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US cement industry: rocking towards a new optimism

World Cement,

Written by Ed Sullivan, Portland Cement Association. This article is an abridged version of the full article, which appeared in the IEEE 2013 supplement of World Cement. Subscribers can view the full article by logging in.

The US economy has been running weak for so long that some suggest moderate economic growth is the way things will be for the foreseeable future. This thought process is especially prevalent in the hard-hit construction industry. PCA, however, does not believe the numbers work for a tepid economic turnaround during the next five years, but instead that they point to larger increases in economic growth.

The first two quarters of 2013, despite PCA’s optimistic views, will have subdued economic growth, near 2%. Economic uncertainty generated by a dysfunctional US Congress, higher tax rates and forthcoming government spending cuts are responsible for this slow pace growth. As expected, cement consumption during this period will also likely be depressed – especially when compared to the first quarter of 2012, which had extremely favourable weather conditions.

Recessions, by their design, correct past economic imbalances. Easy credit, loose underwriting standards, debt-based consumer spending, overvalued real estate, and robust federal, state and local spending appetites were all carried to massive excess during the boom period of 2003 – 2006. The recessionary correction, as a result, had to be equally substantial – and prolonged.

As this correction process nears its completion, extremely positive developments are taking place. While the government debt has been a great focus of attention, private debt shows a much better picture. Consumer debt has been in decline as a share of disposable income since 2005, led by historically low interest rates and a desire by US consumers to pay down their bills. Corporations and private businesses are also seeing an easing in the availability of cash and, finally, banks are healthy again.

Recessions historically generate their own fuel to begin the next recovery – at robust rates of growth. Sub-trend growth has generally characterised the economy for the better part of six years – an extraordinarily long period of time – implying that huge and unprecedented pent-up demand has been created and is waiting for its release.

At issue is the timing of its release. PCA believes the beginning may be close at hand and could materialise in strong economic growth in the second half of 2013 and beyond – stronger than many expect.

Residential outlook

Since 2005, PCA has leaned against the consensus with its pessimism on housing starts. That view proved to be correct and served as good guidance to the industry. The basis of our pessimism has been our view of tepid economic growth and sustained high foreclosure rates that manifest themselves in depressed home prices and bloated inventories, telling homebuilders to sit on the sidelines. These conditions no longer exist.

PCA is now counted among the housing optimists. Total housing starts are expected to reach 954 000 units in 2013, reflecting further improvement over 2012’s nearly 30% growth. The possibility of one million starts in 2013 should not be dismissed. While the first half of 2013 will be mired in the fiscal cliff hangover, PCA is decidedly optimistic about second half 2013 economic growth, job creation and consumer sentiment – all of which translate into stronger home sales and starts activity. Furthermore, pent-up demand for housing has been building since 2006 and is estimated to be near 3.2 million single-family starts by the end of 2012. While the timing and magnitude of its release onto the market is difficult to predict, its presence adds further support for an optimistic outlook with regard to residential construction.

Nonresidential outlook

Nonresidential construction increased an estimated 10% during 2012 and similar gains are expected in 2013, driven by growth in the predicted return on investment (ROI) for commercial properties. ROI, according to the PCA viewpoint, has two essential components: net operating income (NOI) and asset appreciation potential. Between the two, PCA believes NOI is the more important metric to focus on since it also plays a role in determining asset appreciation potential.

Several issues confront a recovery in nonresidential NOIs and construction activity, including depressed occupancy and usage rates, soft leasing rates, declining commercial asset prices and tight lending standards. Job creation, either directly or indirectly, translates into higher occupancy and leasing rates. Combined, these factors determine the expected return on investment for most commercial properties. Given PCA’s expectation that nearly 2.2 million net new jobs will be created during 2013, occupancy and leasing rates should continue to its gradual improvement and drive growth in this sector. As the economy gains even more momentum in 2014, this sector will become an increasingly larger supporter of cement consumption growth.

Public outlook

Public construction will act as a small drag on overall cement consumption during 2013. Several aspects characterise PCA’s public construction outlook, including assessments of state and local construction spending, and the new highway bill. As the economy gains momentum in 2014, this sector will become an increasingly positive contributor to construction growth.

State and local construction spending has reached a trough point and should not create a drag on overall cement consumption during 2013. Furthermore, with a strengthening in the job market, state budget surpluses are expected to materialise by fiscal 2015. These will usher in an increase in state and local construction spending.

Putting it all together

There is still some waiting to endure, but the time is now measured in quarters – not years. The generation of unprecedented levels of pent-up demand signals that the potential of more robust economic growth lies ahead. The condition of private sector underlying fundamentals among consumers, corporations and banks is arguably strong. The issue is timing. By mid-year, uncertainty generated by politics is expected to be replaced by a gradual strengthening of confidence that will trigger the release of the underlying economic potential. With its release, housing starts will grow stronger, occupancy rates and expected ROIs on commercial buildings will rise and the public sector drag will eventually be replaced by a mild positive. When all three sectors of the construction market beat positive (residential, nonresidential and public), robust growth rates in cement consumption have always materialised.

Cement consumption grew 9% during 2012 and similar rates of growth are expected for 2013. Given the dynamics outlined above, double-digit growth in cement consumption is expected to materialise in 2014 and those rates of growth may be sustained for a number of years.

Written by Ed Sullivan, Portland Cement Association. This article is an abridged version of the full article, which appeared in the IEEE 2013 supplement of World Cement. Subscribers can view the full article by logging in.

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