Why Contractors Are Renting More and Buying Less
Contractors are facing tough times. Many have scaled back, cut costs and adapted to doing more with less in order to survive.As a result, equipment rentals are flourishing as a means of lowering overhead expenses by trimming debt, licensing fees, taxes, insurance and maintenance.
"Although it may seem counterintuitive, rental companies should be heartened by all this uncertainty," says Frank Manfredi, president of equipment research firm Manfredi & Associates, Mundelein, Ill. "The uncertainty will drive equipment users to use rentals more and more."
One company that has benefitted from the weak economy is United Rentals Inc., led by President and CEO Michael Kneeland.
Under his direction last year, United topped Wall Street expectations, with $2.61 billion in revenue for a 16.7% increase over 2010. The company experienced a 6.1% rental-rate increase and a 69.1% time utilization rate for a 37.7% earnings margin before interest expense, income taxes, depreciation and amortization.
Emboldened, United announced in December it would acquire rival RSC Holdings Inc. for $1.87 billion in cash and stock, plus $2.3 billion in debt. Set to close by summer, the deal would give RSC shareholders a 30% stake in the combined company and add three new positions to United's 11-member board.
United's market dominance is tough to match; the RSC deal would give the combined companies an even bigger footprint. The RSC purchase would more than double United's industrial market presence, a tactic which plays a key role in its long-term growth strategy. Industrial projects are typically less susceptible to the boom-and-bust realities found in the buildings market; they also last longer. Effectively, RSC would boost United's industrial revenue to 35% from 15% of sales, says Nicholas Coppola, an analyst with Thompson Research Group.
"The industrial sector is the first thing to bounce back in an economic recovery," Kneeland told ENR in an exclusive interview. "Also, industrial customers tend to keep equipment longer. About 90% of our fleet already meets the needs of the industrial sector, including aerial lifts, power generators, light towers and air compressors. RSC is a game-changer."
Mind-boggling Logistics
The logistics of the deal are mind-boggling, but they promise to save both companies millions of dollars each year while growing sales. United plans to untangle the firms' geographic overlaps by streamlining RSC's 4,700 employees in 446 rental locations across 43 states and three Canadian provinces. The consolidation would shutter between 50 and 100 branches, saving an estimated $200 million in annual expenses. United would buy back $200 million of its common stock once the deal closes on April 30. United also says it plans to initiate an across-the-board 5% rental rate increase in 2012 to help pay for the stock purchase.
RSC represents the largest acquisition in United's 15-year history, Kneeland says, and the company is still weighing a potential name change. RSC—the nation's second-largest rental firm, according to industry journal Rental Equipment Register (RER)—has a loyal customer following and slightly higher profitability than United. The mega-deal marks a major turnabout from five years prior, when United planned to sell the company for $4 billion to private "equiteer" Cerberus Capital Management, which backed out over contract terms. An ensuing court battle resulted in United receiving a $100-million termination fee.
"After the Cerberus transaction, we went back to our core business," Kneeland says. "We saw the opportunity to grow within."
United was already the nation's largest rental company prior to the deal, RER says, with 8,600 employees in 550 locations in 48 states and 10 Canadian provinces. And RSC was no slouch, with $1.52 billion in revenue in 2011, or 23.3% more than in 2010. Together, the two firms would create a rental juggernaut with a 15% market share, which is three times the size of their next-closest competitors, Sunbelt and Hertz, says Coppola.
The United deal comes as contractors increasingly are looking to offload the heavy risk of managing fleets of equipment. According to a recent survey of the Associated General Contractors of America's members, roughly 66% of construction firms say they plan to lease equipment this year, while only 40% intend to buy new machines.
The rental market, consequently, captured a price increase of 8.9% in 2011, says J.P. Morgan analyst Ann Duignan, who believes an industry "renaissance" is under way. North America's equipment rentals will generate $33.5 billion in revenue in 2012, which is 6.9% higher than last year and more than three times the expected 2012 growth rate for the U.S. gross domestic product, reports the American Rental Association (ARA), a Moline, Ill.-based trade group.
As rental companies continue to consolidate, they cement changes in the equipment market's competitive landscape. One impact is the demise of the locally owned rental store. In acquiring more stores, companies like United gain stronger access to credit, buying power and negotiating leverage with suppliers and vendors, leaving little room from smaller-sized competitors, says Lawrence De Maria, who co-heads Chicago-based William Blair & Co.'s global industrial infrastructure group.
One example came around the same time the United-RSC deal was announced last year. Unlike United, Ahern Rentals Inc., the country's largest independent rental company, suffered through the downturn. With $620 million in debt, the company filed for Chapter 11 bankruptcy in December. The Las Vegas-based, family-owned company was originally due to file its reorganization plan this month but just recently asked the court for an extension until this summer. Meanwhile, Ahern is faced with a possible takeover bid from billionaire Tom Gores' Platinum Equity LLC, which also runs crane-rental giant Maxim Crane Works L.P.
Bankruptcy as an Exception
Unlike previous downturns when it was common for rental companies to write down debt under Chapter 11, bankruptcy is more the exception this time around. The downturn brought an economic boom for many rental companies, which proceeded cautiously into the recession, observers say. Year-end results are telling. Aggreko generated roughly $2 billion in revenue last year, a 14% increase over 2010, while H&E Equipment Services saw $720.6 million in total revenue, or 25.5% more annually. Hertz Equipment Rental took in $1.2 billion in revenue last year, a 13% gain. Sunbelt Rentals enjoyed over $1 billion in revenue for the nine-month period ending Jan. 31, a 20% increase over the same period a year earlier, and Essex Crane Rental Corp. experienced a 53.8% year-to-year boost, with nearly $59 million in rental revenue.
One way that rental firms weathered the storm was by allowing their fleets to age. The average rental-equipment age was 51.8 months in January, with high-reach forklifts being used the longest, at 4.32 years, reports Rouse Analytics, a Beverly Hills, Calif.-based benchmark service. Machines are now getting younger. Rental firms are gradually replacing their aging machines, fueling an uptick in sales that has buoyed manufacturers' earnings.
Companies like Sunbelt and Volvo see the United-RSC deal as an opportunity to pick up share by providing new machines, says Duignan, who adds, "A larger customer always results in pricing power."
The rental boom has made manufacturers more reliant on large-scale capital expenditures, forcing them to dig deeper to find contractor business. Volvo Rents, for example, has been on an aggressive buying spree since mid-April 2011, when the company decided to run company-owned stores in addition to its franchise network. The subsidiary has been broadening its geographic footprint ever since, snapping up mom-and-pop businesses at a dizzying pace.
Still, manufacturer-branded rental franchises, such as Caterpillar, Volvo and Komatsu, often "are less about competing than trying to fill the demand to be a one-stop shop for customers," according to Adam Fleck, an associate research director with Morningstar Inc. "It's more of a pull than a push model. A used car eventually leads to new purchases, with better trade-in opportunities. It makes sense to keep those customers within your eco-system," he added.
Others in the rental business are also facing a bright future, with total industry revenue expected to hit $53.1 billion by 2016, ARA says. There will be 13,975 domestic construction equipment rental locations by year's end, or 145 more than in 2011, adds Manfredi. Rental locations will each generate over $2 million in revenue this year, he notes, which is nearly $200,000 per store more than in 2011.
Opportunity for Market Penetration
"There is a real opportunity for rental businesses in this industry to gain further market penetration by aggressively selling the value of equipment rental at this point in the economic recovery," says Christine Wehrman, ARA executive vice president and CEO. "[We] solve immediate issues when people are dealing with capital availability and downsizing of owned fleet due to economic reasons."
Credit is a huge factor that plays into the rent-or-buy decision, experts say. In some cases, "a contractor may be receptive to making an equipment purchase, but because of financial stresses from prior-year losses, they may not qualify for traditional financing," explains Sidney Sexson, senior vice president at Wells Fargo Equipment Finance.
Rentals also bypass otherwise pricey retrofits needed for new emissions compliance, as federal, state and local authorities require clean diesels and other eco-friendly machinery. Later-engined machines falling under the Tier 4 federal emission standards "cost roughly 10% to 15% more than earlier model-year counterparts," Sexson adds. "Being new on the market, there is a general apprehension as to how well they will perform."
Renting can shield contractors from downtime. Although equipment rentals are only 1% to 3% of a project's total cost, a non-functioning machine can cripple a job, Kneeland says. Contractors are gladly shifting that downtime risk to rental companies that can ensure round-the-clock service for non-stop operation.
"We tend to rent specialized pieces of machinery because maximum utilization is so important for cost-effective management. It also gives us a chance to try out new equipment before buying to see if it's a good fit," says Paddy Murphy, general manager for Aggregate Industries' Southwest region. "We sold $10 million of equipment in the last six months due to low utilization and the cost of ownership."
Meanwhile, the value of good-quality used iron has shot up, encouraging contractors to liquidate. Struggling to keep machines busy, fleet owners have sold assets as international demand and a weak dollar combined for lucrative paydays. Late-model earthmoving machines—such as backhoes, dozers and wheel loaders—have been in high demand overseas as manufacturers curtailed production during the recession, auctioneers say.
Last year was characterized by the ongoing tight supply of good-quality, late-model used equipment, resulting in a strong pricing environment and intense competition, said Ritchie Bros. CEO Peter Blake in a recent statement.
Ritchie Bros. Auctioneers reported a record $3.7 billion in gross proceeds last year. The Vancouver, B.C.-based auction company is off to a strong start in 2012 with its largest-ever heavy-equipment auction, held Feb. 13-18 in Orlando, Fla., where more than 10,000 lots sold. The haul included 375 wheel loaders and 350 hydraulic excavators for a record $203 million in gross auction proceeds.
Online auctioneer IronPlanet also is booming, generating a record $50 million in gross sales during its first auction this year in Polk City, Fla., drawing 42,000 attendees Feb. 21-24. These results follow $568 million in 2011 sales—the most in company history—with 40% of lots drawing international bids.
The result of these transactions is a leaner domestic equipment fleet, according to experts.
"Used equipment prices are at their highest levels since first half of 2008," De Maria explains. "Fleets have shrunk, and now utilization is going up. Renting can be a good solution, especially in an uncertain environment."
