Cover story: Outperforming the general economy

Equipment rental revenue growth to continue

Editor’s note: The latest update to the ARA Rental Market Monitor™, an online subscription service available to American Rental Association (ARA) members, shows that the equipment rental industry’s revenue growth will continue to increase faster than the general economy in 2013 and possibly beyond. In an exclusive interview with Rental Management, Scott Hazelton, a senior partner with IHS Global Insight, which compiles data and analyses for the ARA Rental Market Monitor for ARA and Rental Management, discussed some of the factors involved and the resulting expecations to help readers better understand the forecast for the industry’s future. An edited version of his comments follows.


RM: In the final analysis, did 2012 live up to expectations for the equipment rental industry?

Scott Hazelton: Yes. In fact, the year came in almost exactly as we expected. Interestingly, the early take on the year was for revenue growth of just under 10 percent. Economic growth stalled mid-year and we lowered expectations for rental accordingly. In hindsight, that was too pessimistic and while the results are still being finalized, revenue growth in 2012 was likely up just under 10 percent.

RM: Why is the equipment rental industry forecasted to continue to outperform the economy and the industries it serves in 2013? Can this continue?

Hazelton: The conditions that have allowed rental to outperform the economy are ameliorating, but will persist through 2013. On the financial front, the Federal Reserve survey of lenders indicates that credit is easing, but it still remains tight for small companies and financial regulations are becoming more onerous. The “fiscal cliff” was partially addressed and there is some increased certainty on tax rates, with some of the compromise working in favor of equipment rental companies. However, the impasse on spending and budget cuts remains. This is a two-edged sword for rental — while budget cuts can remove or delay spending on projects that rent equipment, they also can limit government spending on new equipment and move capital spending to rental. In any event, continued wrangling over the direction of government spending has not improved business certainty.

We also expect a different pattern to economic growth in 2013. In 2012, the economy started out with very strong growth, which diminished over the year with the fourth quarter showing virtually no growth at all. The pattern in 2013 will be the reverse — the first quarter will likely be weak, but we expect acceleration over the course of the year. Especially given the false dawn of early 2012, companies are going to be reluctant to invest significant sums in new equipment until they are convinced that this time, recovery is real. That will not be until late in the year, and the interim solution will be to rent equipment.

RM: Are the 2013 expectations different for Canada?

Hazelton: The forecast is somewhat more muted for Canada. Canadian economic growth is expected to remain weak for the medium term, with particular weakness in the housing sector as mortgage rules are tightened. Just as a housing recovery drives nonresidential construction with a lag of 12 to 18 months, the housing sector will serve as a brake on Canada’s construction industry. The weakness is compounded by stable, but slow growth in infrastructure spending by the public sector. This is not necessarily bad as Canada embarked on counter-cyclical infrastructure spending in the recession to stimulate the economy. As such, the relatively slow increase in public investment comes on top of a solid base. We expect construction and industrial equipment growth to range from 2 to 5 percent, while party and event runs from 2 to 4 percent over the next several years.

As with the U.S., we expect a temporary soft patch in the energy sector in 2013 with renewed interest in 2014 and beyond. The later years of the forecast could improve dramatically should the U.S. decide to authorize the Keystone pipeline. While this would drive strong construction related spending in both the U.S. and Canada, the size of the pipeline investment would be a larger share of Canadian activity and thus drive stronger growth. With U.S. State Department approval recently secured, an important obstacle is removed, but it remains to be seen whether the Obama administration will give final approval to proceed.

RM: Many have said the recession “changed everything” when it comes to running a business. What should equipment rental companies be watching for in today’s economy?

Hazelton: I think that saying this recession changed everything lacks a historical perspective. Recessions hit the weakest companies the hardest. This does not necessarily mean that they were badly run, but they were in weak markets, had overextended themselves at a bad time, had insufficient reserves or credit lines, and so on. Recessions always lead to lower demand, tighter credit and severe contraction in isolated markets. This recession was different in that it was deeper and financially induced, so demand fell further, credit became extraordinarily tight and severe contraction hit even large markets, such as Florida and Nevada. Recessions are tough teachers and they don’t always grade fairly, but I think the lessons that they teach are timeless in the modern economy — diversify your markets and product lines, have great communication with your financial partners and talk frequently with your customers to know whether they are likely to be growing or slowing.

In terms of monitoring the economy itself, on the national or state scale, watch the employment numbers — they are the best indicator of absorption of current vacant space and the eventual need to build anew. One can also watch the Institute for Supply Management (ISM) index as it is a reliable indicator of near-term future demand. On the local level, watch the permitting process at the town or city planning boards in your area. Permits for commercial development take several months to move through the system, so seeing an increased volume or larger sized deals in the current volume is a positive sign. Talk with the developers early in the permitting stage — once the permits are in place, the equipment suppliers are likely in place already. The time it takes to get a permit approved is sufficient to get the equipment and potentially staff members in place to deliver.

RM: We now have the ARA Equipment Rental Penetration Index™, which pegged penetration in construction equipment at about 51 percent in 2011. Do you see this number growing?

Hazelton: In the near term, certainly yes. The index is the ratio of construction equipment in use by rental fleets to total construction equipment in use by both contractors and rental firms. Given the outlook for revenue growth, there is no question about the need for rental equipment companies to add to their fleets and to utilize those new additions productively. Now, it will be true that contractors will see more work in 2013 and will add to their fleets as well. However, many of the factors that held back non-rental fleet investment over recent history remain, such as fiscal uncertainty, tight credit and the increasing cost of regulations. As such, we expect non-rental fleet investment to grow more slowly than rental fleet investment, which will lead penetration to increase. It also is likely that once a business has become accustomed to equipment rental — as the current rental penetration rate suggests is true — they decide to maintain the level of service that rental offers and opt to rent additional equipment rather than purpose new fleet as the broad economy improves. As such behavior becomes a permanent business practice, the level of the penetration rate becomes permanently higher as well.

RM: The current forecast for investment by equipment rental companies shows significant double-digit increases this year, as well as in 2014 and 2015. Why?

Hazelton: The key driver to investment by equipment rental companies is revenue growth and particularly future revenue growth. There can be a delay in the transmission of revenue growth to equipment investment when fleets are under-utilized, but that is not currently the case. In this environment, significant increases in rental revenue can only be met by adding additional equipment. Most importantly, the forecast is one of improving market conditions in all three major segments. As such, rental equipment companies can rationally expect to need more in 2013 than in 2012 and more in 2014 than 2013. Under these circumstances, rental equipment companies are justified in putting more of their growing revenue into fleet investment. In making the investment forecast, we watch the share of revenues that are invested into new fleet. The current forecast for the construction and industrial equipment segment — the most investment intensive — is projected to be just above 35 percent in 2014. This share was more than 40 percent between 2003 and 2006, so the outlook for investment is quite consistent with revenue behavior and could even be argued to be on the conservative side.