Can’t look back at 2010 to plan for 2011
BY TALBOT H. GEE
Special to The Wholesaler
My 2010 forecast for the HVACR wholesaler market ended up being fairly accurate, however not entirely for the reasons I predicted. Federal and utility support of energy efficiency improvements were unprecedented and the market’s financial footing was surely better than 2009, but to classify 2010 as a recovery year is somewhat misleading when looking at the data.
AHRI’s central air-conditioner and heat pump shipments through October 2010 were essentially flat compared to 2009 despite an exceptionally hot summer in most parts of the country, and the amazing amounts of incentives for high-efficiency system installations. JP Morgan Equity Research forecasted 15% growth in 2010 unitary shipments, which considering their compelling data showing seven million legacy systems due for replacement and the positive economic, weather, and incentive drivers, probably should have been within reach.
Through October though, HARDI’s Monthly Sales trends were showing average running 12-month distributor growth of 8%, seemingly supporting the empirical data showing 12% more repairs done than condensing units shipped. The parts business is a good one for HARDI distributors, however when looking forward to 2011 one must not forget that residential equipment sales remain the long-term driver of industry growth. The unitary sales experience of 2010 does not provide a positive leading indicator for 2011. Next year’s performance will likely be influenced by three major equipment-related trends:
1. How much 2011 demand was pulled into 2010 by the $1,500 tax credits?
2. How much will the sales mix of high-efficiency systems suffer without the $1,500 tax credit incentive?
3. What is the volume and margin impact of the reintroduction of newly-produced R-22 condensing units?
Before making any 2011 determinations, let’s evaluate macroeconomic factors that may provide a market boost absent in 2010.
HARDI’s chief economist, Alan Beaulieu of the Institute for Trend Research (ITR) had this to say to HARDI distributors in his final quarterly forecast of 2010 issued in October: “Subscribers to the full edition of this report will see that HARDI member sales have been rising in similar rate-of-change fashion to overall activity in housing permits and the U.S. economy in 2010. This fact, coupled with seasonably warm weather and other stabilizing economic factors, has resulted in remarkable improvements in sales over 2009. However, linear thinking is not advisable as we approach 2011.
“Many regions will experience a period of flattening housing activity in late 2010 and early 2011. Unemployment and subsequently foreclosures are still very high, home prices are still low (though stabilizing) and credit is still tight. These factors will keep general economic recovery tempered and we have built that into our forecasts for the housing and commercial markets. Know that the worst is over, conditions are improving, but 2011 growth will be mild for most.”
With two additional months in 2010 considered, Beaulieu added in late December: “The wholesale trade industry is doing well with durable goods posting a solid 11.4% year-over-year gain. This activity is being driven by both business and consumer-based demand. However, the leading indicators most important to HARDI members are showing that activity in the HVACR market will be slowing in terms of the rate of rise. For instance, companies that experienced a 10% year-over-year growth rate in 2010 should not expect another 10% increase in 2011.
Firms tied to new home construction will not fare as well in 2011 as their more industrial brethren. There will not be a quick rebound in the housing new construction market in 2011. Wholesalers should plan on a repeat of the 2010 level of activity. Wholesalers who work to key in on the remodeling market will fare better. The remodeling index for projects under $25,000 in value is encouraging and it should remain a good source of business for many distributors.
The nonresidential construction market is still two quarters away from beginning a recovery that will be painfully slow in terms of the rate of rise. Employment will need to drive occupancy rates up before a lot of activity will be evident in this market place. The economy will not be creating many jobs in the industrial/office/commercial realm in the next year. Industry participants should stay lean, efficient and look for opportunities in new, previously unexplored markets.”
Remodeling upswing
To this point, the improving remodeling index is one HARDI will be watching very closely in 2011. This is encouraging since our industry has seemingly suffered in recent years by homeowners’ unwillingness to make major investments in homes for which they had little commitment.
Keep a close eye on Home Depot and Lowe’s reports and SEC filings to see if homeowners maintain their appetite for home improvements next year. While I do not expect either retailer to be a significant player in the HVAC business, it is hard to imagine homeowners investing in a several thousand dollar HVAC replacement (especially in the absence of a robust tax credit) if they aren’t willing to spend money on other, less expensive home projects.
New Congress a wild card
Potentially pouring salt on an already wounded commercial market, it is possible the new Congress — feeling mandated to rein in federal spending — may raid and reclaim unspent stimulus funds; a large portion of which is earmarked for commercial, government, and institutional building upgrades and energy efficiency retrofits. Most of 2010’s commercial projects were tied in some way to stimulus-funded energy efficiency improvements in government buildings, universities, and schools.
To count on those stimulus dollars being there in 2011 if they’ve not yet left the Department of Energy, GSA, Department of Defense, or the Office of Management and Budget would not be a sound basis for commercial growth strategies or predictions next year. That being said, 2010 featured a surprisingly strong supermarket and commercial refrigeration market with several large chains hitting their five year retrofit cycle or pulling the trigger on energy and refrigerant reduction retrofits.
Considering the generally weak consumer and retail spending figures throughout 2010, this is encouraging and should indicate further opportunities in a more retailer-friendly 2011. Finally, regarding commercial business, while it may be unlikely to see significant new construction or major equipment retrofitting, 2011 could be a good year for the controls/building automation industry as facility owners and managers seek additional ways to lower maintenance and utility overhead without spending the big dollars on new mechanicals.
R-22 uncertainty
Focusing again on residential markets — specifically the outlook for unitary equipment sales in 2011 — it seems like an annual event to declare the next year as the most uncertain and unique one ever. This time last year it was uncertainty not only about the shaky economy, but how the next stage in the R-22 phase-out would go. It wasn’t until the 23rd of December 2009 when U.S. EPA finally released the two phase-out regulations affirming our hard work and advocacy by ensuring the continued repair and component replacement of existing R-22 systems. However the EPA chose to reject one major HARDI recommendation and decided to allow the continued manufacture and sale of “dry-shipped” R-22 condensing units; at the time choosing not to disrupt the long-standing precedent in refrigeration applications. It was in August 2010 when we first heard of a few residential “dry-shipped” units being sold to wholesalers and just four months later all major OEMs are offering them. These products now arguably represent the greatest level of uncertainty for 2011, which is saying something these days.
JP Morgan Equity Research views these units as a net positive for OEMs and the industry, potentially reviving perennially sluggish unitary sales by providing a low-cost equipment option to home and multi-unit building owners who have resisted equipment ?replacements for several years. While this may be true, so too is the likely negative impact these units will have on the more energy-efficient, profitable and properly-matched R-410a system replacements; replacements by the way that HARDI distributors invested heavily in throughout 2010 since we were supposed to be done with R-22 equipment. Another notable variable would be the uncertainty of the kind of service and call-back issues these field-charged units will present. Returns and corrective repairs are pure profit-suckers for wholesalers who cannot charge back their labor hours, yet unbelievably we’re seeing some “dry-shipped” units being offered with five-year warranties. Coupled with the inevitable race to the price bottom, I have a difficult time seeing how these units will have a net positive profit impact for distributors. Large volume multi-unit customer sales may just provide enough cushion to make this work, but seeing the introduction of “dry-shipped” larger capacity and even heat pump units obviously goes beyond the apartment and condo complex market and adds significant risk.
This risk could have been mitigated somewhat in 2011 had the $1,500 federal tax credits for residential high efficiency retrofits been fully extended. While it cannot be overstated what an accomplishment it was to have kept the credit in the tax code for another year by getting it added to December’s tax bill, the fact remains that the credit was stripped down to pre-ARRA levels providing only $500 in incentives per household that had not claimed such a credit since 2006. HARDI will work to fully reinstate the $1,500 credit amount next year. In the meantime we’re left with a credit unlikely to drive much demand resulting in a strong incentive for early 2011 business to get pulled into 2010 so taxpayers can claim a full, $1,500 credit.
Many HARDI members are reporting record sales in November with a strong start to December; enthusiasm which is tempered by the likelihood of a severe drop in Q1 2011. January and February are looking like great months for sales, new product, and profitability training for distributor personnel to prevent or at least mitigate margin slippage that appears to be facing all of us next year.
The federal tax credits drove a major shift in the mix of high-efficiency unit sales (while regrettably not helping volume much though). The percent of 15 SEER shipments moved from just 5% in 2006 to 14% in 2009, to an estimated 23% in 2010 according to JP Morgan. While 38% of 2010 shipments are expected to be greater than 13 SEER, we know many HARDI members saw even stronger high-efficiency sales.
Lower margins next year
This produced margin growth that fueled 2010’s improvement over 2009 despite nearly unchanged unit volumes. Imagining a 2011 without this strong mix improvement, or more likely a significant mix slide is concerning. 2011 is looking to be defined by a firm’s efficiency; perhaps more so than any previous year. Volumes of parts and low-margin units will likely increase while selling big-ticket, high-efficiency systems appears to be facing major headwinds.
I’m glad to see analysts like JP Morgan and others have a bullish outlook for 2011, however distribution isn’t just about volumes and, incidentally, the analysts have been looking for those volumes to rebound for several years now. The profile for profitable HVACR distribution in 2011 will be the best-trained, value-added, leanest, and most forward-thinking companies. Easy to say and somewhat cliché yet true nonetheless when looking toward a year that is losing its greatest profit drivers.
Talbot H. Gee is executive vice president & COO of Heating, Airconditioning & Refrigeration Distributors International (HARDI).