Giants enjoy the rebound

BY ROBERT P. MADER
OF CONTRACTOR'S STAFF

THE NEWS THIS YEAR is much better than we have been obligated to report in the past few years. This time around, the nation's top mechanical contractors say that most markets are doing pretty well and the worst that can be said is that manufacturing is flat.

Some scattered clouds still remain. The economy is uncertain, with the U.S, Commerce Department reporting in late April that first quarter gross domestic product increased 3.1% when economists had predicted 3.5%. Rumblings persist about a housing bubble, insurance remains expensive and fuel prices are a drain on any contractor running a fleet.

But that's as bad as it gets. The Giants, by and large, are having good years.

Where the action is
"Our commercial backlog is up for the first time in three years," says EMCOR Group's new President and COO Tony Guzzi. "Because the commercial sector is so large, it's pretty indicative of what's going on in the economy.

"Geographically, Boston is better — health care and research labs are driving the market along with residential condo-type development. It's still not outstanding, but it's better. In New York City high-rise residential is strong. The interiors business is very busy because service sector employment is up. Chicago is slow to middling, nothing of consequence. D.C. is very strong in both government and residential and condo and apartment development. South Florida is strong with condos and wastewater and waste treatment. Las Vegas is booming and busier than heck. On the West Coast, Northern California is not doing that well. Southern California is strong."

Like many other contractors, Guzzi reports that hospital construction is up. The education market seems to be doing well although EMCOR found the K-12 market unrewarding and bailed out of it in the second quarter of last year. The office market seems to be trying to come back (lease rates are up in a few key markets), although Guzzi notes that he's not seeing any small office building development. Shopping center renovation work is coming along.

EMCOR got out of the K-12 educational market because endemic scheduling problems and few rewards made it a problematic market "for a sophisticated contractor with high-end labor," he says. The company is working at colleges, building residence halls and research buildings and upgrading data communications and telecommunications systems.

Banks are continuing to build data centers. EMCOR is doing some upgrade work for semiconductor manufacturers, but Guzzi characterizes that as "a little bump."

"Health care will be attractive for as far as we can see," he says. "There are a lot of facilities being built to take care of an aging population."

Projects in the range of $200,000 to $500,000 are starting to come back, Guzzi says, an important indicator for contractors of all sizes.

"The service side is seeing emerging signs that small-ticket delayed spending on upgrades may be ready to pop this year," he notes.

Hospitals continue to renovate or build new facilities in the St. Louis and Denver markets, says another new president, Patrick Murphy Jr. of Murphy Co. Mechanical Contractors & Engineers. Hospitals are constantly renovating so they can install the latest technology in the various segments of the hospital business where they can make money, he says.

Murphy Co. is performing more renovation, retrofit and energy management work in the commercial market, with some new construction in the mix.

"Our take on the manufacturing side of the market is that it's really only steady," Murphy says. "We have not seen it rebound as the economy starts to come back."

John E. "Tripp" Ahern III, president and CEO of Fond du Lac, Wis.-based J.F. Ahern Co., concurs. "Where we have seen an impact in the economy in the upper Midwest is in the area of manufacturing and light industrial work," Ahern says. "There's no question that there has been a dramatic tailing off of capital projects among people like that over the last three or four years, and we're not seeing that pick up to any great degree. There are some manufacturing clients that we have that are doing very well and continue to expand their businesses, but I would say those situations are rare."

Ahern is seeing the same big jump in health-care spending along with state government spending.

"I think in the next 12 months, we see two areas with the greatest potential as being the health arena and government spending on items such as well water and wastewater treatment, and schools and universities and a variety of capital spending projects that they have," Ahern says. "We see it mainly through the University of Wisconsin system. They are on quite a spending binge and it appears that will continue over the next three to five years."

Mandatory fire sprinklers
More than 40% of the company's work is fire protection, and Ahern says the contractor would continue to pursue it vigorously. He's seeing more legislative initiatives to put fire sprinklers in facilities that have not required them, such as schools, dormitories and certain high-rise buildings.

Steve Comunale, president of Barberton, Ohio-based S.A. Comunale, agrees with Ahern that codes and legislation are driving the fire sprinkler market. Communale is not only sprinklering dormitories in Ohio, Pennsylvania, New Jersey and West Virginia, but also fraternity houses and off-campus apartment buildings.

"We're also finding on the fire-protection side that a lot of municipalities are sprinklering all new housing," Comunale says.

His firm will do residential work in a separate division, and he notes that United Association Sprinklerfitters Road Local 669 offers a residential rate.

Comunale is also finding work in ballparks, hotels, convention centers and huge warehouses. With the unfavorable balance of trade, imports are pouring into the country and they have to be warehoused somewhere. Comunale has done a half dozen warehouses of more than 1 million sq. ft. On the day CONTRACTOR talked with him, Communale said he had sold an 800,000-sq.-ft. warehouse job two hours earlier.

"Every school board in Ohio has a school program, either retrofit or new construction," Comunale says, "and hospitals are still a good market for us."

Business is strong around the nation's capital. Comunale is doing a 1 million-sq.-ft project for the U.S. Census Bureau consisting of two buildings with a parking garage in between. He says he's also seeing a rebound in his automotive business. His company is working for General Motors, Honda and Jeep for the first time in a long time.

Still, the industrial market keeps eroding, says Warren Hill, chairman of Chicago-based Hill Mechanical Group.

"We think of ourselves as an industrial contractor, and more and more that's not what's happening in Chicago," Hill says. "There used to be a plant in every square mile grid back in the 1960s that employed 500 people. Now they're gone."

Instead, Hill Mechanical has found work in the multifamily condo and health-care markets. Hill tries to work as a prime contractor, but much of the work he deems "interesting" because of its size (such as high-rise condos) goes through generals. He describes the margins as "brutal."

Nevertheless, Hill Mechanical has done a fair share of prime and negotiated work, such as an office building in downtown Chicago that was negotiated. Hill also was the prime contractor replacing air handlers in two terminals at O'Hare International Airport, and the company finished 120 days early and only 0.3% over contract because the city had asked for additional demolition work. In addition, Hill Mechanical is prime contractor on a design/build job at DePaul University, revamping and relocating a boiler plant.

On the bubble
So what about that housing bubble? "Interest rates are driving multifamily housing," Hill says. "Three years ago we figured the housing party was over, but as long as you can borrow money, you can keep going. Every week we hear about a major new project. They've got to be 70% sold to get financing and they're getting it. I don't know what we would do in Chicago if we lost the condo market."

Hill is doing a new development in northwest suburban Park Ridge, Ill., that generated so much interest that 300 people showed up to enter a lottery to see who would buy 80 condos.

Out in the bubble-land of California, Rick Wylie, president of Buetler Corp., says that demand continues to be strong enough to prop housing prices up. Buetler commands 75% of the residential new construction plumbing and HVAC market in north central California, from Sacramento on south, Wylie says.

"The price appreciation has gone up for a longer time than anyone is comfortable with," Wylie says. "It has to stop appreciating, but there's a dearth of supply in our market in California. The cities restrict growth and push it through so many bureaucratic mazes and environmental impact studies that it takes two or three or even 10 years to get a project approved. There's not enough land available for development.

"There's OPEC-like supply control and therefore pent-up demand, and that's what's driving prices so high. So far the demand is large enough that we can meter out what's available on the supply side and enough buyers to handle the prices."

California really needs 250,000 housing units a year and has managed to build about 150,000, Wylie says.

External forces
Of the external forces that have an impact on contractors' business, most are manageable now that commodity prices have settled down.

"We saw an unexpected sharp uptick in the prices of steel, both carbon and stainless, that had an impact last year," Ahern notes. "I think the outlook on where prices are headed is hard to define, which creates an issue in respect to how long can you hold bids open and guarantee prices to the customer. But we're managing as best we can and we spent money last year and early this year to increase inventory to lock in prices on commodity items."

Some projects didn't proceed last year because commodity prices increased costs on a job by 6% to 10%, EMCOR's Guzzi says. Shortages of some metals caused expensive labor to be unproductive.

He doesn't see that happening again this year, he says, "but people have been careful about bidding and buying out jobs quickly." Wylie adds that he was able to negotiate a commodities surcharge with his home builders that enabled Buetler to keep its head above water.

The price of gasoline, however, is becoming a problem.

Comunale may be thought of as a sprinkler contractor, but its origin is as a full mechanical and it has a four-yearold HVAC service division. Communale has 275 service and construction vehicles, and while gas consumption has remained level, the cost has gone up every month.

"You can try to pass it on, but if you have a good service base, you can't nickel and dime the customer for a fuel surcharge because it gives them a reason to go someplace else," he says.

He's weeding out vans and pickups that get less than 12 mpg and teaching people that they don't need to carry 6,000 lb. of material they won't use.

"The big impact is that you spend a lot of money per month on gasoline for the service fleet and construction fleet," Guzzi says. "We try to price it into service jobs with truck charges, but on construction it's a fixed cost and you have to eat it. Nobody's going to pay you a fuel service charge on a construction project."

Insurance is still a big problem, especially in fire protection because of the potential for water damage, Communale notes.

"We've seen an increase in general liability and umbrella policies and tightening of how many companies are underwriting and the risk they are willing to take on," Ahern says.

Construction defect suits in California requires that builders buy "wrap" policies, Wylie says, especially on multifamily housing, because most of the subs can't get insurance on their own.

Buetler's deductible is $150,000 in many cases so it has self-insured through a captive insurance company in Bermuda. It is also vigorously fighting every lawsuit. Insurance companies wasted a lot of money trying to buy off plaintiffs' lawyers, Wylie notes. Now that Buetler fights every suit, trial lawyers are beginning to leave them alone, he says.

While the bonding companies lost money in the recession, most companies say they have a solid relationship with their surety. EMCOR took over many jobs from bonding companies in the past couple years, Guzzi says.

"We have long standing relationships with our insurance and bonding companies, and we think they are fine and we are fine with them," Ahern says. "But in talking with them, we hear ugly stories on the bonding side on defaults on the part of contractors."

Labor shortages do not appear to be an issue yet, although Ahern says that if all the projects that are on the boards actually break ground, it might become a problem in the next 12 to 36 months.

Murphy Co. is actively hiring salaried workers in the Denver and St Louis markets, service technicians in both markets, and it's looking for craft workers for heavy industrial jobs in petrochemical, refining and steel.

Many of the Giants are unionized and their unions are keeping them well supplied, they say. Some general contractors, however, may be trying to poke their way into the market.

" The other trend we're seeing is some supply chain compression," Murphy says. "We're seeing that with vendors and contractors coming into the market with a little bit of turnkey pricing to customers. General contractors appear to be interested in trying to selfperform pipefitter work."

But the overall mood is upbeat. Wylie says every cloud has a silver lining.

"I have boundless confidence in American ingenuity," he adds.

Comunale says: "2005 is going to be great year. Revenue is up and we're looking forward to nice continued growth in 2005 in so many markets."