Top Industry Trends to Watch in 2015
Mid-market companies can profit by harnessing industry knowledge to build smarter, more agile enterprises.
The U.S. middle market remains a powerful economic engine, outpacing the national economy in both revenue and employment growth during 2014, according to a new report from the National Center for the Middle Market.
Indeed, mid-market firms now rank as the nation’s leading job creator, employing more than 60 percent of all new workers. Moreover, mid-sized companies have achieved a remarkable run of accelerating revenue growth for four consecutive quarters (fourth quarter 2013 through third quarter 2014).
Several key trends promise to affect mid-market companies during 2015, offering both new opportunities and risk across diverse industries.
To sustain--or even surpass--last year’s growth, however, mid-market firms will need to stay ahead of crucial trends in 2015, from the rapidly evolving healthcare environment to next-gen technology and changing supply chain dynamics.
Here are key insights for financial leaders, compiled by GE Capital’s team of industry analysts. For additional in-depth analysis, market trends and hot topics, sign up to receive our free Industry Research Updates and Monitors.
Aerospace & Defense
While the worst fears for declines in defense spending have not been realized, we expect yet another year of divergent fortunes between the commercial aerospace and defense sectors. The commercial airplane production “super-cycle” is in its middle stages and, barring any unforeseen global economic collapse, is expected to remain intact through the next three or four years.
Conversely, the defense industry will continue to adapt its business models and cost structures to the realities of a lower “new normal” for domestic and global defense spending. Primary trends that will influence the commercial aerospace and defense supply chains during 2015 include the following:
• Positive commercial aerospace fundamentals: The factors underpinning the positive fundamentals of the global airline industry are expected to remain intact. Moderate global gross domestic product (GDP) growth should translate into a slow expansion of global passenger traffic and, likewise, airline fare and fee revenue. Increasing airline revenue will continue to be leveraged by the profit-enhancers of lower fuel prices, airline (capacity) consolidation and post-bankruptcy rationalization of the industry’s financing cost structure. All of these factors support a record high backlog and a strong production growth outlook for the commercial aerospace supply chain.
• A Growth in aircraft deliveries: Large commercial aircraft deliveries are expected to grow 4-5 percent through 2019, given six to nine years of production backlog at Boeing and Airbus. Declines of older platforms (such as the Boeing 747 and 777) will be more than offset by a steady increase in new platforms (such as the Boeing 787). Additionally, while the annual number of narrow-body units produced is currently more than double the number of wide-body units, the expected five-year compound annual growth rate (CAGR) of wide body production (5-6 percent) is expected to outpace the expected growth in narrow body production (3-4 percent).
• Aircraft replacement demand may be in jeopardy. The prior urgency for “re-fleeting” demand for more fuel-efficient commercial aircraft has been supported by high oil prices over the past couple of years and is undoubtedly at risk if oil stays at very low levels for a long period of time. The flip side of lower oil is a tailwind for commercial airline financials, particularly for those airlines that are unhedged, that have rarely been better. Given the healthy financial condition of most airlines, near-term deliveries of fleet upgrades should remain intact given the long-term nature of the asset-acquisition decision and from a competitive standpoint to expand capacity and routes while providing a superior passenger experience. That being said, orders for replacement aircraft that are scheduled for delivery two or more years out may be more susceptible to cancelation or deferral if fuel prices stay at low levels into 2016. As such, the commercial book-to-bill that has been well above parity for the past few years is likely to revert toward parity and may even dip below parity as the year progresses.
•Funding sources will remain diverse: Despite a lingering threat to the reauthorization of the Export-Import Bank of the United States, both international and domestic airlines will continue to have access to diversified, readily available financing sources for aircraft purchase orders. These include original equipment manufacturer (OEM) captive financing, a growing number of public and well capitalized aircraft lessors, and accommodative bank debt and capital markets.
•Defense markets are likely to remain under pressure. The worst of the domestic defense spending declines will likely bottom out in 2015 and then stabilize as the push for fiscal austerity is diluted by lack of political will. Pressure on defense spending is not just a domestic issue as global defense spending is expected to decline by 3-5 percent into 2016, according to a forecast by Moody’s Investors service. As such, intense competition for fewer new foreign military programs will pressure the profitability of those opportunities.
•The F-35 (Joint Strike Fighter) will remain one of the few large weapons platforms achieving meaningful growth. Cybersecurity, intelligence, surveillance and reconnaissance (ISR) will also continue to be relative safe havens. Some defense suppliers will migrate their business models toward commercial applications to offset the secular decline in U.S. Department of Defense (DoD) weapons-related procurement.
•Despite revenue pressure, heavy cost cutting in the defense supply chain will keep margins somewhat intact. Larger defense prime contractors are likely to continue to fare better than second- and third-tier suppliers as large ongoing weapons programs are less likely to be cut mid-stream. Conversely, smaller defense contractors will continue to be more susceptible to the risk of shorter life-cycle programs that are easier to delay or cancel. The medium- to long-term outlook for persistent financial stress will no doubt increase the pressure for mergers and acquisitions (M&A) among second- and third-tier defense suppliers.
•DoD OCO funding is expected to remain under pressure. Unless a significant military engagement somewhere in the world demands U.S. involvement, DoD funding for Overseas Contingency Operations (OCO) will continue to fall. As a result, defense services contractors--including those involved in construction, security and maintenance--will continue to feel the financial brunt of troop withdrawals from Afghanistan and Iraq.
Sales and production growth will continue, but at a slower pace in 2015-2016. Signs of an aging cycle (now five years off the bottom) include topping out of used-vehicle pricing, which is expected to decline as supply rises, fairly stretched variables on the financing side, with interest rates at a bottom, loan tenors extended (such as 84-month loans) and leasing share now above pre-crisis levels.
On the positive side, average vehicle age is still high, consumer confidence and unemployment have continued to improve and gas prices are low. Other significant trends include:
• Automotive financing demand should remain elevated. Factors driving this trend include continued high new model launch, new technology activity (which drives capital expenditure demand), and rising M&A activity related to supplier needs to gain scale and service global platforms.
• A strengthening U.S. dollar vs. the yen is a longer-term threat to Detroit’s Big Three. The exchange rate could weaken the D3’s (General Motors, Ford and Chrysler) competitive position and prove a windfall to the J3 (Toyota, Nissan and Honda). However, onshoring/reshoring of manufacturing remains a positive trend for the North American auto industry generally, with North American light-vehicle production still gaining domestic share compared to imports.
• Recall activity has come further into the limelight following General Motors’ ignition switch issues and, more recently, Takata’s massive airbag recall. Recall risks tend to rise with new product and technology launches, suggesting the potential for recall activity to remain elevated.
• The auto industry is still in the early stages of key technological advances. These developments are largely related to rising CAFÉ and emission standards, including increasing electrification, light-weighting and powertrain efficiency development. Ford’s launch of an aluminum-intensive body for the Ford F150 (the best-selling vehicle in the U.S.) was a major development in 2014, the results of which will be watched closely in 2015.
• Car ownership may transform over time as new, disruptive business models, such as Uber’s, develop and mature. These megatrends may profoundly shift the industry’s ecosystem over time, offering both threats and opportunities to OEMs and OEM and aftermarket suppliers.
•On the fleet management side, “big data” analytics will increasingly drive optimization of costs, safety and other metrics. Improving fuel efficiency, cheap gas prices, increased product options and safety technologies are also plusses, although higher recall rates and longer up-fitting lead times may be the price paid. Also, increasing vehicle complexity and new materials may lift repair costs.
Chemicals and Plastics
U.S. chemical production growth is forecast to accelerate from 2 percent in 2014 to 3.7 percent in 2015 and 3.9 percent in 2016, according to the American Chemistry Council’s Year-End 2014 Chemical Industry Situation and Outlook report.
For North American integrated petrochemical producer margins, 2014 was another banner year. However, margins may have seen at least a near-term peak in late 2014 following the collapse in crude oil pricing. Notable trends including the following:
• When oil prices fall, the high end of the ethylene cost curve falls, because it is based mostly on oil-based/naphtha inputs. Ethylene forms the backbone of the bulk of downstream plastics/resins production. Historically, crude oil prices have been highly correlated with polyethylene prices.
• North America remains very competitive at the low end of the global ethylene cost curve. Although the oil-to-natural-gas price ratio has fallen following oil’s price drop in late 2014, the ratio remains elevated versus historical levels. Moreover, European naphtha prices were off about 30 percent from June to late 2014 and natural gas-based ethane prices also fell by 20 percent. Finally, U.S. ethylene and polyethylene capacity utilization has remained high.
• North America’s favorable cost position is driving production growth. More than 215 new chemical production projects valued at over $135 billion have been announced in the U.S., according to the American Chemistry Council, helping capital spending to surge nearly 12% in 2014 to more than $33 billion.
• The shale revolution is also impacting the fertilizer business, with a large wave of new U.S. ammonia/urea capacity investment in the pipeline slated for 2016-2019. However, permitting, potential engineering and construction (E&C) cost inflation and other obstacles are likely to slow the pace of planned expansions, which could keep ethane pricing depressed and sustain North America’s healthy margins/cost advantage compared to most of the rest of the world.
Key indicators to watch in 2015 include the following:
1. Raw materials pricing volatility, including oil price volatility tied to potential Middle East or other political turmoil (or lack thereof) and OPEC supply side developments.
2. Key cyclical and secular growth drivers such as the recovery in housing in the U.S., emerging market growth and the pace of actual new capacity additions.
3. The continued quest for sustainability and raw materials diversification, such as increased bioplastics usage in products like Coca-Cola’s “PlantBottle.”
4. Continued consolidation (as already seen in areas such as titanium dioxide Ti02) and shareholder activism. Both drivers will likely continue in 2015, especially given the still slow-growth environment, the collapse in oil pricing and high cash balances for some companies.
The U.S. construction outlook could be analogous to a tale of two cities in 2015, with stabilizing and perhaps flattish residential demand offset by continued strong, if not strengthening demand, both reflecting a relatively improving economy and rising interest rates. Among the new directions we see for 2015 are the following:
• Non-residential construction should be solid, propelled by elimination of slack in the economy. GE Capital forecasts real GDP to grow 2.6 percent in 2015, up from a projected 2.1 percent in 2014 with a modestly slower but continued solid growth in industrial production of 3.5 percent. As a result, the American Institute of Architects projects overall non-residential building construction to rise 8 percent in 2015, compared to a rise of 4.9 percent in 2014, driven by strong growth in office buildings, industrial facilities and hotels.
• U.S. construction machinery capital expenditures are projected to rise almost 14 percent year-over-year (YoY), after growing 7 percent YoY in 2014, according to IHS Global Insight. As with non-residential construction, machinery cap-ex will be driven by relatively low office and industrial vacancy rates as well as an uptick in hotel construction due to growth in revenue-per-available room (RevPAR). In particular, industrial demand should remain strong as retailers build out distribution facilities to speed order fulfillment.
• Residential construction could be a wild card for the year, as rising interest rates may lead to a further rise in 30-year mortgage rates, hindering the market. However, this could take time to play out with rates currently at about 4.0 percent, well above the historic lows of about 3.3 percent seen in the winter of 2012, but still below the recent peak of over 4.5 percent seen in September 2013, according to the Federal Reserve Bank of St. Louis. Under these conditions, we would expect to see existing home sales up high single digits to approximately10 percent, but this will strictly be a function of the rise in mortgage rates.
• Public construction is slated to rise in the low single digits, according to the Manufacturers Alliance for Productivity and Innovation (MAPI), as ongoing improvement in state budgets is offset by constraints on federal spending. We expect continued growth in transportation spending, with a rise of about 2.2 percent as it recovers from a large pullback during the recession and the impact of Recovery Act funding tapers off. However, this could be hampered by the need for a more permanent funding solution for the Highway Trust Fund, a stopgap measure passed in July 2014 to extend funding.
Oil prices continued their slide in early January 2015 following the OPEC decision on November 27, 2014 to hold output levels. The surprise to the market was not so much that OPEC did not cut production but that it signaled it would not defend prices in the future. This decision will be a clear test of the resurgent U.S. oil industry.
Low oil prices are expected to persist through the first half of 2015. More pessimistic views call for a sustained down market deep into 2016. Companies are currently assessing the implications of this, and we expect declines in spending along with increased volatility through 2015. Other market forces to track include the following:
• Oil macro indicators signal oversupply. Non-OPEC supply growth was 1.8 million barrels per day (Mbd) in 2014, while demand growth came in less than 0.7 Mbd. The oil market will begin 2015 oversupplied by roughly 1.0 Mbd. With OPEC continuing to produce at 30 Mbd, the price response from North American producers becomes critical. There are forces that can rebalance the market in 2015 including new disruptions and more opportunistic buying from China and others. However, producer hedges and high inventories will slow any price adjustments.
•O&G upstream activity is showing signs of contraction. Recent onshore drilling and rig trends are only showing modest declines, but expectations of a significant downturn are on the horizon. Capital spending from North American producers is expected to contract 15-20 percent. Variation in the quality of producers’ assets means lower prices will hurt some companies worse than others. Offshore indicators are similarly negative with offshore drillers increasingly considering "warm stacking" their rigs to reduce capacity.
• The U.S. is expected to be the primary beneficiary of lower oil prices that will act like an $80 billion stimulus to the U.S. economy. In other countries, such as Japan, weaker currencies will offset some of the benefit of lower oil prices. India and Europe are likely to benefit. Russia and OPEC countries, particularly Iran and Venezuela, will see sharply lower government revenue and this will impact economic growth.
• Natural gas prices start the year low. The combination of mild winter weather and continued strong production growth from the Appalachia region has resulted in high gas storage inventories. If winter weather-related demand fails to emerge, gas prices could track similar to 2012 and remain low through 2015, supporting industrial consumers but putting further pressure on cash-strapped oil and gas producers.
Clearly, the near-term oil and gas market is challenging for the producer community, but beneficial to energy consumers. Without clear data showing supply reductions, prices will continue to lurch on new information. At the time of this writing in early January, strong Russian and Iraqi production data from December, firm comments from the Saudis, and demand-side weakness are all playing on traders’ sentiments. As a result, prices have fallen another $15/bbl since mid-December 2014. In 2015, key questions include:
• Does oil demand firm up as expected?
• Will Saudi Arabia let market forces work or will OPEC pressures drive an output cut?
• How long until a non-OPEC supply response occurs?
The answers to these questions will determine how long this oil cycle lasts.
A slow growth environment, with U.S. consumer discretionary food spending constrained, has challenged food processors. However, moving into 2015, the drop in oil pricing and a modest lift in wages could buoy disposable income and restaurant traffic. Moreover, food companies may benefit from lower raw material/packaging and transportation costs, although some of these benefits may be largely passed on to the consumer in more competitive segments.
Among the key industry trends are the following:
•On the agricultural commodities front, projections point to lower prices in 2015. As of January 2014, the World Agricultural Supply & Demand Estimates Report (WASDE) was forecasting that 2014/2015 wheat, corn and soybean prices would fall 11 percent, 21 percent and 18 percent vs. 2013/14 respectively.
•On the protein side, live cattle prices are forecast to rise 74 percent while whole broiler prices are forecast to fall 1 percent on average in 2015. Salmon and shrimp pricing are expected to be lower in 2015 after a run-up in pricing in 2014 has eased, particularly in shrimp.
•Certain sectors are expected to see stronger-than-average growth, compared to the overall food category. For example, increasing consumer focus on health and wellness has spurred strong demand for proteins, gluten-free, organic and natural products.
•Changing demographics and crossover appeal continue to drive demand in ethnic foods, particularly Hispanic flavors and cuisine.
•Demand for snacks and prepared foods is escalating due to today’s busy lifestyles.
Despite a glitch-plagued rollout, the Healthcare.gov website as finally able to enroll almost seven million individuals for healthcare coverage under both state and federal healthcare exchanges in 2014.
While the Affordable Care Act (ACA) will once again come before the Supreme Court in King v. Burwell, the case is not set to be heard until March 2015 with a decision expected no earlier than June or July. Meanwhile, the second year of healthcare open enrollment will proceed, as will implementation of the employer mandate extending healthcare coverage to employees of companies with 50 or more full-time employees.
In this environment, healthcare and healthcare costs will remain at the forefront of the national debate and employers’ minds for 2015. As the U.S. continues to struggle with access and affordability of healthcare, a number of other pivotal trends will play out:
•Hospital inpatient volumes will remain under pressure. According to Moody’s, median inpatient hospital volumes fell 1.3 percent in 2013, with “generally anemic patient volumes characterized by outpatient growth and inpatient declines” forecast for 2015. We expect a decrease in uncompensated care for providers, as well as a rise in Medicaid as a percentage of the payer mix, particularly in states that have chosen to expand Medicaid.
•With its first year behind it, Healthcare.gov should potentially perform better, allowing a greater number of people to sign up for healthcare coverage. While the final number will be a source of great speculation, the Centers for Medicare and Medicaid Services (CMS) estimated in November 2014 that approximately nine to 10 million more individuals would receive healthcare coverage via state and federal exchanges in 2015.
•The healthcare business model will evolve even more rapidly than before. With 2-8 percent of Medicare hospital inpatient revenues at risk due to required discounts or penalties for value-based purchasing (VBP), bundled payments or reductions in re-admissions (as reported by the Advisory Board), providers are increasingly adopting new business models to effectively and profitably serve patients in the VBP era. In fact, according to Leavitt Partners, there were about 630 accountable care organizations covering over 20 million lives in the U.S. as of June 2014.
•Patient engagement and responsibility will increasingly affect decision-making. Over the last several years, both government and private payers have encouraged patients to become more engaged in their health and wellness through various incentives and support mechanisms (such as second opinion lines and transparency services). This trend, combined with the continued move to higher deductible plans where patients bear a greater portion of upfront responsibility for deductibles and co-pays, is likely to lead to patients routinely seeking greater value in their care by applying such tools as comparison shopping and increased use of retail clinics.
•Private health exchanges will begin to gain meaningful share. According to Accenture, 40 million covered lives will be on private exchanges by 2018, representing a market opportunity of almost $6 billion. Employers will look to private exchanges to both simplify the administrative burden and potentially shift employees to a defined contribution model.
Various cross winds will beset the IP&S sector in 2015. The most important trends and indicators include the following:
•The U.S. economy appears to be enjoying a well-entrenched recovery that should gain momentum in 2015 with real GDP growth rising toward 3 percent. In 2015, however, growth in Europe and Japan has been weak, with China also slowing.
•The U.S. dollar has rallied, reflecting the relative strength of the U.S. economy. This boosts manufacturers’ competitiveness abroad and could hurt U.S. trade flows for some segments. Overall, we expect U.S. industrial production to slow modestly to 3 percent in 2015 versus 4 percent in 2014. That said, improving domestic demand and the “shale revolution” are expected to fuel longer-term trends in the U.S. near-shoring and re-shoring of manufacturing.
•The recent drop in oil prices going into 2015 will have both positive and negative effects on various segments within IP&S. On the positive side, the drop in oil pricing suggests lower input, packaging and transportation-related costs for many manufacturers. Lower oil, gasoline and diesel prices are also a boon to certain end markets for IP&S companies, such as automotive and trucking. However, IP&S companies with exposure to upstream oil and gas-related business could see orders weaken due to project delays or even cancellations.
•3D printing and the proliferation of connected devices are expected to continue to impact the manufacturing value chain. Ongoing advances in real-time prototyping form manufacturing are likely to propel increasingly widespread use of broader applications, which should start to realize some of the cost and pricing economics of scale of greater manufacturing levels. In addition, connected devices and wearables are expected to broaden out to industrial applications that would improve efficiency and productivity.
Information Technology (IT)
Innovation and value creation in the realm of next-gen platforms and applications will continue to disrupt legacy IT architectures. Investment specifically geared toward extending the capabilities of cloud, social, mobile and big data will accelerate and account for 30 percent of total IT spending and nearly all of the industry’s growth during 2015. Primary trends that will influence IT vendors and end-users during 2015 include the following:
•At the outset of 2015, global IT spending is expected to grow in the range of 3.5 - 4 percent. However, there will be a significant underlying divergence by geography as well as technology. Aggregated IT spending in mature economies is expected to grow no more than 2 percent globally (2.7 percent in the U.S.) while spending growth in emerging economies will be closer to 7 percent. Similarly, investment in next-gen technologies and services will rise approximately 13 percent, while spending allocated to legacy platforms and applications will be close to flat and may even decline by the year end, according to International Data Corporation (IDC).
•The transition of the IT delivery model toward cloud service providers (software applications as well as hardware infrastructure) will accelerate. Growth in data center spending will continue to be dominated by large cloud service providers while IT vendor business models delivering software and infrastructure functionality via cloud services will significantly outgrow traditional on-site infrastructure/perpetual software licensing models. With the massive scale of investment and commodity pricing posing as significant barriers to entry, there will be few new entrants and more likely consolidation in the infrastructure-as-a-service market. Conversely, with few barriers to entry, developers of new applications will continue to proliferate while benefitting from historically low cost economics enabled by next-gen development and delivery platforms.
•Security threat detection and mitigation will remain a spending priority and will receive the least amount of scrutiny within corporate IT budgets. The unrelenting adoption of cloud, mobile and social media have significantly increased the complexity of how corporations and individuals interact with and try to protect their devices, systems, data, personal information and money. Next-gen platforms and applications will enable new security innovations that protect both the mobile edge of the network as well as data stored at the core. These innovations include payment platforms that are biometrically enabled, specific threat intelligence enabled by big data analytics and ubiquitous use of encryption for regulated data stored in the cloud.
•Big data analytics and the Internet of Things (IoT) will continue to be major destinations for investment and innovation. According to IDC, the worldwide market for software, services and analytics related to big data will reach $125 billion in 2015. The edge of the network will continue to extend into the physical world with more “smart” cars, commercial buildings, homes, industrial equipment and wearables connecting to the Internet. IDC estimates the overall global market for IoT-related hardware, software and analytics enabling nearly 15 billion “Internet aware” devices will grow 14 percent to $1.7 trillion during 2015. Further, the global IoT market is expected to grow to 30 billion devices and $3 trillion worth of related spending by 2020.
•Slowly growing global public IT vendors with large cash balances that far exceed reinvestment opportunities will be on the radar of well capitalized and media savvy activists. Activists will continue to agitate for a return of capital to shareholders in the form of large share buybacks and accelerated dividend increases in addition to other attempts to extract value including mergers, break-ups (for example the EBay/PayPal, HP split) and divestitures (such as IBM selling its server, PC and semiconductor manufacturing operations).
Social media and mobile adoption proliferate as the post-PC era takes hold. At year-end 2014, more than 135 million tablets and nearly 245 million smartphones were forecast to be in use in North America.
As the array of mobile devices expands, users’ interactions with media are being redefined. Content owners are electing multiple, simultaneous distribution platforms while the ability to engage the user, measure the usage and price accordingly is sparking the next evolution of media. Video advertising and rich media advertising have invaded all usage platforms, driving a notably higher proportion of Internet ads. Programmatic ad buying is expected to play a growing role in advertising distribution in 2015.
More trends to watch in the coming year:
•Internet ad revenues will grow in the mid-single digits. The growth rate decline is attributed to increased interest in mobile advertising versus the traditional online search and display ad market as well as increased use of programmatic advertising buying. Internet ad growth (excluding mobile) will remain a bright spot in an industry that expects to endure a 1-2 percent growth rate in 2015.
•Advertising will continue to shift to mobile and social media. The mobile ad market was projected to top $12 billion in 2014, an increase of more than 65 percent year over year (YoY). This trend is forcing advertisers to rethink their advertising strategies and adapt them for tablets, smartphones and other mobile devices.
•Programmatic advertising buying, while a single-digit percent of ad revenues (in 2014?), will gain traction in 2015 as some of the largest advertising buyers shift more of their budgets.
•TV everywhere will continue to gain incremental traction as cable and satellite companies look to combat the enormous growth of over-the-top (OTT) services. Traditional distributors are entering new, long-term and comprehensive contracts with content products to expand digital rights.
•Retransmission revenues, which were expected to rise about 35 percent YoY in 2014 to hit just under $5 billion, will continue to grow in at least the mid 20 percent range in 2015, with major markets seeing above-average growth. This trend will intensify margin pressure on operators as they renew contracts.
•OTT services will accelerate as many multiple service operators (MSOs) now report more high-speed customers than video customers. Additionally, video content owners, such as CBS, are more aggressively pursuing an OTT strategy while still including their broadcasters. This will potentially shift more ad dollars away from traditional TV.
Slowing growth in China, weak growth in several other emerging markets, and some negative numbers out of Europe and Japan have pressured global commodities/metals demand and pricing. A strengthening U.S. dollar has also been and is expected to remain a headwind. Global GDP is only expected to see only a modest pick-up in 2015-2016.
Key trends to track include the following:
•Bulk commodities such as iron ore and coal appear likely to remain particularly challenged by oversupply and weak Chinese demand. Base metals also face slowing demand growth, but most appear somewhat less challenged by a surge in new low-cost supply (with some markets still actually in deficit). Steel dynamics tend to be more regional in nature, with U.S. steel demand and pricing benefitting from improving end market consumption and an increasingly consolidated supply base. However, global steel supply is excessive, and rising U.S. steel import supply remains a threat (possibly to be countered by more trade case filings). Precious metals prices appear likely to remain under pressure, given continued deflationary forces and a strengthening U.S. dollar.
•The North America metals industry will see continued active “above ground” cap-ex activity. Drivers include continued electric furnace and metals processing investments lifted by cheap natural gas (and related infrastructure growth), reshoring of manufacturing, increasing aluminum consumption in the automotive industry, growing aerospace demand, and a recovery in non-residential investment.
•Mill producer M&A will likely slow due to concentration issues, though cross-border investment could remain active. However, the service center, processing and fabrication areas remain generally fragmented and should remain active on the M&A front. The scrap industry is also very fragmented and will likely be an area of increasing deal flow potential on the lending side.
•Metals miners will continue to focus more on improving existing asset efficiency and shareholder-friendly activity. M&A activity is likely to reflect divestures that allow miners to focus more on core assets, with private equity possibly stepping up from otherwise rather dormant activity in the space.
A mixed economic backdrop is expected to drive modest retail sales growth in the 3-4 percent range in 2015, compared to 5.5 percent average growth in 2010-2012 and 5.8 percent in 2002-2006. Low- and mid-income households will be particularly constrained by stagnant earnings despite improvements in employment status and the housing market as well as lower gas prices.
The key influencers in this industry include the following:
•Channel shift to continue: Consumers’ focus on value and convenience will continue to shift discretionary spending away from traditional retail channels in favor of e-commerce and discount venues. Brick-and-mortar specialty stores that lack an effective omni-channel strategy will continue to donate market share. As a result, M&A activity could pick up as traditional retailers look to rationalize store footprints and reduce costs associated with incremental investment in multi-channel systems on top of upgrading and maintaining storefronts.
•Margin pressure from accelerated growth in e-commerce: The accelerated growth and shift to e-commerce/m-commerce has diminished the pricing power of most retailers. This trend has increased margin pressure, given increased competition on free shipping and negative leverage of in-store fixed costs due to declining traffic. Middle-market retailers will likely emulate their large competitors by enhancing capacity to fulfill online orders with store inventory, which could drive better gross margin with improved inventory efficiency, lower shipping costs and potential impulse purchases in the case of store pick-up.
•Retail square footage rationalizing: Mall traffic will remain difficult, exacerbated by accelerated growth of the online channel on top of the encroachment by the discounters for many years. Square footage growth will be limited and primarily driven by dollar stores, fast-fashion retailers and outlet malls. Contrarily, the secularly pressured sectors, such as office products, consumer electronics, teen apparel retailers and department stores will continue to rationalize their retail locations.
•Capital spending on multi-channel systems looms large: There is increasing need for investment in multi-channel systems to maximize flexibility for the consumer and efficiency for the business. Based on GE Capital, Americas’ recent CXO Survey, many middle-market retailers have caught up with the game by optimizing their websites for mobile purchases and accepting point-of-service (POS) mobile payments. There is more work to be done to enhance the multi-channel capacity, such as enabling inventory search and fulfillment capabilities across store systems and distribution centers, as some large retailers have accomplished.
• Cost of healthcare: With the ACA in its second year, healthcare costs remain an overhang for middle-market employers that are mandated to extend healthcare coverage to full-time employees. There could also be a negative impact from the ACA on those consumers who do not qualify for subsidies and are forced to spend more on their health insurance. For larger retailers, the incremental cost of complying with the ACA appears to be manageable as their current coverage generally meets or approaches the ACA minimum requirements. Larger retailers are also better positioned to hire temporary employees.
Telecommunications will play a central role in technology adoption and use as telecom carriers and cable MSOs expand their fiber footprints and upgrade networks to meet the growing demand from businesses and consumers. Among the noteworthy industry developments are the following:
•Wireless telecom service providers continue migrating to different usage models. Key drivers of the trend are the growing marketplace for mobile data and larger battle building between Wi-Fi usage and cellular usage by customers.
•Regulatory affairs will heat up the net neutrality debate. This is causing consternation within the telecom industry because it’s expected to be disruptive to capital spending in 2015 and could reduce overall service sector spending.
•Data centers and cloud continue to move toward center stage as network complexity rises. Users are becoming increasing global and consume more data--a trend that coincides with most data becoming more centralized in larger, third-party data centers while somewhat smaller data centers will be built in secondary markets to support more low latency applications including OTT video. These data centers, combined with increasing use of cloud-based applications and platforms, will help shape the evolving telecom networks.
•M2M (machine-to-machine technology) and the connected car concept gain traction as more new cars than ever will be embedded with wireless modules in 2015.
•Metro fiber network expansion is likely to continue efforts to seize new revenue opportunities from areas such as data centers, office buildings and wireless towers. Regulatory affairs could derail long haul fiber network upgrades.
Entering 2015, carriers were benefitting from a near Goldilocks supply/demand environment with profit tailwinds highlighted by strengthening freight trends, pricing leverage due to tight capacity and declining diesel prices. GE economists remain optimistic that the domestic economy will continue to improve gradually, with expectations that real U.S. GDP growth will accelerate from 2.2 percent in 2014 to 2.8 percent in 2015.
However, the trucking environment is not entirely absent of challenges. Driver turn-over at historically high levels in the long-haul market, operating inefficiencies related to regulatory mandates, driver shortages and associated upward pressure on driver compensation and benefits will likely remain challenges for the industry.
The primary trends that will influence the truck transportation industry during 2015 include the following.
•New construction activity, light vehicle sales and consumer retail sales will continue to be the primary drivers of freight tonnage. Demand in all of these segments should benefit from expectations of a modest acceleration in domestic GDP growth during 2015. The lone emerging headwind could be transport related to energy production, given the sharp decline in crude oil prices that started during the second half of 2014. That being said, we believe the benefits to the entire trucking industry of lower crude prices, namely in the form of increasing tonnage from a GDP tailwind and lower diesel prices, significantly outweigh any drag on tonnage for all but those carriers with a highly concentrated exposure to energy transport.
•An upward bias in interest rates due to the likelihood of Federal Reserve tightening in 2015 is not necessarily a significant threat to the primary drivers of tonnage so long as any increases are gradual and likewise reflective of and absorbed by a steadily growing and generally healthy economy. However, any significant spike in the volatility of interest rates or other macro influencers would present a greater challenge to the sustainability of economic growth and likewise tonnage trends, particularly as it relates to construction and consumer retail sales.
•Given a difficult comparison to 2014, growth in North American production of both medium- and heavy-duty trucks is expected to remain positive, albeit slower, during 2015. Barring a severe economic downturn, future production cycles are expected to be less volatile from peak to trough than in the past due to better forecasting, improved communications systems that provide better visibility of channel inventory and lessons learned from the past.
•At the outset of 2015, carrier profitability stood at multi-year highs driven by record freight tonnage and elevated freight rates supported by constrained capacity and lower fuel prices. While this environment should remain largely intact during 2015, it’s unrealistic to expect that the pace of improvements seen in these factors will be replicated. Nonetheless, fleet owners are demonstrating their confidence in the sustainability of strong freight and profitability trends with large investments in fleet equipment upgrades and expansion not seen since the 2006 timeframe.
•While the financial incentive to acquire modernized equipment for greater fuel efficiency has been dampened by falling diesel prices, the current cycle will still be supported by the need to alleviate capacity constraints and stem near-record driver turnover amid a severe drive shortage. At the outset of 2015 and following 20 percent growth and multi-year highs in 2014, heavy-duty truck sales in the U.S. were projected to grow in the low double digits (i.e. 10-15 percent). That being said, the portion of replacement demand related to improved fuel efficiency is undoubtedly at risk in an environment of multi-year low diesel prices.
Rates and Capacity
•The gains in freight rates seen in 2014 will likely moderate in 2015 as strong truck orders in 2014 will hit the road throughout 2015 and begin to at least partially relieve industry capacity constraints that were prevalent in 2014. However, gating factors to excessive expansion of industry capacity include steep barriers for new market entrants, such as a stiffening regulatory environment, driver shortages that are particularly acute in the long-haul market, liability risk and insurance costs, and elevated new and used equipment costs. Additionally, upward pressure on driver wages will help justify higher freight rates despite downward pressure on fuel surcharges.
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