Industry wary of economic slowdown

<i>2008 Wells Fargo Construction Industry Forecast</i>

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Now in its 32nd year, our annual Construction Industry Forecast has proven itself a valuable predictor of what is in store for the large, diverse and critically important North American construction industry.
It is clear that no one possesses perfect information about the future health of the U.S. and Canadian economies and what effect an economic slowdown may have on the infrastructure construction industry.
However, the 2008 Wells Fargo Construction Industry Forecast captures and consolidates the thoughts of some of the industry's best-informed people. The credibility of this Forecast rests on the fact that it is based on the opinions of those who know the construction industry best — the people who lead contracting and equipment distributor companies. Their insights have enormous value because they are grounded in real-world, day-to-day experiences in their hometowns.
Ron Riecks, general manager, Wells Fargo Construction
The Research. The 2008 Wells Fargo Construction Industry Forecast is based on more than 1,150 telephone surveys with the "president" or "chief financial officer" of construction contracting companies and construction equipment distributor firms.
Surveys of executives in the United States were conducted during late August and early September 2007. Surveys of executives in Canada were conducted during October and early November 2007. Companies surveyed were selected in a random sampling process that considered a variety of factors, including regional representation in both the U.S. and Canada and Standard Industry Classification (SIC) Code.
Optimism Quotient. The Optimism Quotient (OQ) is this Forecast's primary indicator for assessing and comparing respondents' expectations of local construction activity for the coming calendar year in comparison to the year in which the survey is conducted. In general, an OQ score of 100 or more represents high optimism for increased local construction activity. A score above 75 represents more cautious or measured optimism. A score below 75 signals that fewer executives say local construction activity will increase than say it will decrease — a more pessimistic point of view.
Respondent Classification. "Contractors" are companies that execute construction projects and, for purposes of this survey, broadly were classified into the following categories: Infrastructure Contractors, Aggregate Producers, Residential Builders and Non-residential Builders. "Distributors" are dealers of construction related equipment and are primarily identified with the SIC Code 5082. These companies most often sell heavy equipment, light equipment or general construction equipment, and provide a range of products and services to the construction industry.
U.S. national trends
Key findings
Executives expect comparable non-residential construction activity in 2008About one-third see better business outlook for year aheadIndustry wary of impact of U.S. economic slowdown
A number of factors are wildcards in creating a complete preview of 2008, including a declining housing market, volatile oil prices and pre-election year hoopla. These factors — and many others — are on the minds of the 913 American construction industry executives who share their thoughts in the Forecast.
Nationally, our bellwether Optimism Quotient (OQ) slipped six points this year, from 86 to 80, which reveals executives' cautious or measured optimism about construction activity in their local areas.
While many respondents show significant wariness about the future, they also find a silver lining. Close to three-fourths of contractors expect at least as many chances to bid on jobs next year. Many equipment distributors say they expect improvements in commercial and industrial sectors. And both distributors and contractors see multiple business opportunities including, for some, the chance to become less reliant on the highly cyclical residential construction business.
Activity mostly unchanged
Nationally, most respondents said they anticipate that the overall construction climate in 2008 will be comparable to what it was in 2007.
Equipment distributors see more opportunities outside the troubled housing industry. Continuing the trend of strength in non-residential construction through 2006 and 2007, 80 percent said non-residential activity will increase or stay the same in 2008. This is in contrast to the 62 percent of distributors who feel that way about residential construction.
Seventy-five percent of contractors said local construction activity will increase or stay the same. Almost one-third of contractors expect to see more bidding opportunities in 2008, compared to 26 percent who think bidding activity will decrease.
Executives in several parts of the country — the New England and Mid-Atlantic regions, for example — are more optimistic than they were a year ago. Participants in the East South Central and West South Central regions are most positive about 2008, even though they are less optimistic than they were in last year's Forecast. Respondents in the Mountain and Pacific regions anticipate a slowdown in local construction activity but view opportunities for growth and diversification.
Asked to describe the overall business outlook for the industry in 2008, 34 percent of contractors see a better year ahead, compared to 33 percent in the 2007 Forecast. Thirty-six percent of distributors expect next year to be better, compared to 43 percent a year ago; 45 percent of distributors expect a comparable year in 2008, up from 36 percent who expected things to hold steady in 2007.
Close watch on U.S. economy
Of the contractors projecting less construction activity for 2008, almost half point to a slowing economy as a primary cause. Forty-five percent of contractors (more than twice the number as last year) said either that their volume of work has decreased or that specific projects have been canceled or postponed.
More than 80 percent of distributors who think activity will decline listed a slowing economy or declining business cycle among the reasons they anticipate a less vigorous non-residential construction climate in 2008. Many contractors (28 percent) believe conditions are right for construction activity to grow in 2008; 29 percent of distributors agree, at least in terms of non-residential business. In their view, a stronger economy, more building opportunities and population growth will drive more activity.
Equipment overview
Key findings
Contractors boost equipment budgets for 2008Average age of equipment continues to climbHighway trucks top shopping list for 14th year
The eagerness of American contractors to invest more money in construction equipment is one of the most positive indicators in the Forecast. A strong 37 percent of contractors expect to make equipment purchases in 2008, which is only 5 percent fewer than in last year's Forecast.
However, equipment-buying budgets are up significantly for 2008. On average, contractors buying new equipment expect to spend more than $98,000 on their purchases; that's 26 percent more than their 2007 budget plan and about 2½ times what they expected to spend in 2004. Planned spending on used equipment grew for the fourth consecutive year, up 15 percent from last year's survey to more than $78,000.
Most equipment distributors expect their sales volume to hold steady in 2008. For the second year in a row, 83 percent of distributors said new equipment sales will either grow or stay the same in the coming year.
Thirty-five percent said used-equipment sales will increase and 52 percent said they will stay about the same. Distributors who expect their sales to increase project a healthy 16 percent gain, in both new- and used-equipment markets. More than half of distributors (52 percent) help their customers arrange financing for their equipment purchases.
Contractors look to buy
One-third of contractors with buying plans expect to buy both new and used construction equipment, up from 19 percent with similar plans a year ago. Almost half of contractors (47 percent) plan to buy only new equipment in 2008 and 20 percent will limit their purchases to used machinery.
Thirty-eight percent of the contractors who plan to invest in equipment in 2008 expect to purchase at least one highway truck. In this survey, highway trucks have been the most sought-after item on contractors' shopping lists for 14 consecutive years. The number of contractors planning to purchase off-highway trucks increased from 6 percent in the 2007 Forecast to 16 percent this year.
About one-in-four contractors expects to buy a hydraulic excavator in 2008. Rubber-tire backhoe loaders, wheel loaders and crawler dozers also rank high among anticipated purchases.
Contractors prefer to own
Equipment ownership is still the norm in the construction industry, according to contractors taking part in the 2008 Forecast. Contractors expect to meet more than 80 percent of their 2008 requirements with equipment they own. The average age of contractors' principal equipment increased to 7.8 years from 6.5 years in our 2007 Forecast.
Even though their equipment is getting older, fewer contractors are concerned this year than last about rising service, maintenance and parts costs. Fifty-four percent said they expect parts costs to increase in 2008, compared to 65 percent who anticipated parts spending would increase in 2007. Last year, more than half of contractors expected maintenance and service costs to rise; this year, 45 percent and 43 percent, respectively, anticipate more spending in those areas.
Servicing and maintaining their equipment is a priority for contractors. Most (62 percent) said they will handle equipment repairs and maintenance on their own in 2008, compared to 58 percent who expected to do the work themselves in the 2007 Forecast. Thirty-seven percent said they will rely on distributors for at least some of their repair and maintenance needs.
Rental overview
Key findings
Contractors expand use of rented equipmentRental rates expected to hold steady in 2008Excavation equipment rises on most-rented list
Contractors find renting or leasing a good alternative to purchasing construction equipment, especially for equipment they don't use very often. More than half (54 percent) said limited need is one of the reasons renting or leasing makes sense. One-third said they rent to meet unexpected needs and 21 percent said lower cost makes renting an attractive option.
Eighty-one percent of contractors' equipment needs will be met with equipment they own. But the number expecting to rent or lease equipment in 2008 is slightly higher than in the 2007 Forecast (19 percent vs. 14 percent). Contractors said they will meet 7 percent of their 2008 needs with leased equipment, 3 percent with rented equipment and 8 percent with rented equipment on which they have a purchase option.
Contractors rent or lease a variety of equipment types including loaders, backhoes, dozers, forklifts and fork trucks. Almost twice as many survey participants expect to rent excavating equipment in 2008 as in last year's Forecast.
Distributors see rental holding up
Forty-seven percent of distributors expect their rental income to rise in 2008 and another 41 percent said it will stay about the same. Slightly more heavy-equipment distributors (50 percent) believe they can grow their rental business.
Fewer distributors this year expect to expand rental income by raising rates. In fact, for the first time since 2004, fewer than half of distributors (38 percent) plan to raise rental rates in the coming year. Fifty-seven percent of distributors said they don't expect much change in their rates. Contractors have similar expectations: 41 percent expect rental rates to climb and 57 percent don't expect them to change.
For the first time this decade, distributors think revenue from their straight rental business will exceed their rent-to-own sales. On average, they expect 64 percent of rental sales from their traditional rental business, compared to 40 percent a year ago. Contractors plan to meet 8 percent of their equipment needs with rentals and 3 percent with rent-to-buy equipment. After several years of growing their rental fleets, fewer distributors expect to add new rental equipment in 2008. Thirty-six percent said they will grow their rental inventory, down from 41 percent last year and 52 percent in our 2006 Forecast. Those expecting to add equipment plan to grow their fleets by a healthy 18 percent, on average.
Contractors favor big rental companies
Contractors prefer to rent equipment from large national rental companies, which they said will provide about 68 percent of their needs, on average, in 2008. Distributors' share of the rental business grew for the second year in a row, from 11 percent in the 2007 Forecast to 14 percent this year. Not surprisingly, distributors see the big rental companies as major competitors. Seventy-two percent said they compete with the equipment rental giants, up slightly from the level of competition reported a year ago. Distributors feel good about their ability to compete; 45 percent said they are taking business away from rental companies. That number is up from 40 percent in the 2007 Forecast and it's the highest rate of competitive success this decade.
Distributors continue to price competitively in the rental business. Twenty-eight percent said they have reduced rental rates to win business, up from 22 percent who reported cutting rates a year ago. But that number is still well below the figure reported in our 2003 Forecast, when 54 percent of distributors said they had cut rates to compete.
Financial overview
Key findings
Construction firms see strong earnings growthExecutives less concerned about rising fuel costsOther factors outweigh rates in financing choices
Most contractors and equipment distributors believe that they will grow or maintain their profitability in the coming year. More than half of each group said their net income will stay about the same; 35 percent of distributors and 30 percent of contractors expect net income to increase.
The contractors who think net income will grow expect a very ambitious 34 percent increase, on average, which is well above their healthy 21 percent prediction of a year ago. Distributors are more conservative in their estimates; on average, those anticipating an increase are looking for 19 percent net income growth in 2008, compared to a 15 percent prediction a year ago.
The median 2008 sales volume for distributors in our Forecast is $3.77 million, up just slightly from $3.67 million a year ago. Contractors' median revenue is $590,000 up about 16 percent from last year's estimate. Seventy-two percent of distributors report annual sales of more than $1 million, with 27 percent expecting revenues of $10 million or more in 2008. Forty-one percent of contractors expect sales of $1 million or more, up from 29 percent a year ago; 9 percent of contractors will have sales of $10 million or more in 2008.
Firms less worried about financing costs
Interest rates have been on the minds of construction company executives for the past five years. In last year's Forecast, for example, 84 percent of contractors and 80 percent of distributors predicted that their financing costs would rise in 2007. This year, just 56 percent of contractors and 50 percent of distributors said financing costs will increase in 2008.
Cash flow seems to be a somewhat more pressing issue this year than last. Fifty-five percent of contractors, compared to 45 percent last year, and 49 percent of distributors, compared to 44 percent, said cash flow was one of the construction industry's most serious problems for 2008. More than half of each group also considers profit margins and cost of capital to be serious problems. Construction leaders place a high priority on finding the right financial services partner. This year, they made it clear that interest rates — while important — aren't the only factor they consider. In fact, contractors cited "personal experience with a provider" and "construction industry reputation" as more important selection criteria than "interest rates." More distributors mentioned "personal experience with a provider" than "interest rates" as a factor they consider.
Eyes on costs
Fifty-four percent of contractors and 40 percent of distributors said higher fuel prices will have a negative effect on their profitability in 2008. Concerns over fuel costs were more severe last year, when 59 percent of contractors and 46 percent of distributors said higher prices at the pump cut into their profits. Most construction company leaders (63 percent) said they pass some, most or all of these variable costs on to their customers.
As their equipment fleets age, many contractors are keeping a close watch on other equipment-related expenses such as service, maintenance and parts. More than 40 percent of contractors said they expect their costs in these areas to increase in 2008.
Insurance costs have been a serious financial concern for construction companies for the better part of the last decade and 2008 is no exception. More than 80 percent of contractors and 70 percent of distributors identify high insurance costs as one of the construction industry's most serious problems for the year ahead.
Business strategy overview
Key findings
Construction companies focus on diverse marketsExecutives turn to each other for industry insightContractors highly satisfied with distributors' work
As a key element of their business strategy, many construction companies specialize in a few of this diverse industry's many segments. For example, more than 37 percent of the contractors taking part in the 2008 Forecast said residential construction is their primary source of business in the coming year. Seventeen percent will focus on commercial and industrial buildings, including warehouses.
Compared to past years, more of the contractors surveyed for the 2008 Forecast? are involved in infrastructure and construction materials projects.
Seven percent said most of their business will come from excavation or clearing; 6 percent specialize in government infrastructure projects, including road, highway, bridge and overpass construction. Other areas of specialty include earthmoving and reclamation; stone, sand and gravel production; water and sewers; and concrete or asphalt paving.
Most distributors said their primary source of business is general building construction (23 percent), earthmoving and reclamation (19 percent), or excavating and clearing (10 percent). Other segments that distributors plan to emphasize in 2008 include concrete or asphalt paving, oil and gas, mining, and crane service.
Leaders rely on associates
When looking for business insights, construction executives prefer to get information first-hand from friends and colleagues in the industry. Ninety-one percent of distributors and 88 percent of contractors agree that other construction people are a top source of industry information; about one-third of both distributors and contractors said friends and colleagues are the single most valuable source of construction industry information.
Industry journals, the Internet, meetings and seminars, and daily newspapers are valuable information sources for more than half of all contractors. More than half of distributors give high marks to industry journals, the Internet and financial services organizations.
Diversification is a primary marketing strategy for almost half of distributors (48 percent), up from 30 percent who said they planned to diversify in the 2007 Forecast. Thirty-eight percent plan to advertise in 2008 and one-third expect to take on new equipment lines. More equipment distributors will use innovative financing programs, such as manufacturer subsidized financing (30 percent) or dealer financing programs (27 percent), to spur business growth.
Contractors happy with distributors' support
Contractors say that distributors are doing a great job. In fact, the 2008 Forecast sets a new benchmark with 55 percent of contractors unable to suggest even one area in which distributors can improve. Twenty percent want to see better pricing and financing programs from distributors and 16 percent suggest service improvements.
Contractors' satisfaction with equipment manufacturers also has improved in the last two years. In the 2006 Forecast, 24 percent identified product quality issues and just 19 percent could think of nothing manufacturers needed to improve. For 2008, 46 percent have no improvement suggestions, 22 percent want better pricing and financing, and 14 percent still have quality concerns.
Almost all distributors have suggestions for ways manufacturers can improve. More than half (53 percent) want to see better pricing and financing, compared to 41 percent who made those suggestions a year ago. Twenty-two percent of distributors are looking for better levels of service and 12 percent see opportunities for product-quality improvements.
In a tough competitive market, 28 percent of distributors expect the number of local contractors to decline in 2008; just 17 percent predicted a reduction a year ago. Nineteen percent of distributors expect to see more active contractors working in their area. On average, contractors work with 2.6 distributors; that number has stayed constant in recent years.
Issue and opportunity overview
Key findings
Companies see diverse range of opportunitiesExecutives focus on keeping pipeline filledWorker shortage, insurance costs are top concerns
American construction leaders see a wide variety of opportunities and challenges, according to the results of the 2008 Construction Industry Forecast. The housing industry has been a driving force in the U.S. economy for the better part of a decade, but experienced significant challenges in 2007. In 2008, industry leaders expect a wide range of opportunities to surface beyond residential construction.
About two-thirds of contractors think that their best prospects for the year ahead lie outside the residential construction segment in such areas as commercial construction, government projects, water and sewer work, and road and bridge projects. Our survey has consistently found even more diversity in the opportunities that equipment distributors plan to pursue and this year is no exception.
Diverse range of possibilities
Twenty-eight percent of distributors said that general construction is their top opportunity for 2008. General construction has been the most cited distributor opportunity in our Forecast for at least the past decade. Many distributors (21 percent) see commercial construction and commercial projects as their best business opportunity for the coming year, followed by road and bridge work (13 percent), oil and gas development (10 percent), mining (8 percent) and other government projects (7 percent).
In spite of the housing downturn in 2007, about one-third of contractors believe that residential construction will provide their best business opportunity for 2008. Twenty-three percent of contractors think that commercial construction offers more opportunities than any other sector of the construction industry. Government projects (12 percent); water and sewer work (7 percent); and road and bridge construction and repair (6 percent) were mentioned as prime opportunities by many contractors.
A significant number of contractors (11 percent) said business diversification was their best opportunity for 2008.
Worries over workload, workers
American construction executives are more concerned about keeping their project pipeline filled in 2008 than they have been in recent years. Forty percent of distributors and 44 percent of contractors said lack of work is a serious industry problem for 2008 and about one-in-six executives said lack of work is the most serious problem the industry faces.
The possibility of that their workloads will decrease hasn't changed the fact that a shortage of qualified, motivated technicians and other skilled employees is serious problem for the construction industry nationwide. The scarcity of good workers has topped the list as the most serious problem for contractors in each of the last three Forecasts and for equipment distributors in four straight. This year, 29 percent of contractors and distributors said a scarcity of workers is their most serious problem for 2008.
When given the chance to identify several problems they consider serious, more than 80 percent of contractors and more than 70 percent of distributors mention rising health insurance costs. Health insurance has ranked as the top industry problem for six years straight.
Almost twice as many contractors as last year said government regulation is the industry's most serious problem. More than half of contractors and 43 percent of distributors said government regulations are one of the most serious problems they face.
In the next issue if CD… Construction overview by region
The results of the 2008 Industry Forecast highlight that, despite its size and influence on the national economy, construction continues to be a local industry. It's helpful to take the temperature of the construction business as a whole, but there's probably a lot more value in knowing the industry's health where you live and work.
author: By Jason Bader




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