Sunday, November 16, 2008

What’s Going to Happen In 2009?

We all need to think some more about 2009 – things are changing at a fairly rapid pace. We have two choices: (1) assume chaos and cut to the bone, or (2) try to divine the logic of what’s happening and plan accordingly. The global consumer is roaring like a lion with his/her response to what has happened with our economic meltdown. It is quite logical. Responses to the current situation should also be quite logical. Somehow, logic has not been in abundance in Washington. We are thinking of swapping an auto industry bailout for a free trade agreement with Columbia. We’ve ushered in a plus-$150 billion bailout of AIG with its relative handful of middle class jobs (you know, the folks who clean the executive bathrooms for their top money men and women). Yet, few take issue with the plus-3 million jobs in the motor vehicle industry getting vaporized by the toxic waste left by Wall Street greed.

Planning for an uncertain future must start with the absolute basics of what we know. The NY Times has abundantly reported and charted rising unemployment and job loss rates. People are frightened about their ability to economically survive and, as a direct result, are significantly cutting back on spending. Home prices have fallen off the cliff and left little positive equity for funding large purchases. We are more than one year away from any improvement here, so folks are cutting back on buying big stuff. The plunging Dow has become a graphic display of personal wealth. 401K plans and retirement savings are down, for many (if you are lucky) by a third. So, folks are uncertain about the future and are thinking of how they will replace their lost wealth. They are troubled, scared, and uncertain. So, they cut back. Those with the courage to spend get their hands slapped when financing their purchase – many have high, but flunking, credit ratings. Congress allocated $700 billion for a bailout, but nothing good seems to be happening. Gas prices are plunging because nobody’s driving their car – a mixed message for this industry, if ever there was one. Goods consumption is down, so fewer “goods” need to be moved. Therefore, the trucking industry is getting whacked both by intermodal freight and simple raw forces of nature. The Fed is now worried about “deflation” – we can see it in falling grain prices … and this is the segment we felt good about earlier this year. This can be pretty depressing. Instead, I call all this “data.”

So, we can either become paralyzed while soaking up more bad news, or we can trust Barack to figure a way out of this box and be logical. Best bet is to trust Barack. Logically, we can’t fix the long range problems with our economy until we fix the most pressing short range issues. As a fresh new president, what would you rather do first, (1) create a million new jobs out of the ether, or (2) save a million jobs from getting axed? Barack’s a smart guy and will pick door number 2. So, logically, he will choose to rescue the motor vehicle industry, because there are at least a million jobs on a quick-step march to the guillotine. How will he do it? Barack’s a smart guy and knows he needs a genius to explain why spending $150 billion on AIG makes sense. The big takeaway here is that while we are spending that $150 billion, the Dow’s slipping and jobs are being shed at a record pace. So, he will figure out that he needs to do something different. If logic prevails, we are likely to see a 2-pronged bailout. Prong 1: do something that promotes buying new vehicles right now – this will create a group of “hot-ter” products; and Prong 2: separately, provide unfettered loans ($25 billion or so) to the domestics, so that they can stay in business for the next year or so. Based on pure logic, we expect that sales of domestically assembled motor vehicles will rebound sometime in the second quarter of 2009 (compared to the atrocious second half 2008 running rate.) The domestics will receive loan guarantees, and Cerberus will turn over Chrysler to the “right” suitor.

What does all this mean for automotive service parts sales? For the “hot-er” segments, (second quarter volume pick up) accessories will rebound (even SUVs will sell because of lower gas prices). For those who are not bailed out, owners will continue to delay vehicle purchases and will look to repair and maintain what they’ve got. (If the dollar continues to strengthen, small car foreign OEMs might weather 2009 without much storm damage.) This should boost M&R sales for all OEMs across all segments in 2009. Troubled dealers continue to pressure fixed operations to carry more and more of the dealer fixed costs. So, typical dealers will put more pressure on increasing labor rates, labor content, parts margins, and shop fees. Unless the OEMs do something about this, much of the 2009 surge will go to the independents as vehicle owners increasingly confirm the busted notion that dealers are the high cost spread. Since the Prong 1 stimulus might not be in the form of a rebate or incentive, it might not have as negative an impact on residual values as what goes on in the current rebate war. So, fewer totals and a positive signal to collision sales. Adding fuel to this growth will be cheap gas, causing more miles driven, leading to more crashes. The top three areas to stress in 2009? Accessories, kinder and simpler service retention, and collision.

What does it mean for Ag? Logically, the US needs stable-to-increasing agriculture exports to hold on to any semblance of a balance of trade. So, don’t expect to see less assistance for ethanol production and other farm subsidies… in fact, you might see more as we march more strongly to energy independence. Key futures of commodity prices have fallen to 2007 levels, with wheat back-sliding the most. Corn harvests will be down 6% in ’08, but soybean harvests will be up 15%. The dollar has strengthened mightily – this is bad for exporting both food and tractors. Although tractor sales are up 4.1% in 2008, Ag will not be able to hold on to 2008 levels of whole goods growth; but, it won’t be all that bad. Tight credit will further dampen whole goods sales, while M&R parts will do OK as farmers squeeze more life out of what they’ve got … and use it to harvest 2008’s bumper crops. The biggest whole goods hurt will be in the small stuff – lawn & garden and mid-sized stuff for the smaller lawn and grounds care contractors. Since Ag has much higher service retention than auto, the parts sales for this segment will look a lot better than the sales for incidental items. What to stress in 2009? How to reduce cost of ownership through repair and maintenance – across all segments.

What does this mean for construction? Logically, good and bad. The big stuff used for “WPA” roads, bridges, and airport type infrastructure investments will do well, both domestically and export. But, this will take a couple of quarters to get any sort of momentum. This is due to China’s massive half-trillion-dollar economic stimulus, as well as likely US and other global get-to-work job rescue programs. In 2009 US exports will not be boosted by an incredibly cheap dollar – so, pricing will be an issue. Outside this, most analysts see capital spending drying up. The small stuff for residential construction will get some benefit from the smaller infrastructure rebuilding projects, but largely will have to wait another year in the ER for trauma care. I suspect parts sales will follow whole goods sales, because there’s little need to squeeze more life out of equipment that’s not being used. 2009 pressure points? Mining, supporting the big stuff, seamless exports, and for the second tier players, integrating operations and assets to get much of the waste out of the value-chain.

What does this mean for heavy trucks? First off, somebody has to figure out why low sulfur diesel, that was supposed to cost a nickel a gallon, ended up costing a buck a gallon. This still is pushing freight to intermodal. The good news is that this trend will abate somewhat by falling diesel fuel prices. Total freight movements will be down as we consume less. Port of call networks will be rationalized as container rates fall – this will hurt intermodal, as inland stem distances fall. Diesel engine sales to the domestic super duty market will continue to shrink in 2009. And, truck exports will be hurt by the stronger dollar. If that complexity is not enough, 2010 emission regulations should act to pull ahead truck sales like it did in 2006/7 (though few in the industry are holding their breath on this one – expecting a much smaller spike). The good news is that engine technology to meet 2010 standards could be a differentiator. Chaos. But, this segment is used to this type of cyclicality and will survive. 2009 focus? Cutting back in capacity, SG, and jobs for 2009, but still planting seeds for 2010 growth.

What does this mean for cycles and recreational vehicles?
2009 will be a very tough year. You need to work on lowering fixed costs.

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