecast. Source: US Department of Agriculture.
7.0 7.1 7.1 6.2 7.1 7.0 5.9 5.8 6.0 5.3 5.3 5.5 5.2
16.2 16.5 15.7 14.4 16.6 17.5 15.2 13.6 13.8 12.4 12.1 12.9 12.2
Given the leading nature of farm income, we expect equipment sales to show signs of softening demand in 2009, as farm input costs of fertilizers, seed, labor, and land remain relatively high and prices for agricultural commodities remain below the peaks set during 2008, thus narrowing margins for farmers. Consequently, we anticipate that endmarket conditions for farm equipment manufacturers will decline from the growth rate set in 2008. We still expect to see continued strength in the global farm sector, which we believe will benefit on a recovery in agricultural commodity prices from the sharp pullback in late 2008 and through 2009.
INDUSTRY SURVEYS
The three biggest global manufacturers of farm equipment, Deere & Co., AGCO Corp. and CNH Global NV (the Netherlandsbased maker of Case and New Holland tractors), collectively posted an increase of 15.0% in agriculture equipment revenues in 2008, year-over-year. Together, these firms control about 55% of the global farm equipment market. Sales of farm equipment in 2008 were aided by continued positive farm conditions globally; however, we do see pockets of weakening demand in Latin America, Eastern Europe, Russia, and Asia/Pacific from continued credit constraints. Farms benefited from historically strong commodity prices in 2008, aided by global demand for food and energy crops and a weak US dollar. In 2009, the global landscape has shifted dramatically, with a sharp pullback in agricultural commodity prices as the global recession has hurt demand, notably for food and energy crops. Competing with energy crops are fossil fuels, which have fallen even more sharply since the global downturn began. The price per barrel of oil (as measured by West Texas Intermediate/Light Crude) has dropped from a high of $147 in July 2008 to an expected average of $42 per barrel in 2009, according to forecasts from the US Energy Information Administration (EIA). Should fossil fuel prices remain low, demand for energy crops will also be subdued and, therefore, hurt agricultural equipment demand. Global grain stocks for wheat and corn are forecast to be at or near 30-year lows relative to consumption.
US CORN USED IN FUEL PRODUCTION (Millions of bushels)
1 4,000 1 2,000 1 0,000 8,000 6,000 4,000 2,000 0
1 982 85 88 91 94 97 00 03 06
35 30 25
20 1 5 1 0 5 0
E09 E1 E1 E201 2 5 8
Biomass fuels legislation contributing to farm equipment demand The updated rulemaking for the Renewable Fuel Program of the Energy Policy Act of 2005 provided a comprehensive program for 2007 through 2012 and beyond. The policy mandates a rise in renewable fuel use in gasoline to 7.5 billion gallons by 2012, nearly double the estimated four billion gallons of fuel ethanol consumed in the US in 2005. The Energy Independence and Security Act of 2007 expanded the Renewable Fuels Standard to require that 36 billion gallons of ethanol and other fuels be blended into gasoline, diesel, and jet fuel by 2022. Ethanol production in the US has continued to increase over the past several years, from less than 3 billion gallons in 2003 to over 9 billion gallons in 2008. The USDA estimates that about 25% to 33% of all corn grown will be used to manufacture ethanol in the 200809 crop year. A total of 3,026 million bushels is expected to be used for fuel consumption out of a total production of 12,774 million bushels. Additionally, the economic stimulus bill has a number of provisions aiding renewable biomass fuels (algae fuel, bagasse, babassu oil, biobutanol, biodiesel, biogas, biogasoline, cellulosic ethanol, ethanol fuel and vegetable oil), which are derived from crop farming. The legislation extends tax credits through 200910 depending on
Other corn usage (left scale) Fuel alcohol use (left scale) % of corn production used for fuel (right scale) Source: US Economic Research Service.
(Price, $/barrel) 1 40 1 20 1 00 80 60 40 20
S&P GSCI Agriculture Index (left scale) Crude oil price (West Texas Intermediate, right scale)
Source: Standard & Poor's.
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the type of biomass fuel or renewable diesel (except foreign-produced fuel) including regular fuels that incorporate biomass gas, energy-efficient biomass fuel stoves, and energy efficiency improvements at the residential level. We see these tax credits as directly benefiting agricultural machinery demand for energy crop production. Energy crops are Chinese tallow, hemp, maize, rapeseed, sorghum bicolor, soybean, stover, straw, sugarcane and sunflower. According to the Annual Energy Outlook 2009 from the US Energy Information Administration, renewable fuel will comprise 5% of total fuel usage in the US in 2009, rising gradually to 9% of total usage in 2030, aided by legislative support. The EIA assumed a growth factor of 3.3% per annum. Although fuel ethanol can be produced from different feedstockincluding corn, milo, barley, sugar, starch, and othersin the US, it is produced primarily from corn. Based on statistics provided by the USDAs Economic Research Service, corn used for fuel production is expected to account for 31% of total US corn production in 201617, up from an estimated 20% in 2006 (see chart entitled US corn used in fuel production). The amount of corn used for ethanol has already gone up dramatically, and is projected to have accounted for 27% of production in the 200708 crop year, up from only 7% as recently as 2001, and less than 1% back in 1980. Ethanol represents the third largest market for US corn, after livestock feed and exports. Until the end of 2006, corn and ethanol prices moved independently; however, this changed in 2007, when their prices became highly correlated. For example, in June 2008, corn was $7.50 a bushel and ethanol was $3 per gallon; by October 2008, corn was $3.73 per bushel and ethanol was $1.65 per gallon. A fundamental economic relationship of 2.8 gallons of ethanol to a bushel of cornthe amount of corn it takes to produce the 2.8 gallons of ethanolexists because the ethanol industry is the marginal consumer in the corn market. In our view, long-term energy demand will continue to drive the growing of corn and other energy crops, raising demand for those crops and, ultimately, cash receipts for farmers, giving them more money to spend on agricultural machinery.
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INDUSTRY PROFILE
Heavy equipment trends vary by market
The heavy machinery industry is large and diverse. For purposes of this Survey, Standard & Poors focuses on three main sectors: heavy trucks, construction equipment, and agricultural equipment.
HEAVY TRUCKS
The heavy truck industry is comprised of the design, manufacture, distribution, service, and spare parts sectors, and related financing activities. Based on the combined revenues of the worlds five-largest truck makers, the heavy truck industry contracted slightly in 2008 from 2007, hurt by anemic global endmarkets. We expect this contraction to continue in 2009 as the global economy continues to face a challenging operating environment. However, we do expect a pick-up in activity in late 2009, aided by key replacement cyclical requirements from aging fleets. Heavy trucks, known as Class 8 trucks, are primary haulers of freight in North America and are a beneficiary of economic demand. Economic activity generates haulage, which increases demand for heavy trucks; as a general rule, freight haulage expands or contracts in conjunction with the economy. The majority of demand (about 75% in a HEAVY EQUIPMENT REVENUES AND NET INCOME, BY SEGMENT typical year) is from replacement or the (Ranked by 2008 revenues) scrapping of worn-out equipment, while the OPERATING remaining 25% of demand is driven by REVENUES PROFIT* regional population growth (i.e., the --------- (MIL. $) --------- -------- (MIL. $) -------fractional rate at which the number of COMPANY 2007 2008 2007 2008 individuals in a population increases or HEAVY TRUCKS TABLE B06: HEAVY EQUIPMENT decreases). The current demand for the Daimler AG 41,569 39,925 INCOME, 3,097 2,246 REVENUES AND NET heavy truck industry in North America is Volvo AB 29,045 25,906 2,349 1,551 BY SEGMENT Paccar Inc. 14,296 14,143 1,353 1,157 still suffering from a case of supply Scania AB 13,060 11,342 1,798 1,542 overhang from the overbuying that Navistar International 7,809 10,317 141 818 occurred in 2006 ahead of an EPA emission CONSTRUCTION EQUIPMENT standard change in 2007. We see this Caterpillar Inc. 20,678 23,089 3,006 2,834 overhang of heavy trucks, in combination Volvo AB 13,515 19,294 1,878 3,053 with a contracting economy, continuing to Deere & Co. 8,016 9,986 1,250 1,486 hurt manufacturers in 2009. We do not Komatsu Ltd. 7,157 7,568 765 127 CNH Global NV 8,291 7,148 652 230 expect any pick-up in heavy truck purchase Kubota Corp. 5,035 4,818 571 466 activity until the second half of 2009, when Terex Corp. 5,023 4,464 321 26 we see economic growth beginning.
AGRICULTURAL EQUIPMENT
The heavy equipment manufacturers that participate in the truck industry experienced an overall decline in segment revenues of about 4% from 2007 to 2008, which translated to a segment operating income decline of 16%, as the industry was hurt by a spike in raw material costs from historically high commodity prices. For 2009, we expect a further decline in revenues of between 20% to 25%, as the global recession continues to hurt the truck manufacturers. Due to the manufacturing leverage inherent in financial results of the heavy truck companies, we expect earning to be down around 50% to 60% year-over-year in the first half of 2009, before a recovery is evident late in the second half of 2009. This will lead to further production cuts through 2009 as inventories of trucks continue to be downsized. We expect the heavy truck manufacturing industry could shrink to activity levels not seen since 2002.
Deere & Co. CNH Global NV AGCO Corp. *Before taxes. Source: Company reports.
INDUSTRY SURVEYS
CONSTRUCTION EQUIPMENT
The construction equipment manufacturers make and sell construction equipment, including track and wheel tractors, track and wheel loaders, pipe layers, motor graders, wheel tractorscrapers, track and wheel excavators, backhoe loaders, log skidders, log loaders, off-highway trucks, articulated trucks, paving products, skid steer loaders, and related parts. These manufacturers also produce machinery for other industries, such as agriculture equipment, and energy and mining equipment; and they provide other services, such as logistics, remanufacturing, part manufacturing, and maintenance services. The largest companies in this sector also have financial-service subsidiaries that can provide financing solutions to both the client company and its customers. The largest manufacturers are true global conglomerates, operating in virtually every country on the planet. Investors have perceived that the era of automatically generating profits has come to an end. Construction equipment manufacturers have all entered the global recession, as demand for construction equipment softens substantially. CNH Global NV, in February 2009, stated in a presentation that companies are restructuring and cutting costs as the recession deepens. The global heavy machinery manufacturers posted segment revenue growth for construction equipment sectors of about 13% in 2008, although segment operating income overall declined 2.6% as manufacturers were hurt by escalating raw material costs. Additionally results were impacted by non-cash charges in the fourth quarter of 2008 from goodwill write-down and asset impairment charges. We expect revenues to decline about 25% in 2009, and earnings by around 50%, as the construction industry struggles with a lack of demand across the industry. We see some pockets of strength, notably in certain sectors of the mining and energy industry stemming from pent-up demand for specialty equipment that was not previously supplied due to manufacturing volume constraints. We expect heavy construction equipment demand to remain soft through the end of 2009, when we expect these companies to become beneficiaries of global stimulus packages with a focus on infrastructure development.
AGRICULTURAL EQUIPMENT
The agricultural equipment manufacturers manufacture and distribute agricultural equipment and related replacement parts worldwide. The group produces tractors, combines, planters, tractor-pulled implements and other specialty farm equipment used in farms and in specialty agricultural industries. They also offer related services such as precision farming technologies that enable farmers to gather information, such as yield data, by utilizing satellite global positioning systems; and have divisions which provide financing to customers. The agricultural equipment manufacturers all had a record year in 2008, with segment revenue growth of 34% and segment operating income growth of about 57%. The agricultural equipment manufacturers benefitted from record agricultural commodity prices, which translated to record farm income, allowing farmers to spend more on farming equipment. Additionally, emerging markets such as Brazil, Argentina and Eastern Europe continued to be strong growth markets for agricultural equipment manufacturers. For 2009, we expect a softening of demand, resulting in an overall revenue decline of about 15% and, subsequently, net income declining 30%, from lower agricultural commodities prices through 2009.
INDUSTRY TRENDS
In the heavy machinery industry, demand drivers and business economics can vary from one sector to another. Nonetheless, industry sectors also share a number of trends and themes: consolidation, expanding use of captive finance subsidiaries, focus on productivity, customers ever-growing demands for improved value and service, and e-commerce initiatives. We talk about the common trends first and then describe those affecting individual sectors.
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Fleet operators typically have 30 days visibility on haulage demand. They continue to be hurt by a sharp drop in haulage volume since November 2008, which has continued through February 2009. This drop in haulage volume has led to idle fleet capacity and a further cut back in fleet size by fleet operators. Generally, fleet operators have no plans to purchase heavy trucks for haulage other than the replacement cycle. The drop in fuel costs since mid-2008 has provided working capital benefits. The BRIC countries have extended their global positions through heavy-duty truck manufacturers such as KAMAZ Inc. of Russia (of which Daimler AG acquired 10% in December 2008), Sinotruk Ltd of China, and Tata Motors Ltd. of India (the worlds fourth-largest truck manufacturer). The Chinese heavy truck market is now the largest in the world, with key market positions held by local manufacturers. Brazil, on the other hand, does not have its own heavy-duty truck industry and, as a result, has been divided up by developed-world manufacturers. The Brazilian market is continuing to grow as an important source of sales for heavy duty truck manufacturers. The market is expected to grow in 2009, albeit substantially slower than in 2008. We do not foresee any significant Brazilian players entering into the industry at this stage. We see further consolidation of the heavy truck manufacturers when the credit markets unfreeze and credit begins to flow again for mergers and acquisitions. Volkswagen (VW) is the largest shareholder in both Scania AB and MAN AG (MAN). In January 2009, MAN bought VWs Brazilian truck business. MANs CEO, Hakan Samuelsson, has indicated that he is still eager to unite with Scania after having failed in a hostile bid in 2006. We believe smaller manufacturers, such as Navistar and Freightliner in the US, are also potential take-over targets. We see the number of developed-world major heavy truck manufacturers being just six in the near future (from 10 in 2008): Cummins Inc., Daimler AG, Hino Motors Ltd (owned by Toyota), MAN, Paccar Inc., and Volvo AB. Heavy construction manufacturers The heavy construction industry was hurt from the sharp decline in construction activity. It has also suffered from the pullback in mining and energy activity. In 2009, we still see pockets of strength in some emerging market economies, such as China and Brazil, although sharply down from 2008 levels. There is still some pent-up demand for certain mining equipment. We do not see these demand factors changing until, at the earliest, the second half of 2009, when we believe demand will begin to return to the market as central governments spend aggressively to stimulate economies with a large focus on infrastructure development. Agricultural equipment manufacturers The agriculture equipment manufacturers segment left 2008 and moved into 2009 with a better outlook than the other heavy equipment manufacturers, as farms continue to produce agricultural commodities at healthy profit levels. However, through COMMODITIES FUTURES INDEX VS. February 2009, we have seen a softening in AGRICULTURE EQUIPMENT REVENUES demand for agriculture equipment as (Index, Jan. 1 1 , 970=1 00) (Billions of dollars) farmers remain cautious of the economic 550 55 outlook and current climate. Demand for 500 50 450 45 agriculture equipment is strongly 400 40 correlated to agricultural commodity 350 35 prices, which have held up better than 300 30 CHART H06COMMODITIES 250 25 mining and energy commodity prices, FUTURES INDEX VS. 200 20 although they have still fallen considerably AGRICULTURE EQUIPMENT 150 15 from mid-2008 peaks. Agriculture 100 10 REVENUES 50 5 commodity prices are still considerably 0 0 higher than they were at the beginning of 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2007, due to a secular shift in demand as S&P GSCI Agriculture Index (left scale) emerging markets become more affluent Agriculture equipment manufacturing revenues* (right scale) and drive agricultural prices up. In 2009, *Top three companies. farm balance sheets remain historically Sources: Standard & Poor's; Company reports.
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INDUSTRY SURVEYS
strong, with the US Department of Agriculture (USDA) expecting the farm sector to continue its upward trend, reaching $2.2 trillion in value, driven by substantially increased farmland values. The USDA also expects debt to continue its downward trend, expected to reach 9.1% of farm assets financed by debt. However, the USDA does expect average net cash incomes from specialty crops to decline.
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later. This rapid increase in supply depressed the prices of used vehicles in the market and ultimately led to a significant number of lessors incurring substantial residual value write-downs. Impact on earnings As mentioned above, heavy equipment manufacturers are counting on service revenues from areas such as leasing and financing to generate reliable earnings streams, greater sustainable income growth, and higher returns. Although leasing and financing are generally much more profitable businesses than manufacturing, they also shift more of the financial risk from the FINANCIAL SERVICES OPERATING PROFIT 2008 dealer/customer to the equipment manufacturer, as previously discussed. Moreover, leasing and FINANCIAL TOTAL SERVICES FINANCIAL financing operations generally require heavy TABLE B03 FINANCIAL OPERATING OPERATING SERVICES machinery makers to take on large amounts of SERVICES OPERATING PROFIT PROFIT AS A % debt, primarily to finance the purchase of PROFIT2008 COMPANY ----------- MIL. $ ----------OF TOTAL equipment that is going to be leased or sold. Other Caterpillar 7,876.0 545.0 6.92 financing activities may include using various types CNH Global N.V. 1,650.0 390.0 23.64 of hedging instruments and offbalance-sheet Deere & Co. 3,420.0 478.0 13.98 Paccar 1,464.0 216.9 14.82 arrangements; these, too, can raise equipment Volvo 2,020.5 178.1 8.81 makers financial risk profiles.
Source: Company reports.
Individual companies earnings contributions from financing activities are shown in the table entitled Estimated percentage of consolidated net income derived from financial services divisions. One of the key takeaways from this table, we believe, is that the finance subsidiaries appear to represent an increasingly important source of earnings and cash flow during periods of weakness in the manufacturing side of the business. For example, many of the companies listed in the table experienced weak demand for their products in 2001 and 2002 as the overall economy slowed, while 2004 until mid-2008 marked significantly improved conditions for both the industry and the economy. In the previous period, companies tended to derive a greater proportion of net income from their finance divisions, while starting around 2004 and continuing through mid-2008, the proportion of net income derived from the finance division was much smaller. All else being equal, we view this is as a positive relationship and one of the benefits of operating a financial services division.
FOCUS ON PRODUCTIVITY
Standard & Poors believes that a common characteristic among many of the more successful heavy machinery companies is a relentless focus on enhancing productivity. While there are many ways of achieving increased productivity, many corporations have embraced a philosophy known as Six Sigma. The term Six Sigma can mean different things to different companies. However, we view it simply as a disciplined approach to process improvement. Six Sigma uses a five-step model known as DMAIC (define, measure, analyze, improve, control) for improving a process. In the define stage, the problem is defined and an improvement goal is established. The measure stage uses various data analysis techniques to measure the existing process (i.e., to establish a baseline) and to identify quantitative metrics for measuring progress toward the goal. During the analyze stage, potential ways of achieving the desired goal are explored. In the improve phase, the new process is implemented. Finally, in the control stage, systems designed to control the new process are institutionalized. While many companies have embraced Six Sigma to varying degrees within their own organizations, some companies, such as Caterpillar Inc., are looking beyond their own facilities and have begun working with suppliers to identify ways of doing things better, in an effort to improve the productivity of the entire supply chain. In a recent Caterpillar 10-K, the company stated: At Caterpillar, Six Sigma goes beyond mere process improvement; it has become the way we work as teams to process business information, solve problems and manage our business successfully.
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As mentioned previously, we see a pick-up in activity in late 2009 and into 2010 as the
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business cycle once again turns up for the heavy truck industry. We think the sales bottom of 93,000 vehicles in 1992 could be tested again in 2009; February 2009 sales were only 8,864 vehicles, a 20% drop from January 2009 and 47% lower than February 2008.The North American truck replacement cycle at the end of 2008 was 7.5 years, the highest in more than 20 years, which we see as a key to stimulating demand. Another positive indication is the global emphasis on infrastructure spending in many of the national stimulus packages. Large construction projects stimulate demand for heavy trucks because of the need to cart large quantities of building products. Over the long term, we expect truck and truck engine sales to continue to show dramatic swings, with underlying growth averaging 4% to 5% annually.
We expect companies manufacturing infrastructure equipment to benefit from an expected $90 billion in direct spending on Department of Transportation (DOT) projects in the U.S. included under the American Recovery and Reinvestment Act of 2009. Additionally, a further $32 billion will be spent on an electrical smart grid. Other international countries are still in a state of flux on determining final amounts to be spent.
2006 2007 2008 2009
2001
2002
2003
2004
2005
Nonresidential
Source: US Department of Commerce.
Residential
FARM EQUIPMENT EXPENDITURES & FARM INCOME (In billions of dollars) 400 350 300 250 200 1 50 1 00 1 985 87 89 1 8 1 6 1 4 1 2 1 0
Chart H01: FARM EQUIPMENT 91 93 95 97 99 EXPENDITURES & 01 03 05 Farm machinery expenditures (right scale) FARM INCOME
Gross farm income (left scale)
8 6 07 F2009
During the last 10 years when global growth was robust, a general theme among developed countries was to balance their books by cutting back on public works programs. This has now created a strong need to update, maintain and build infrastructure. CIBC World Markets Inc. (the investment banking subsidiary of Canadian Imperial Bank of Commerce) released a study in January 2009, which estimated that updating the worlds infrastructure could cost between $25 and $30 trillion over the next 20 years. Canada, for example, has eliminated its budget deficit; however, it has built up an infrastructure spending need of $120 billion in the process. The report forecasts that, annually, the US will need to spend $180 billion, Europe $205 billion, Asia $400 billion, and Africa $10 billion.
The American Recovery and Reinvestment Act has infrastructure and public building investment provisions totaling $134.8 billion to be spent on infrastructure projects in addition to already-scheduled spending of $66.6 billion. Additionally, upgrading
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the nations aging power grid could total $1.5 trillion over 20 years, according to the Brattle Group, Inc., a business consulting group. China and Russia both spend about 6% of GDP on infrastructure, versus 2% in Europe and 1% in the US. Over the long term, we believe that total private spending on US construction will likely increase about 3% to 4% per year, on average, in line with historical growth in GDP.
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HEAVY TRUCKS
The heavy truck category comprises medium-duty trucks (Class 57; 14,001 pounds to 33,000 pounds) and heavy-duty trucks (Class 8; more than 33,000 pounds). Leading heavy-duty truck manufacturers model their operations around the industrys cyclicality and the need to customize products. They focus on the design and assembly of truck platforms, and they rely on suppliers of parts and components to design and produce the various mechanical, electronic, interior, and exterior systems that are assembled to make a vehicle. This practice lets the truck manufacturer or assembler maintain the lowest possible fixed-cost base, and it gives customers greater flexibility to outfit vehicles as they desire. What customers want Heavy trucks are highly customized vehicles, manufactured to suit the end user. Buyers have traditionally selected the hard partsengines and transmissions (power trains), axles, suspensions, wheels, tires, brake systems, seating, and other interior and exterior featuresbased on the purpose and route the truck is to serve. Considerations include the distance traveled per trip, geographical region, road topography, and cargo type. For example, for long-haul shipments where speed of delivery is a priority, carriers may prefer a comfortable truck with a large fuel tank. In the case of heavy-load shipments where weight limitations are a consideration, a carrier may choose to go with a lighter truck and a smaller fuel tank. Today, customizing extends to sophisticated electronics systems, such as antilock brakes, crash avoidance warning systems, and tracking and communications devices enabled by the global positioning satellite (GPS) system. A customer may decide to add these electronic features to boost the operating efficiency of its fleet, to improve safety and reliability, or to satisfy regulatory mandates. Despite the high degree of customization, the product life cycle of heavy trucks is quite long. Basic vehicle redesigns occur as infrequently as once a decade; when they happen, they are primarily the result of breakthroughs that permit more efficient truck design through improvements in aerodynamics or weight reductions in components made by assemblers. Interim efficiency improvements come primarily from gains achieved by component suppliers, especially in the power train and axle categories. Concentration and competition The heavy truck industry is a concentrated field, with just four major competitors in the Class 58 segment of the North American truck market: Freightliner (a division of DaimlerChrysler AG), Volvo Trucks North America Inc., Paccar Inc., and Navistar International Corp. Industry concentration also extends to the component level. Currently, there are just three domestic heavy truck diesel engine makers, two axle makers, and two transmission producers. Despite this concentration, price competition tends to be intense over the course of the industrys business cycle. This is partly because customers closely compare competing trucks and the combinations of components on competing vehicles. Price competition varies in intensity, depending upon the desirability of a particular order. Customers gain bargaining power by virtue of the size of their potential orders and their own financial soundness. Unlike the domestic automobile industry, the heavy truck industry has not faced significant foreign competition. Some foreign manufacturers, such as DaimlerChrysler and Volvo, have acquired US heavy truck manufacturers rather than establish completely new truck brands. Due to different geographical terrain and local needs, Class 8 trucks are not manufactured in many foreign countries. Outside the US, two factors favor the use of smaller trucks: goods typically move relatively short distances, and narrow city streets cannot accommodate large trucks. Thus, import competition in North America has not been a factor in the Class 8 market. In the medium-duty trucks segment (Class 57), however, foreign truck producers have made inroads into the US market.
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Orders and distribution Customer orders are the lifeblood of the truck industry, helping to determine manufacturers production plans and profit outlook. Most production is customer-specifiedthat is, it consists of trucks made to order. Thus, a manufacturers order backlog is critical in determining its production line rates and employment levels. Given the high level of training that workers need to produce these specialized vehicles, advanced planning is required. Truck manufacturers monitor the backlog to determine how many workers are needed and how many will need to be trained. During periods of economic weakness, truck orders slow as fleet operators usually find themselves with excess capacitythat is, idle trucks. In the transportation business, this is called unused equipment. During such periods of excess capacity, fleet operators often cancel or defer pending truck orders. Instead of replacing aging trucks, fleet operators repair them, thus extending their useful lives. To conserve cash during prolonged financial crunches, fleet operators sometimes cannibalize idled trucks for spare parts. Truck makers establish and support networks of independently owned dealers. These dealers stock sample vehicles and maintain inventories for sale to independent truck operatorsindividuals who typically operate a single vehicle at a time, which they buy out of inventory. Dealers are also responsible for gathering orders and passing them through to the manufacturer. Most dealers are affiliated with a single manufacturer. The manufacturer typically supports the dealers sales and marketing efforts (with cash payments, marketing strategies and materials, and the like), provides wholesale financing of dealers inventory, and offers sales and lease financing to retail customers. Manufacturers also give discounts, rebates, and other marketing subsidies to stimulate sales when necessary. Regulation The US government regulates the truck industry through its safety and emissions laws. Truck manufacturers must comply with its mandates, and parts and components suppliers are often concerned as well. Regulations concerning such items as brake systems usually force a truck maker and its systems producers to work closely together to achieve compliance. Emissions regulations are primarily the province of the engine manufacturers, which often keep truck makers apprised of regulatory and production developments.
AGRICULTURAL EQUIPMENT
Producers of agricultural equipment manufacture the machinery farmers use to cultivate land and to plant and harvest crops. This equipment includes tractors, plows, cultivators, sprayers, spreaders, combine harvesters, balers, and assorted implements attached to the tractors and combines for tending crops. Most producers of motorized agricultural equipment also manufacture construction and industrial machinery, such as logging equipment and general-purpose tractors. As with heavy trucks, the most important segments of the agricultural equipment sector have become concentrated after much consolidation in the 1980s. Today, the remaining large players are looking overseas to extend their reach into new markets. Many are entering developing areas of the world and the recently opened markets in Eastern Europe via acquisitions and joint ventures. In addition, over the past decade, a new market has begun to emerge for these companies in the under40-horsepower tractor market. Purchasers of these smaller tractors include homeowners, turf and land caretakers, commercial contractors, public agencies, rental businesses, golf courses, hobby and part-time farmers, and industrial plants. The Association of Equipment Manufacturers (AEM), a trade organization, estimated that sales of units of under-40-horsepower tractors (used by the AEM as a proxy for overall agriculture equipment demand) will decline about 11% in 2009 from 2008. Competitive pressures affect the fortunes of agricultural equipment makers. These pressures largely result from wide swings in crop prices and in farmers income, often caused by the impact of weather on the success or failure of crops. When crop prices and farm incomes decline, demand for agricultural equipment usually dips as well. During periods of weakness, prices deteriorate as equipment manufacturers attempt to maintain sales and output. Eventually, they slow production and lay off workers.
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In North America, agricultural equipment is purchased or leased by individual farmers and farm cooperatives for use on the 2.1 million US farms in 2008 and 0.23 million Canadian farms in 2008. In the European Union (EU) countries, 9.9 million farms were in operation in 2003 (latest available), according to the European Commission. (Note: This EU total is not comparable with previous years because more countries are now included.) Establishing a pipeline Agricultural equipment producers establish and support networks of dealers who maintain inventories of popular models and equipment. In addition, farm equipment makers finance sales and leases. Most agricultural equipment is sold out of inventory. The variables for a tractor include engine size and power, the number of drive axles, the type of tires, and such amenities as air conditioning and audio equipment. Combines are somewhat more customized for each client, depending on the specific application and the combination of farm implements required to perform the tasks. Characteristics that help determine the way a tractor or combine is outfitted include the size and quality of the land farmed, the crop planted, and the climate of the region where the equipment will be used. Government subsidies prop up farm income Demand for farm equipment closely reflects fluctuations in farmers incomes. In years that follow good harvests and favorable prices, farmers tend to reinvest their profits in new equipment. However, farmers incomes can fluctuate wildly, due to the vagaries of weather and volatile crop prices. For decades, the US government and the EU countries have implemented various farmer aid programs, in an effort to try to stabilize volatile farm incomes. During leaner years, the level of government support can range from 30% to more than 50% of farmers annual income. These programs primarily consist of subsidies, which farmers receive if they cannot generate returns greater than production costs; price supports, which guarantee purchases of crops at preset prices; and set-aside programs, which essentially pay farmers not to grow crops. The problem with subsidies and price supports is that they typically exacerbate supply and demand imbalances. These programs encourage farmers to plant more crops, even when prices are low, because the government guarantees payments. This scenario ultimately can lead to gluts in grain supply, dramatically increasing the likelihood of chronically weak grain prices and tepid long-term growth in farm income. Domestically, in an effort to wean the farming industry from government payments, Congress eliminated most subsidy and set-aside programs in 1996, when farmers were enjoying a rare period of strong worldwide demand and crop prices. Subsequently, the farm depression in the late 1990s brought the subsidy issue back to the forefront. As a result, Congress and President George W. Bush resurrected these subsidy programs by passing the Farm Security and Rural Investment Act (known as the US Farm Bill) in May 2002. The Congressional Budget Office estimated that the program would cost approximately $171 billion over 10 years. The current farm bill, known as the Food, Conservation, and Energy Act of 2008, replaces the last farm bill that expired in September 2007. The current bill calls for farm subsidies totaling $307 billion over five years. According to the USDA, farmers are expected to receive $11.4 billion in farm subsidies in 2009, down from $12.4 billion in 2008 and $11.9 billion in 2007. We see this funding subject to change in view of the funding needed for the American Recovery and Reinvestment Act of 2009 passed by the Senate in February 2009. In the European Union, subsidies have been commonplace for a number of years. Under the Common Agricultural Policy (CAP), the EU equivalent to the US Farm Bill, support payments total approximately $50 billion a year and account for over 40% of the European Unions annual budget. Government regulations have not been all bad Government regulation has not severely constrained the agricultural equipment market in terms of equipment design. For instance, the US Environmental Protection Agency (EPA) has not yet implemented emission regulations for agricultural and other off-highway vehicles, although such regulations have been contemplated from time to time and probably will be put in place eventually. They are not likely to raise
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difficulties for the industry, however, in that they would mostly affect the diesel engines employed in farm equipment. Because farmers buy most of this equipment with government money, which is guaranteed, it is easier for manufacturers to pass along costs associated with developing compliant engines. In addition, the US Farm Bill allocated funds for farmers to buy cleaner-running engines.
CONSTRUCTION EQUIPMENT
Construction equipment manufacturers produce a broad line of heavy-duty off-road vehicles that are used in the construction of highways and buildings, as well as in mining, forestry, and landfill operations. These machines facilitate the recovery and movement of heavy payloads. Equipment typically produced by these manufacturers includes vehicles such as tractors, loaders, excavators, backhoe loaders, off-road trucks, scrapers, graders, pavers, log loaders, feller bunchers, skidders, and land compactors. These categories include some of the largest pieces of machinery in the world, designed to perform some of the most physically demanding tasks. The particular segments that the industry serves influence demand for construction equipment. The largest factors are related to residential, nonresidential, and public construction, which comprise new housing, buildings, roads, highways, dams, and other major construction projects undertaken by both the government and private industry. As with heavy trucks and agricultural equipment, distribution of construction equipment relies on dealer networks supported by the manufacturers, which finance sales and leases. Unique to the construction equipment sector, however, are dealer-owned rental fleets that have been recently established. This equipment is leased to construction and maintenance companies that need it for relatively brief periods. Types of construction equipment Most construction equipment can be segmented into one of three broad categories. Earth-moving machinery. This segment encompasses a broad range of equipment used to excavate and transport earth for purposes of building construction. It includes crawler dozers, loaders, wheel loaders and dozers, scrapers, graders, hydraulic excavators and backhoes, trenchers, pipe layers, and off-highway trucks. Building construction (residential, commercial, industrial, and institutional) is by far the leading source of demand for earth-moving equipment. Road and dam building projects also have generated considerable demand historically, but with the interstate highway system virtually complete, that market will center on road repair and maintenance in the future. Domestic dam building has slowed, and a number of large projects are nearing completion in foreign countries. Excavators and cranes. Used on virtually all types of construction projects, excavators range from small backhoes that can be mounted on a tractor or other prime mover to large walking draglines and power shovels used in major surface-mining projects. Because power shovels have relatively long, useful lives, replacement parts account for a significant portion of shovel makers total sales. The major markets for cranes include bridge, highway, and large commercial and industrial construction projects. Heavy cranes are increasingly employed in offshore oil drilling and production platforms. As with power shovels, replacement parts are an important supplement to original equipment sales for the manufacturers. Most makers of heavy-lift cranes also produce hydraulic cranes. Underground mining machinery. This category comprises essentially three types of machinery: conventional equipment, continuous miners, and longwall systems. The latter two are used primarily in the underground production of coal. Conventional equipment includes cutters, drills, loaders, shuttle cars, conveyors, and roof bolters. The continuous miner removes coal from the face of a seam and loads it into cars on conveyors, obviating the need for cutting machines, drills, or explosives. This system improves both mine productivity and worker safety.
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Also efficient are longwall mining machines, which shear coal from the face of a seam in long slices and move it to the surface via conveyors. In mines where coal seams are thick enough and where the estimated mine life justifies the capital investment, this equipment can substantially improve productivity. Other construction equipment. This category includes asphalt and concrete pavers; mixing, spreading, and finishing machines for asphalt and concrete; compactors, with both highway and landfill applications; air compressors and air tools; pumps; hoists; and rock-crushing and screening equipment. Many earthmoving equipment companies are also active in this area. Heavy-duty machinery engines Engines for heavy-duty machinery are manufactured for a variety of applications. In general, however, they are classified as either on-highway (heavy- and medium-duty trucks) or off-highway (construction and farm equipment). The industry is highly concentrated, heavily regulated, and influenced by the same types of factors as the end markets that it serves. Primary participants in the on-highway segment include Caterpillar Inc., Cummins Inc. (formerly Cummins Engine Co.), Navistar International Corp., Volvo, and DaimlerChrysler. Manufacturers of off-highway engines include Caterpillar, Cummins, Deere & Co., Ford Power Products, General Electric Co., and Waukesha Engine (a division of Dresser Inc.).
CONSTRUCTION EQUIPMENT
Construction spending. The US Census Bureau, a data-gathering agency within the US Department of Commerce, tracks construction spending on a monthly basis. It divides the data into residential, nonresidential, and public construction categories, and then into narrower categories that can be tracked for guidance on industry conditions. The Census Bureau disseminates statistics on construction spending 60 days after the close of each month. Seasonally adjusted annualized spending for residential, nonresidential, and public construction fell 9.1% to $986.2 billion in January 2009, from $1,085.3 billion in January 2008.
AGRICULTURAL EQUIPMENT
Cash farm income. A key economic statistic for agricultural equipment makers is cash farm income: the aggregate net income from all individuals and companies engaged in agriculture. How much money farmers make has a direct influence on their equipment spending plans. Naturally, farmers tend to spend more to upgrade and replace farm equipment in prosperous times and to delay farm equipment purchases during lean times. Cash farm income statistics are provided on an annual basis by the Economic Research Service unit of the US Department of Agriculture (USDA). Net farm income was an estimated $89.3 billion in 2008, up from $86.8 billion in 2007. It is projected to decrease to $71.2 billion in 2008. (For long-range cash farm income projections, see the table entitled Farm income projections in the Current Environment section of this Survey.)
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Grain production and prices. Production levels of crops such as corn, soybeans, and wheat directly affect prices and, thus, farm incomethe primary demand driver of farm equipment purchases. The USDAs National Agricultural Statistics Service reports crop prices in its monthly Agricultural Prices publication.
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and services sold from sales, and divide the result by sales. It is one of the clearest performance measures of a companys operations because it excludes the impact that a companys financial structure has on its ultimate profitability. Gross profit margins can lend important insight into trends in market pricing, product mix, and costs of raw materials and labor. In addition, they can enable the analyst to discern the impact of raw material and labor costs on the business. Tracked over time, gross margins can provide a reliable read on a companys productivity, particularly in the case of companies that disclose unit sales. If unit sales are known, the analyst can calculate per-unit revenue and gross profit by dividing sales and gross profit, respectively, by the number of units sold. For heavy-duty machinery companies, trends in gross profit margin may vary widely from one sector to the next. For instance, heavy truck makers typically have a high level of fixed costs and, thus, a high break-even point. Once the break-even point is passed, they enjoy substantial profits per unit sold. They will therefore have wide swings in gross profit margin over the course of an economic cycle. SG&A expense SG&A expense represents the selling costs and general and administrative expenses of a company. Companies with large direct sales forces and branch offices throughout their covered regions are likely to have higher SG&A expenses as a percentage of sales. However, in return, they are also more likely to have a knowledgeable sales force and greater penetration of their target markets, which could yield improved sales results. In contrast, companies that rely more upon independent dealers (who also sell competing products) tend to incur lower selling costs, with the potential trade-off of a less knowledgeable sales force and/or nonexclusive arrangements. Other costs The remaining items in the income statement tend to be heavily influenced by a companys particular financial and operating structure. Interest expense is a function of a companys capital structure, while taxes can be heavily influenced by the geographic location of a companys operating subsidiaries or the parent companys state or country of domicile.
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level of free cash flow for a company is one of the key steps in the discounted cash flow (DCF) approach that we use to value heavy-duty machinery companies.
KEY INDICATORS
Key indicators of a heavy-duty machinery companys current health and future prospects include new orders and order backlogs, the book-to-bill ratio, and unit volume and production line rates. New orders and order backlogs The two most important of the key indicators are new orders and order backlogs. New orders and order backlogs are among the most closely watched data for the heavy- and medium-duty truck, and the agricultural and construction equipment sectors. When examining these figures, however, an analyst should be keenly aware of how a company calculates its data. When examining orders, it is necessary to know whether the company is disclosing gross, firm, or net orders, whether backlogs represent firm or funded backlogs, or if the company has increased the backlogs worth by including the value of options or potential follow-on orders. In its most general sense, the term backlog represents the accumulation of unshipped orders. However, there are different kinds of backlog. Gross orders represent the value of new orders that the firm has received. Net orders represent gross orders minus the value of any cancellations. Some orders are firm and funded (meaning that the customer has already made an initial deposit and will pay the balance upon shipment) and thus cannot be canceled. Others are unfunded, such as contracts with government bodies that must authorize funds for financing the purchases. While a higher backlog can be indicative of an upswing in demand, backlog should not be viewed in isolation; a higher backlog without a corresponding increase in new orders may indicate production problems. Occasionally, a company will call its backlog a total backlog and include the value of all optional parts of a contract. In such cases, two figures are usually disclosed: the firm backlog and the total backlog. For example, if a heavy truck firm received orders for 300 trucks, of which 100 were firm orders and 200 were options on orders, the firm backlog would be 100 trucks, while the total backlog would be 300 trucks. A companys policy for recognizing orders often depends on the customer involved or the specifics of a contract. For instance, it is common for companies that receive multiyear government contracts to recognize in the backlog only the portion of the contract that is funded in the current government fiscal year. The portion of the order pertaining to future years may be recognized only when funds are appropriated by the government organization. Book-to-bill ratio The book-to-bill ratio compares the value of a companys new unfilled orders (bookings) with the value of its products sold or services provided (billings) typically on a quarterly or annual basis. This ratio can be calculated for durable goods orders and construction orders. A ratio above one indicates that the company has received more orders than it is able to fill out of current production. Conversely, a ratio less than one means that the company received fewer orders than it is able to fill. A ratio equal to one indicates that the orders received equal the amount that the company is able to fill. Unit volume and production line rates Unit volume is a common measure of growth in the heavy- and medium-duty truck, agricultural equipment, and construction equipment industries. Tracking the number of units ordered, built, or sold makes comparisons easy over a long time period without having to adjust for inflation, as must be done when examining dollar values for these industries. Production line rates and, more directly, expected changes in line rates can be used to prepare an estimate of future revenues.
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INDUSTRY REFERENCES
PERIODICALS Agricultural Outlook http://www.ers.usda.gov Monthly; focuses on the farm economy. Construction Equipment http://www.constructionequipment.com Monthly; covers the construction equipment industry. Engineering News-Record http://www.enr.com Weekly; covers engineering and construction. FAPRI-UMC Reports http://www.fapri.missouri.edu Series published monthly (or more frequently) by the Food and Agricultural Policy Research Institute (FAPRI) at the University of Missouri; provides various farm statistics and projections. Machinery Outlook http://www.manfredi.com Monthly; covers the diversified machinery group. Wards Automotive Reports Wards Automotive Yearbook http://www.wardsauto.com Weekly and annual publications, respectively, covering auto and truck manufacturing. World Agricultural Supply and Demand Estimates (WASDE) http://www.nass.usda.gov Monthly publication of the USDAs National Agricultural Statistics Service; provides various agricultural statistics and forecasts. TRADE ASSOCIATIONS American Machine Tool Distributors Association http://www.amtda.org Trade association for US machine tool distributors. Association of Equipment Manufacturers (AEM) http://www.aem.org Trade organization representing manufacturers of agricultural, construction, mining, forestry, and utility equipment, plus suppliers of related products and services. It provides statistics and addresses safety, technical, and public policy issues. RESEARCH FIRMS AND INSTITUTIONS Americas Commercial Transportation Research Co. LLC (ACT Research) http://www.actresearch.net Independent commercial vehicle research organization. Publishes five monthly reports covering the North American medium and heavy truck and trailer markets, and maintains supporting databases; also publishes special reports and white papers. Food and Agricultural Policy Research Institute (FAPRI) http://www.fapri.missouri.edu Independent, nonprofit agricultural forecasting organization at the University of Missouri. F.W. Dodge http://www.fwdodge.com Provides construction information, statistics, and news. GOVERNMENT AGENCIES Bureau of Labor Statistics (BLS) http://www.bls.gov/data The federal governments principal fact-finding group in labor economics and statistics; part of the US Department of Labor. The Federal Reserve System http://www.federalreserve.gov Government organization that supervises and regulates banks, conducts US monetary policy, and provides services to the US government and the public. US Census Bureau http://www.census.gov Part of the US Department of Commerce; collects US population and economic data. US Department of Agriculture (USDA) http://www.usda.gov A cabinet-level department; performs agricultural research and economic analysis.
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Ticker
Company
CONSTRUCTION, FARM MACHINERY & HEAVY TRUCKS AG AGCO CORP DEC ASTE ASTEC INDUSTRIES INC DEC BUCY BUCYRUS INTERNATIONAL INC DEC CAE CASCADE CORP # JAN CAT [] CATERPILLAR INC DEC DEC OCT DEC OCT AUG DEC SEP DEC DEC OCT DEC DEC DEC
[] []
CUMMINS INC DEERE & CO FEDERAL SIGNAL CORP JOY GLOBAL INC LINDSAY CORP
[] []
Note: Data as originally reported. CAGR-Compound annual growth rate. S&P 1500 index group. []Company included in the S&P 500. Company included in the S&P MidCap 400. Company included in the S&P SmallCap 600. #Of the following calendar year. **Not calculated; data for base year or end year not available. A - This year's data reflect an acquisition or merger. B - This year's data reflect a major merger resulting in the formation of a new company. C - This year's data reflect an accounting change. D - Data exclude discontinued operations. E - Includes excise taxes. F - Includes other (nonoperating) income. G - Includes sale of leased depts. H - Some or all data are not available, due to a fiscal year change.
Net Income
Million $ Yr. End 400.0 63.1 233.3 NA 3,557.0 755.0 2,052.8 31.3 373.1 39.4 79.6 79.3 1,017.9 71.9 119.7 287.3 (124.7) 130.6 293.8 16.3 109.4 215.5 9.4 86.5 86.3 111.1 57.7 (9.3) 58.4 32.1 (10.0) (57.2) 22.3 185.3 23.3 45.0 4.5 NM 11.2 NM NM 42.5 (2.2) NM 19.4 333.6 268.1 1,227.3 613.9 142.4 166.5 205.5 1,496.0 396.5 129.1 59.1 160.2 1,133.2 188.5 114.1 39.8 112.8 906.8 324.1 102.7 18.0 75.6 526.5 (25.5) 81.6 51.4 16.3 416.8 72.8 4.1 4.5 17.2 9.3 (0.1) 40.2 34.6 1.0 14.1 NM 8.0 (76.1) (70.4) (17.1) (88.3) (16.0) 155 488 244 99 2,925 155 (536) 290 649 1,650 294 843 3,483 159 70 243 739.0 1,821.7 29.8 279.8 15.6 715.0 1,453.2 34.4 414.9 11.7 550.0 1,446.8 47.3 146.9 4.8 350.0 1,406.1 (12.7) 55.3 9.3 54.0 643.1 37.7 18.5 12.9 (21.0) 1,021.4 59.4 (174.4) 23.5 NM 7.2 (6.2) NM 5.3 69.5 26.1 (3.6) 82.3 25.0 2.2 12.7 5.0 33.4 152.3 NM 201 53 NM 168 NM 178 50 NM 67 NM 142 58 NM 50 324 1,265 359 545 3,158 116 40 192 246.3 56.8 136.1 60.1 3,541.0 (64.9) 39.6 70.3 45.5 3,537.0 31.6 28.1 53.6 42.1 2,854.0 158.8 12.5 6.1 28.5 2,035.0 74.4 (29.0) (3.6) 18.5 1,099.0 60.6 24.4 (8.3) 21.4 1,513.0 20.8 10.0 NM NA 8.9 40.0 NM NM NA 26.5 62.4 11.1 71.4 NA 0.5 660 258 NM ** 235 406 232 NM 281 234 (107) 162 NM 213 234 52 115 NM 197 189 NM 142 80 NM 21 115 986 272 259 2,789 47 477 128 2008 2007 2006 2005 2004 2003 1998 10-Yr. 5-Yr. 1-Yr. 2008 2007 2006 2005 CAGR (%) Index Basis (1998 = 100) 2004 262 51 NM 133 135 NM 138 (21) NM 40 77 694 218 445 2,510 (5) 251 71
Ticker
Company
CONSTRUCTION, FARM MACHINERY & HEAVY TRUCKS AG AGCO CORP DEC ASTE ASTEC INDUSTRIES INC DEC BUCY BUCYRUS INTERNATIONAL INC DEC CAE CASCADE CORP # JAN CAT [] CATERPILLAR INC DEC DEC OCT DEC OCT AUG DEC SEP DEC DEC OCT DEC DEC DEC
[] []
CUMMINS INC DEERE & CO FEDERAL SIGNAL CORP JOY GLOBAL INC LINDSAY CORP
[] []
Note: Data as originally reported. CAGR-Compound annual growth rate. S&P 1500 index group. []Company included in the S&P 500. Company included in the S&P MidCap 400. Company included in the S&P SmallCap 600. #Of the following calendar year. **Not calculated; data for base year or end year not available.
Ticker
Company
CONSTRUCTION, FARM MACHINERY & HEAVY TRUCKS AG AGCO CORP DEC ASTE ASTEC INDUSTRIES INC DEC BUCY BUCYRUS INTERNATIONAL INC DEC CAE CASCADE CORP # JAN CAT [] CATERPILLAR INC DEC DEC OCT DEC OCT AUG DEC SEP DEC DEC OCT DEC DEC DEC
[] []
CUMMINS INC DEERE & CO FEDERAL SIGNAL CORP JOY GLOBAL INC LINDSAY CORP
[] []
Note: Data as originally reported. S&P 1500 index group. []Company included in the S&P 500. Company included in the S&P MidCap 400. Company included in the S&P SmallCap 600. #Of the following calendar year.
Current Ratio
Yr. End 1.5 2.7 1.7 NA 1.2 1.8 NA 1.9 1.5 2.5 1.3 1.5 NA 2.2 2.0 NA 1.9 1.9 NA 2.5 2.3 NA 2.0 2.2 NA 2.5 2.0 NA 1.8 2.0 49.4 35.4 35.6 43.6 27.2 19.3 44.8 30.9 23.6 36.3 31.0 28.0 30.8 43.3 31.5 1.5 1.4 NA 2.2 1.9 1.2 1.1 NA 1.7 1.9 1.4 1.2 NA 1.9 1.9 1.3 1.0 NA 1.7 2.0 61.0 61.2 26.6 44.8 38.4 13.9 63.1 37.7 35.9 38.1 25.4 0.2 37.2 22.9 30.9 46.6 0.3 19.3 46.8 30.9 49.7 0.5 31.2 48.0 30.5 479.1 388.9 NA 63.0 71.2 NA 108.1 105.8 43.4 460.0 NA 50.7 70.4 NA 71.3 40.5 1.8 NA NA 2.0 2.9 1.9 NA NA 2.0 3.3 1.8 NA NA 1.9 4.7 1.5 NA NA 2.3 3.3 15.3 67.5 45.9 47.1 11.0 13.0 61.6 43.5 35.0 17.4 17.4 60.5 42.6 9.5 17.5 36.6 62.9 47.4 0.2 0.0 44.2 63.2 42.2 31.0 0.0 30.3 NA 151.8 90.5 20.3 26.4 NA NA 50.5 32.4 31.0 NA NA 15.6 30.3 127.5 1.8 NA 38.1 56.2 NA 80.7 49.4 1.3 2.4 2.0 3.4 1.1 1.4 2.7 2.2 2.6 1.2 1.7 2.6 2.1 2.9 1.2 1.8 2.2 3.1 2.5 1.3 24.8 0.0 33.4 NA 77.2 11.8 0.0 37.9 28.3 66.5 26.4 0.0 21.7 11.0 72.0 35.9 0.0 23.2 4.5 65.0 43.1 11.5 36.7 10.2 67.9 66.4 0.0 83.0 NA 410.4 46.1 0.0 99.8 70.9 551.6 84.2 0.0 39.9 30.1 460.3 101.9 0.0 39.0 10.0 423.9 71.4 NA NA 0.3 0.0 180.1 1.4 NA 78.0 57.2 NA 58.6 62.1 2008 2007 2006 2005 2004 2008 2007 2006 2005 2004 2008 2007 2006 2005
Ticker
Company
CONSTRUCTION, FARM MACHINERY & HEAVY TRUCKS AG AGCO CORP DEC ASTE ASTEC INDUSTRIES INC DEC BUCY BUCYRUS INTERNATIONAL INC DEC CAE CASCADE CORP # JAN CAT [] CATERPILLAR INC DEC DEC OCT DEC OCT AUG DEC SEP DEC DEC OCT DEC DEC DEC
[] []
CUMMINS INC DEERE & CO FEDERAL SIGNAL CORP JOY GLOBAL INC LINDSAY CORP
[] []
Note: Data as originally reported. S&P 1500 index group. []Company included in the S&P 500. Company included in the S&P MidCap 400. Company included in the S&P SmallCap 600. #Of the following calendar year.
Ticker
Company
CONSTRUCTION, FARM MACHINERY & HEAVY TRUCKS AG AGCO CORP DEC ASTE ASTEC INDUSTRIES INC DEC BUCY BUCYRUS INTERNATIONAL INC DEC CAE CASCADE CORP # JAN CAT [] CATERPILLAR INC DEC DEC OCT DEC OCT AUG DEC SEP DEC DEC OCT DEC DEC DEC
[] []
CUMMINS INC DEERE & CO FEDERAL SIGNAL CORP JOY GLOBAL INC LINDSAY CORP
[] []
Note: Data as originally reported. S&P 1500 index group. []Company included in the S&P 500. Company included in the S&P MidCap 400. Company included in the S&P SmallCap 600. #Of the following calendar year.
Ticker
Company
CONSTRUCTION, FARM MACHINERY & HEAVY TRUCKS AG AGCO CORP DEC ASTE ASTEC INDUSTRIES INC DEC BUCY BUCYRUS INTERNATIONAL INC DEC CAE CASCADE CORP # JAN CAT [] CATERPILLAR INC DEC DEC OCT DEC OCT AUG DEC SEP DEC DEC OCT DEC DEC DEC
[] []
CUMMINS INC DEERE & CO FEDERAL SIGNAL CORP JOY GLOBAL INC LINDSAY CORP
[] []
Note: Data as originally reported. S&P 1500 index group. []Company included in the S&P 500. Company included in the S&P MidCap 400. Company included in the S&P SmallCap 600. #Of the following calendar year. J-This amount includes intangibles that cannot be identified.
The analysis and opinion set forth in this publication are provided by Standard & Poors Equity Research Services and are prepared separately from any other analytic activity of Standard & Poors. In this regard, Standard & Poors Equity Research Services has no access to nonpublic information received by other units of Standard & Poors. The accuracy and completeness of information obtained from third-party sources, and the opinions based on such information, are not guaranteed.