So, are we entering a recession? Yes and no. For the nation's largest mechanical contractors, the answer is probably no. Contractors who are in the residential market or building strip malls will feel differently.
The basic reason is that the recovery coming out of 9/11 has been slow and steady, so many markets are not overbuilt and contractors still have solid backlogs.
The markets targeted by large mechanicals, such as 100,000-sq.ft.-plus office buildings, hospitals and healthcare, hotels, universities, plants owned by Fortune 500 owners, and water and wastewater treatment, are all solid if unspectacular.
“Normally, going into challenging economic times, the office building market has been overbuilt,” points out Bill George, chief financial officer for Comfort Systems USA, Houston, “but vacancies are low compared with 10-year averages because, coming out of 9/11, building was depressed so there was little activity. As a result, for the first time in decades, we're going into a recession and the markets are not particularly overbuilt.”
Travelers are paying high rates for hotel rooms, George says, because the market isn't saturated. Healthcare is booming because of the aging population and because hospitals are in tight competition with each other.
“So many schools were built in the ‘70s for the Baby Boomers, and a lot of them either need to be replaced or renovated, so it's a matter of when, not whether it's going to happen,” George says.
“We expect a milder recession than 2002 and 2003,” says Tony Guzzi, president and COO, EMCOR Group, Norwalk, Conn.
“Now, if we were building strip malls, I wouldn't be as cautiously optimistic as I am sitting here running EMCOR,” Guzzi says. “It wasn't that big of an expansion, coupled with the fact that if there's a downturn, it will turn into the shortest expansion we've had. They're usually 7-1/2 to 12 years and this one would be less than four years.”
Many good markets
Guzzi can come up with a long list of reasons why markets for large mechanicals will remain robust, starting with energy, energy efficiency and energy infrastructure needs. Healthcare will remain strong long term. Security and terrorism concerns will be good for the fire protection market. Water supply and wastewater treatment is a good long-term market, especially for contractors who are well-positioned in Texas, Florida, California and Arizona, states with water problems. Green building and LEED will provide mechanical contractors with design capabilities the ability to add value. The weak dollar will boost plant construction and expansions in the U.S. to make products for export.
The downturn in the economy will hurt those with bad credit and low bonding capacity, Guzzi says, such as developers who are unwilling to put much in the way of their own assets on the line for a project. People who should never have gotten money in the past, Guzzi says, will not get it. People with good credit and good projects will get financing.
“The days of idiots lending to idiots may be behind us,” he says.
One market that's turning south is ethanol.
“From a piping contractor standpoint, the ethanol market has fallen through the floor,” says Tom Benassi, vice president of estimating for Foley Co., Kansas City, Mo. “The financing has dried up. That will influence other work. Contractors who grew large in that market will move into other industries.”
Notes Michael H. Krueger, CEO and executive vice president of J.F. Ahern Co., Fond du Lac, Wis., “Ethanol has slowed down quite a bit. The expectations of what it would be are different than they were two years ago, at least in Wisconsin. Just like there was a prediction that 20 major power plants would be built here by 2010, which hasn't happened, and ethanol had the same kind of hype that there would be one on every street corner.”
“Two things we're watching closely,” says Guzzi, “are will more food plants be built in the U.S. and how is the ethanol thing going to play out and will we return more land back to pure agricultural use?”
Of all the markets, healthcare has, as Guzzi puts it, the “best underlying fundamentals.”
The booming healthcare market is the result of both aging demographics but also specialization that's needed in the marketplace, says Patrick J. Murphy Jr., president of Murphy Co. Mechanical Contractors & Engineers, St. Louis.
“Hospitals are in competition with each other, like the one we're working on that will convert all of its patient rooms to private rooms,” Murphy says. “Different procedures and the different needs of doctors means that hospitals are constantly building.”
Notes Comfort Systems' George, “Healthcare in the long run is booming for two reasons. One is the underlying demographics are very good. And when I say that it's strong, I mean that it is holding at a high level, not year-over-year increases. And, secondly, most hospitals are seeing what the movie theater or the grocery store people did - they have to upgrade because all of their competitors are.”
Making it, saving it
The energy markets and all that they encompass - from refining to high efficiency HVAC equipment - will continue to be strong.
In the power market, there are a lot of requirements for power companies now so there's a significant amount of scrubber work going on, says Murphy, whose firm also is involved in the refining market.
“Piping and industrial power-type facilities will be strong,” says Foley Co.'s Benassi. “Power goes through cycles every 20 years. Right now power is in that growth pattern and it typically lasts five to seven to 10 years, so it will be strong for years to come. We'll need more power-producing facilities so utilities do an environmental upgrade to an existing plant in order to get authorities to grant a permit for a new plant, either adjacent to an existing plant or in a new location.”
EMCOR is a major player in distributed generation, renewables such as biomass, combine heat and power, solar, and in refineries.
“As more refineries have to switch to use sour crude, it makes it more difficult to get the output they want to get,” Guzzi notes. “And they also have to, by federal law, blend in ethanol and that has implications in how refineries need to be upgraded.”
Influence of LEED
In addition to producing energy, large contractors are finding work saving it with variable-speed drives, free cooling with plate-and-frame heat exchangers, or better monitoring and control. Certification under the U.S. Green Building Council's Leadership in Energy and Environmental Design has had an impact as it spread to more private owners. Guzzi says that last year, EMCOR did more LEED projects for private owners than for institutional owners, the reverse of what it was just a couple of years ago.
While LEED certification is a requirement in the public sector, says Bill Caldwell, vice president, Waldrop Heating & Air Conditioning, Spartanburg, S.C., more private owners demand it. Waldrop recently built a new bean roasting facility for Starbucks outside of Columbia, S.C., that was a LEED project.
Thirty to forty percent of the projects in Texas, especially in the K-12 school market, are LEED certified, says Richard Berger, president of Berger Engineering, Dallas. The schools Berger is building have discarded chillers and boilers for ground-source heat pump loop systems.
“We can get about one-ton per geothermal well, so we may have as many as 500-700 wells for a high school,” Berger says, who notes that the operating cost of a geothermal system is half that of a conventional system. Berger says that all new schools in Iowa will be using geothermal heat pump systems going forward because of the energy savings.
“We're working on a number of LEED projects,” George says, “and we think that's an important trend as the percentage is small. But some of our most attractive projects are LEED projects, and in the development pipeline, more projects are green, whether they are LEED or just attentive to energy efficiency.”
The forecast for the hospitality market is mixed. Guzzi notes that the hotel market has been growing by 50%-60% a year, and that has to stop. Nevertheless, he predicts the high-end hotel market will continue to grow for about 18 months.
Waldrop's Caldwell says he's too far from the coast to get into the hospitality market but he knows that his peers have been building hotels and resorts like crazy from Myrtle Beach to Hilton Head Island.
Gambling is spurring hospitality growth.
Murphy Co. is building casinos in St. Louis. There's a new casino on the riverfront for Pinnacle Entertainments called Lumière Place. There's an expansion under way at the Ameristar casino in St. Charles, Mo., and another casino in St. Louis for Pinnacle that's on the boards but it's not under contract to anyone yet. EMCOR has had a lot of activity in Las Vegas and in Native American gaming in various locations.
If the weak dollar is spurring investment in U.S. plants, Waldrop is benefiting from it.
“BMW announced a $750 million expansion that will have tremendous effect on the marketplace for them and their suppliers here,” Caldwell says.
BMW builds its X-class crossover vehicles in a plant in Spartanburg County, S.C. Caldwell says that BMW has replaced the textile industry as a major economic driver in South Carolina.
Waldrop also recently finished work on a $4 million automotive research facility at Clemson University's graduate school that was jointly funded by BMW, Michelin and Toyota.
Schools still robust
Most of the other Giants also are working at schools and universities.
“In schools, we do both post-secondary and university work,” George says. “Demographically, K-12 projects are expected to be very strong over the next few years.”
J.F. Ahern has a long history of working in the University of Wisconsin system. It's currently installing fire sprinklers at UW Stevens Point, which happens to be Krueger's alma mater.
“The public sector continues to be very strong here [South Carolina] in the primary through secondary public school system as well as higher education,” Caldwell notes. “The market is very bullish, in particular, school districts are having multi-million dollar programs, $400-$500 million programs over the next three to four years. That's coupled with the fact that higher education seems to have, in the State of South Carolina, a lot of opportunities. There are three major universities with research and development-type projects.”
EMCOR has withdrawn from the K-12 market except for some fire protection work, but it works steadily at colleges.
It is possible that the K-12 market will be negatively impacted by the housing downturn. As home prices decline, property tax revenues that fund most local governments may also decline.
“Unless there's a real change in budget numbers from a state tax situation, we see those (school) programs continuing,” Caldwell says. “There's some talk now in Columbia (S.C.) about shortfalls, but as of now major projects are going forward.”
Berger notes that, “162,000 people moved into the Dallas-Ft. Worth area in the last two to three years. The suburbs are growing and bond issues have been voted on, but bonds that were voted on two to three years ago are not meeting financial needs today. There's a need for new schools, so we have to value engineer and redesign jobs to get them in budget.”
Of all the commercial markets discussed by the Giants, office buildings, especially speculative office buildings, will be slow.
Berger says the office building market is off 25% in his area.
“We don't see lot of new office space,” says Caldwell. “That seems to be an area that's beginning to slow.”
Benassi from Foley Co. says the commercial office building market in Kansas City is “not weak, but soft.”
“You can't draw an automatic conclusion that office buildings will suffer as was usually the case going into a recession,” George points out. “But, that said, you've got to know that developers and planners are very aware of the underlying economic environment.”
Steel and diesel
The Giants continue to grapple with high commodity and fuel prices, although that's a level playing field.
“We try to get escalation clauses in contracts, and fuel affects commodities,” Caldwell says. “Vendors are not holding prices very long and neither are we.”
Benassi points out that there's a double whammy from the high price of steel on PVF products, and the cost of diesel makes it more expensive to ship them to the jobsite.
EMCOR won't let its pricing stay out long and asks for escalation clauses in its contracts. Barring that, its size allows it to deal with large wholesalers to get fair pricing and an adequate supply of materials over the term of long contracts. Steel pipe should be easy to get, Guzzi says, but it's sometimes not. Steel tubing for refinery work is likewise sometimes hard to get.
Manpower is adequate
Fortunately, the one resource that's not hard to get this year is people, although there are shortages of certain skillsets, such as welders, Benassi says.
“When we do industrial work, especially in the refinery space because the qualifications are high, it's sometimes a struggle to get the right mix of people because the cost of failure is high,” Guzzi notes.
The Giants also work daily to develop supplies of young engineers, project managers and other middle management. EMCOR gets young people out of college and moves tradespeople into management roles. Former West Pointer Guzzi also likes to seed ex-military officers into middle management ranks of EMCOR's operating companies.
“For us, good project managers are at a premium, and the growing LEED content of our work means we're looking at more people with engineering skills,” George says. All of the Giants who need them are making sure they have LEED trained and accredited people.
The nation's largest mechanical contractors are keeping a wary eye on the economy. Financing may get shaky beyond the residential sector, with the Bears Stearns meltdown and fire sale to J.P. Morgan Chase a case in point. Bonding will be hard to get for contractors who don't have good credit. Liberty Mutual just bought Safeco, so sureties are consolidating in an already consolidated market.
Nevertheless, there are plenty of reasons for optimism.
“The things that we do in our business in plumbing and heating and fire safety don't go away if the economy takes a downturn,” says J.F. Ahern's Krueger. “Nobody's going to stop installing plumbing or fire sprinkler systems.”