According to the numbers, 2018 was a banner year for the HVACR industry.
The average Heating, Air-conditioning & Refrigeration Distributors International (HARDI) member's sales increased 9.8 percent from September 2017 to September 2018, according to the association’s latest Targeted & Regional Economic News for Distribution Strategies (TRENDS) report. This marked the best 12-month sales period for HARDI distributors since late 2010 and early 2011.
Shipments of HVACR equipment are booming as well. Per Air-Conditioning, Heating & Refrigeration Institute’s (AHRI’s) monthly shipment data, U.S. shipments from September 2017 to September 2018 of residential gas storage water heaters increased 2.9 percent; commercial gas storage water heaters, 2.3 percent; gas warm-air furnaces, 9.3 percent; and central air conditioners and air-source heat pumps, 6.9 percent.
The industry’s performance is indicative of the U.S. economy, which expanded at 4.2 and 3.5 percent annualized rates during the second and third quarters of 2018, respectively, according to U.S. Bureau of Economic Analysis data. This marked the first consecutive 3 percent-plus growth quarters for the economy since early 2015.
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The average HARDI distributor’s sales increased 9.8 percent from September 2017 to September 2018. This marked the best 12-month sales period for HARDI distributors since late 2010 and early 2011.
While all this data points to economic success, how are things shaping up at the counter and on job sites? Do those with their boots on the ground anticipate this momentum carrying into next year? DT spoke with a handful of contractors and distributors who experienced exceptional success in 2018 and asked them what worked in 2018, what didn't, and how things are shaping up in 2019 and beyond.
Confident Consumers
Consumer confidence is an economic indicator that measures the degree of optimism consumers feel about the overall state of the economy and their personal financial situation. Typically, when consumer confidence is high, consumers tend to make more purchases.
For the fourth consecutive year, consumer confidence exceeded 90 percent in 2018.
THE INDEX OF CONSUMER CONFIDENCE
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For the fourth consecutive year, consumer confidence exceeded 90 percent in 2018. Consumer confidence in November 2018 scored a 97.5, according to the University of Michigan's Survey of Consumers.
“In times of high consumer confidence, we generally expect consumers to ‘trade up’ when they make purchases,” said Paul Hallmann, economist, HARDI. “In markets for durable goods, like HVACR, that translates to more replacements rather than repairs and increases in the purchase of higher end equipment. With wages on the rise and unemployment at a 49-year low, we should expect 2019 to be another strong year for consumers.”
Todd Washam, director of industry and external relations, ACCA, said consumer confidence helps consumers elect whether to replace or repair faulty equipment.
“When things are good, consumers tend to lean toward replacing equipment, and when things are bad, consumers may opt to save some money and repair what they can,” he said. “That said, during the last recession, many of our members said the industry is essentially recession-proof because everyone needs heating and air conditioning regardless of how the economy’s performing. Everyone still needs to keep food fresh and buildings comfortable.”
JK Hussa, owner of Tualatin, Oregon-based HVACR distributor Airefco Inc., said Airefco exceeded its sales goals in 2018. He attributes a portion of that growth to the best dealers in the world and an influx of new buyers in the Pacific Northwest.
“Our dealers continue to thrive due to their outstanding work ethic and great reputations,” Hussa said. “As consumers turn to them to purchase and service equipment, they’ve been able to address this added business, which we’ve absolutely benefitted from. Additionally, people are flocking to this area of the country. Anywhere from 40,000 to 100,000 people are arriving per year. More people bring more work for us and our dealers, and people are replacing their equipment more frequently than they are repairing. That’s music to our ears.”
Warmer Weather
Another factor that worked in favor of HVACR distributors was warmer than normal temperatures.
In 2018, all U.S. regions were warmer than last year except the New England and West North Central regions, according to the American Gas Association (AGA). For the month of September, the temperature in the U.S. was 21.6 percent warmer than last year and 52.3 percent warmer than normal.
Fargo, North Dakota-based Dakota Supply Group (DSG) — a multi-segmented distributor that covers five states, including Wisconsin, Minnesota, North Dakota, South Dakota, and Montana — reported upper-single-digit growth in 2018.
Greg Servais, HVACR segment manager, DSG, said 2018’s weather patterns helped drive the company's sales.
“We actually had a summer this year,” Servais said. “It was slow to come, as we were shoveling snow in April in Wisconsin, but when it turned, it turned fast, and it stayed warm. You never want to have weather be the basis for your sales, but in the HVAC business, weather certainly drives business.”
While weather is nearly impossible to predict, the National Oceanic and Atmospheric Administration (NOAA) is anticipating an El Niño winter season, which equates to a 70 percent chance that temperatures will be warmer than normal across the U.S.
The National Weather Service’s Climate Prediction Center also predicts warmer than average spring and summer temperatures for most of the U.S. in 2019.
Regulatory Reform
A number of government regulations impacted the industry in 2018.
On Dec. 22, 2017, President Donald Trump signed the Tax Cuts and Jobs Act into law. Included within that legislation were several victories for the industry, including the HVAC Expensing and Technology (HEAT) Act, which includes provisions that allow commercial building owners to expense qualified HVAC equipment. The bill allows taxpayers to write off the cost of qualified HVAC expenses from capital accounts as a deduction for the taxable year in which the equipment was placed in service.
“Our commercial contractors are telling us that they are seeing drastically higher sales of commercial equipment,” Washam said. “One board member, Hickory Sheet Metal Co. Inc. in North Carolina, reported four-times-higher commercial sales in 2018, and we know Hickory isn’t the only contractor experiencing these types of sales increases.”
Is Your State Prepared to Tax Internet Sellers?
Status as of August 2018
Click graphic to enlarge
The U.S. Supreme Court in South Dakota v. Wayfair this year ruled that a state may require collection of sales tax by out-of-state internet retailers who sell into the state. This graphic provides an update on each state. PHOTO CREDIT: Tax Foundation
In June, the U.S. Supreme Court ruled that individual states can now require online sellers to collect sales tax when selling items across state lines. This ruling overturns the 1992 decision in Quill Corp. v. North Dakota, which prohibited states from requiring businesses to collect sales tax unless the company had a physical presence in the state.
A total of 16 states are currently collecting sales tax on sales across state borders. Distributors who sell across states may now be able to recoup the taxes they paid on equipment when they sell it across state lines.
Perhaps the regulatory item most burdensome to the industry is the Trump administration’s steel and aluminum tariffs.
In March, Trump imposed a 25 percent tariff on steel imports and a 10 percent tariff on aluminum. Both elements are key in the HVAC manufacturing process. As steel and aluminum have become more costly to obtain, these expenses have been passed down the supply chain.
“These tariffs have continually peppered us with price increases,” said Brandon Bateman, director of supply chain, Airefco. “The volume of price increases this year has been unprecedented. We’ve been accustomed to a couple of increases in our busiest years, but this year has exceeded any year I’ve been in the industry.”
Due to pre-existing arrangements with dealers, Hussa said Airefco has had to shoulder some of these increases.
“This, of course, eats into our margin, but these are the deals we’ve made, and we had no idea something like this was coming,” he said. “We’re kind of caught in no-man’s land. Luckily these aren’t long-term deals.”
Servais said several of DSG’s vendors raised their prices three different times in 2018.
“We experienced some fairly aggressive price increases this year,” he said. “These increases created a great deal of uncertainty for ourselves, our vendors, and our dealers. That said, there are some automatic growth triggers that occur when prices increase. Twenty percent on an item that costs 25 percent more is going to bring a greater return than an item priced 25 percent cheaper.”
Forecasting 2019
Given the industry’s seasonality and dependence on weather conditions, it’s hard to forecast a specific growth rate for the coming year, said Hallmann, though he is intrigued by the continued success of the economy.
“In terms of the economy, indicators are pointing to another strong year in 2019 with some potential downside risk creeping up by the end of the year,” he said. “There’s some indication of a potential slowdown in late 2019 or early 2020, which is something that we’ve been monitoring closely for more than a year. The magnitude of the slowdown remains in question. There are some clear downside risks in rising interest rates and the withdrawal of fiscal stimulus.
“Additionally, the impact of tariffs remain an unknown,” Hallmann added. “In 2019, we expect to see continued upward price pressure on raw materials. The magnitude of the impact depends on the depth of the tariffs.”
Servais said DSG recently revamped its leadership team, welcoming Mike Meiresonne as COO, Brent Rudser as CFO, and Tracy Koenig as CIO. Behind these moves, Servais is confident DSG will continue to boast positive gains in 2019 and beyond.
“The market is going to grow, and it’s our plan to exceed that market growth,” he said. “We’re poised to not only grow with the market but take market share.”
Servais said DSG is planning to open a technical training lab in Minneapolis next year, furthering its investment in its dealers' futures.
“Contractors tell me every day that they’re desperately in need of training,” he said. “We’re excited to open a facility that has the capacity to train a contractor with three new guys or a group of 30. We’re pretty excited about this.”
Airefco opened a new facility in Vancouver, Washington, on May 1. To keep pace with this growth, Airefco added more than 10 employees in 2018.
“We hired some people to run the Vancouver branch, added some people in sales, hired a service manager, brought on an employee in purchasing, and added some folks to handle data content for our website,” Hussa said. “We continue to invest in outside equipment, parts sales, marketing, and customer outreach. It's our goal to make it as easy as possible for our customers to do business with us, whether that’s through our webstore, training services, or new facilities.”
The company is hoping to continue its growth and is currently evaluating new locations throughout Oregon and Washington.
“We’re looking to expand further into Bend, Oregon, though we’re still trying to decide which locations offer the best fit,” Bateman said. “The key issue is finding the right anchor people to take care of the responsibilities at each location.”
Washam anticipates another strong year for both contractors and distributors in 2019.
“Our members value their relationships with their distributors,” he said. “You see that when ACCA and HARDI are working together. Most of our past chairmen and several board members will be at the HARDI conference, which demonstrates our contractor leadership values distribution’s leaders. We value these partnerships.”
Alan Beaulieu Forecasts HVACR Distribution's Economic Future
Alan Beaulieu, president, ITR Economics, provided an economic forecast for Heating, Air-conditioning & Refrigeration Distributors International (HARDI) members during the organization’s 2018 annual conference in Austin, Texas.
In that presentation, Beaulieu said distributors should not expect a repeat of 2018 in 2019.
“Consumers are going to be price-conscious in 2019,” he said. “Housing starts will continue to slow, and existing home sales are expected to plummet. That means there will be fewer remodeling opportunities, and consumers may be less likely to spend serious money with you next year than they were in 2018.”
Beaulieu said 2019 is shaping up to be a good year for HVAC owners to work on their businesses rather than in their businesses.
“Interest rates will continue to climb and inflation is always a concern, so I suggest you borrow as much as you can now to invest in your company,” he said. “If you want a new CRM, do it in 2019. If you need to upgrade your website, do it in 2019. If you want to add some more marketing, do it in 2019. Use your time next year to prepare for the fallout that looms in the 2020s. Figure out what you need, and who you need, to be busier than you are today and spend the money to make it happen.”
Beaulieu said this additional spending will better prepare distributors for a looming recession, which he anticipates taking place in 2022.
“GDP is flattening out,” he said. “As it flattens, this will have an impact on businesses, consumers, and commodity prices. In 2021, the rate of growth will slow down considerably. This will lead to a significant recession by 2022. This downturn will be significant, though it won’t be as significant as 2008-2009 was.”
While President Trump’s Tax Cut and Jobs Act provided a short-term boost in 2018, Beaulieu believes the tax legislation will not have a lasting effect.
“The tax change will not provide a boost in the economy for any length of time,” he said. “I like many of the changes in the tax code, such as the reduction in categories, and some people are seeing lower rates. Honestly, it's helped some people and hurt others, it just depends on the tax bracket you’re in. Regardless if it’s a personal win or loss, in the end, it will all balance out."
For those considering selling an HVACR distribution business, Beaulieu suggests waiting six or seven years.
“With all this talk of a recession and a Great Depression in 2030, the best time to sell a business would be somewhere around 2025,” he said. “Make sure you pull the trigger before 2029, as there’s typically a three-year earn out, and you don’t want to have your earn out during that 2030 Great Depression. And, I’d suggest you sell it to someone you don’t like, as it's going to be worth much less in the 2030s than it was in 2025. Then, aim to buy it back in 2033, when its price has hit the floor. Make the most in your sale, buy it back cheap, and then enjoy the economic recovery of the late 2030s.”
Publication date: 12/17/2018
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Is Your State Prepared to Tax Internet Sellers?
Status as of August 2018
The U.S. Supreme Court in South Dakota v. Wayfair this year ruled that a state may require collection of sales tax by out-of-state internet retailers who sell into the state. This graphic provides an update on each state. PHOTO CREDIT: Tax Foundation
The average HARDI distributor’s sales increased 9.8 percent from September 2017 to September 2018. This marked the best 12-month sales period for HARDI distributors since late 2010 and early 2011.
THE INDEX OF CONSUMER CONFIDENCE
For the fourth consecutive year, consumer confidence exceeded 90 percent in 2018. Consumer confidence in November 2018 scored a 97.5, according to the University of Michigan's Survey of Consumers.
