Fasten Your Seatbelt: 2011 Big Gains May be Coming in 2011 - Business Outlook
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Fasten Your Seatbelt: 2011 Big Gains May be Coming in 2011

by Eli Lustgarten

Article Date: 01-01-2011
Copyright(C) 2011 Associated Equipment Distributors. All Rights Reserved.


New tax bill brightens outlook for domestic machinery demand.

Can a change in tax policy materially change the economic outlook? Economists are debating that very fact as a result of a compromise reached by President Obama and Congress (read Republicans) to extend the "Bush" tax cuts for two more years and prevent a tax hike shock to the current fragile domestic economic recovery. Included in the compromise are various tax proposals designed to stimulate the economy, including extending or renewing various tax benefits such as the R&D tax credit and potentially adding a new wrinkle to bonus/accelerated depreciation benefit: The proposed legislation, we believe, enables 100 percent bonus depreciation of assets acquired after Dec. 8, 2010 and before Jan. 1, 2012 and placed into service before Jan. 1, 2012; the proposal provides for 50 percent bonus depreciation for 2012. The bill also extends current IRC section 179 expensing or certain property at $500,000 through 2011, which is subject to a phase-out if the property purchased exceeds $2 million.

While we won't know for some time the exact details or full impact of the new legislation for a while, the economic community has nearly unanimously agreed that the "Tax Hike Prevention Act of 2010" is a $858 billion bill containing material stimulus that will raise U.S. GDP growth in 2011 to perhaps 3 or 3.5 percent (or more) from most recent projection in the 2.5 to 3 percent range. More importantly, the passage of this bill may create an environment that will lead to far stronger increases in construction machinery sales than previously projected.

The new "stimulus bill" may have come at a critical time. The most recent economic data shows a strengthening U.S. economy in the fourth quarter of 2010, led by somewhat better consumer spending. Further, industrial production in manufacturing rose 0.3 percent in November, and manufacturing capacity utilization rose to 72.8 percent from 72.6 percent, but still well below the 1972-2009 average of 79.2 percent. Construction activity, however, continues to putt-putt along with housing remaining quite muted. The National Association of Home Builders continues to reduce their 2011 forecast for housing starts to "hopeful" 739,000 for 2011 (was 804,000) though still a material increase from the not-so-easy-to-reach 605,000 that was still projected for 2010 as this article went to press third week of December. Input costs to construction continue to rise, particularly copper, diesel fuel and components such as concrete reinforcing bars, with merchant bars and structural products placing a further squeeze on contractor profitability.

We continue to believe that 2010 was the year of the component supplier who benefited most from the positive side of the bull-whip effect (rebalancing and restocking of the supply chain) after American manufacturers took the cupboard nearly bare during the sharp economic decline of 2009. With the inventory/supply chain effect clearly coming to an end, the shift in demand in 2011 will be from bull-whip-related strength to end-market-related strength.

The new tax bill offers significant hope to the construction machinery market. We believe 2011, if the new tax rules are reasonable, will be the year of the equipment supplier. Domestic demand growth will be enhanced by the unfolding tax package with 100 percent depreciation write-off, which will likely pull forward some planned 2012 equipment expenditures into 2011.

While construction expenditures will still only see modest recovery, spending on new construction machinery may accelerate and be far stronger than originally anticipated. Our original forecast for sales and production of all classes of machines to rise at least double digits (10 to 15 percent) may prove to be conservative with gains in the 25 to 30 percent or more possible, driven by several factors spurring more intense buying, particularly in the second half of 2011:
  • The new, more generous 100 percent bonus depreciation, which is set to expire at the end of 2011
  • Price increases for new equipment being driven by two key factors – higher input costs (steel, copper aluminum) raising prices by about 2 percent; and regulatory-driven cost increases such as the implementation of Interim Tier-4 over the next several years, which we believe will ultimately drive up equipment prices by about 12 percent; these higher prices will be phased in, most likely, in about 4 percent increments
  • With rising, albeit modestly, construction outlays, the need for normal replacement will occur as most construction equipment fleets have aged (and shrunk), particularly in the rental sector
Bottom line: The construction sector may finally realize that the light at the end of the tunnel is indeed a light.

Eli Lustgarten (elustgarten@aol.com) is president of ESL Consultants, an industrial consulting firm.
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