Today equipment rentals are a major channel-to-market in North America for many types of construction equipment. In 1991, when I conducted the first study of this market for Associated Equipment Distributors, equipment rental was in its infancy. People thought of rental companies as a financial house of cards that would collapse at the first whiff of an economic downturn. Indeed, many of the national consolidators did suffer meltdowns, including bankruptcy.
Just about the time that the business was declining at the end of the '90s, the accounting rules for how companies are to handle non-revenue-generating assets, such as goodwill, changed. Those assets had to be justified on a return-on-asset basis or they could no longer be amortized. The ruling ended overnight the use of purchase-method accounting for acquisitions. Rental company operators could no longer overpay for acquired-company assets and bury the overpayment on their balance sheet — also ending the era of billion-dollar write-offs.
Large companies such as Greenwich, Conn.-based United Rentals and Scottsdale, Ariz.-based RSC Equipment Rental survived these changes intact, but companies that were not large enough, such as NationsRent, Fort Lauderdale, Fla.; NES, Chicago; and Maxim Cranes, Bridgeville, Pa.; were forced to reorganize under Chapter 11 bankruptcy protection.
Today, with a few exceptions, the major rental companies are profitable and have recapitalized their balance sheets. The equipment rental business is in its third year of recovery and is expected to continue growing during the balance of 2006 and probably 2007.
Most people now recognize the importance of rentals. I estimate that today, 30 to 40 percent of new equipment is purchased by rental operators. That figure, often cited by analysts as the “penetration” of rentals by equipment users, includes dealer-operated rental fleets as well as rent-to-rent company fleets. To me, the word “penetration” is misleading. To the best of my knowledge, no one in the industry has developed a methodology to measure the amount of equipment rentals utilized as a percent of a user's total equipment use. The only figure that is measurable, and the one I use, is the percent of new equipment sold into rental fleets, and that figure has risen significantly since the early '90s.
In 1991, I estimated the figure in the United States was 5 to 10 percent. There are other countries where the ratio is much higher. In the United Kingdom the ratio is generally thought to be 60 to 65 percent and in Japan the ratio is thought to be in the 70- to 75-percent range. A major question is whether the North American ratio will continue to grow and approach the level of the U.K. or Japan? I don't think so. Both the U.K. and Japan are geographically small and have very concentrated urban markets that lend themselves more toward rentals.
The percentage of new equipment in North America sold into rental fleets exceeds 30 to 40 percent for some product categories that lend themselves to rental. In the aerial work platform and telescopic handler categories the ratio is more than 80 percent. These products are generally used in applications where wear-and-tear is not a major issue. As a result, repair maintenance is relatively low. In contrast, dozers are used in high-maintenance applications and, thus, the percent of dozers sold into rental fleets is low — no more than 10 percent. As the rental market continues to develop, and as equipment users begin to recognize the advantage of someone else assuming the financial risk of ownership, the North American ratio will continue to increase. I estimate that the ratio could go as high as 50 percent within 10 years. I'm skeptical that the ratio will go much higher because of the vast size of our country and the small size of urban areas relative to suburban areas.
How big is the rental market?
I've written before about my methodology for measuring the size of the rental market. For this analysis I relied on year-end 2004 financial performance data. I did not attempt to use year-to-date 2005 financial data because it's difficult to normalize it for comparison purposes. The major national rental companies don't all use the same fiscal year. Furthermore, several companies, such as United Rentals, have not reported their 2004 performance for various reasons. Since Baton Rouge, La.-based H&E Equipment is in the process of going public, it is only reporting partial years in its published documents.
(in millions)
In Figure 1 (above) the top 11 North American rental companies break out their rental revenues from their total revenues.
In total, these companies had rental revenues of approximately $6.7 billion. This list does not include Park Ridge, N.J.-based Hertz Equipment Rental, because it was part of Hertz Corp., which included the company's car rental operations. Therefore, the rental-only revenues are not reported separately. If we were to include HERC total rental revenues, this group would probably be more than $7.5 billion.
We have identified six types of businesses that rent equipment — don't forget that our definition of rental includes rent-to-sell as well as rent-to-rent. The national rental companies report the number of outlets they operate, which makes it simple to calculate rental revenues per outlet for that group. We have made estimates of revenues per outlet for the other five types of outlets using sources that include company reports, industry association reports, trade publications, contacts with manufacturers, rental companies and equipment dealers.
In total, we estimate that in 2004 there were 14,000 outlets that rented construction equipment in the United States. Of those, approximately 3,700 are distributors that rent equipment (see Figure 2 below). Caterpillar is separated from other dealers because it's the largest single group of dealers and because some rental-revenue data is published about it in trade journals. We estimate that Caterpillar dealers, as a group, had 2004 rental revenues of approximately $4.3 billion and represented 19.2 percent of total U.S. rental revenues. We estimate that in 2004 there were approximately 3,000 other authorized U.S. dealer outlets that rented equipment. We believe that each outlet had 2004 rental revenues of $1.8 million, adding up to $5.4 billion of revenues or 23.9 percent of the total.
The 2,250 outlets operated by the major rental companies had reported rental revenues per outlet of $3 million, adding up to $6.7 billion or approximately 25.4 percent of the total. We estimated that there were 1,800 regional rental centers that had revenues per outlet of $2.8 million, adding up to approximately $5 billion or 19 percent of the 2004 total. We define regional rental centers as those that operate more than three outlets located in more than one state. Mom and pops are outlets that are operated by their family owners. There are usually no more than two outlets per family. Mom and pops represent the largest group of rental centers — we estimate 6,250 — that had 2004 revenues per outlet of $800,000, adding up to approximately $5 billion or 18.8 percent of the total.
This report includes an additional rental center category for the 1,100-plus rental locations operated by Atlanta-based The Home Depot, which has found small equipment rental an attractive addition to its home supplies retail outlets. A number of equipment manufacturers have national account sales teams targeting The Home Depot and others like them. In our opinion, the so-called big-box retailers are a channel-to-market that was not on any one's radar screen a few years ago, but will become increasingly important in the future.
The Home Depot's revenues per outlet, we think, are small relative to any of the other groups, but the quantity of stores makes this an area of interest that we plan to keep track of in the future. It should be noted that Lowe's, another big-box home supplies retailer, has an active equipment rental program in its stores that is operated by NationsRent. The results for this program are included in the NationsRent results in the tables that follow.
Add together the six types of businesses in the rental market, and we estimate that 2004 U.S. rental revenues were approximately $26.5 billion.
We've tracked the rental industry for AED for more than 15 years. See Figure 3 on page 90 for our estimates of rental revenues extending back over the years.
According to our estimates, rental revenues grew approximately 11 percent from 2003 to 2004. Growth in the previous year was low at approximately 1 percent; 2002 compared with 2003. We believe that revenues this year will grow by at least the 11 percent we saw last year, and with the aggressive rental rate pricing reported by the national rental companies, the percent gain could be even higher.
For tracking purposes we compared our estimate of the rental revenues per location in 2004 with our estimate of those for the year 2000. It's interesting to observe that there were gains in every category, but the largest gain, just under 30 percent, was observed among the Cat dealers — a gain nearly twice as large as the total gain of 15.8 percent for everyone. We estimate that the Mom and pops group had no gain during this period (see Figure 4, page 90).
In the eyes of investors
There is a great debate among industry participates about whether the rental model for construction equipment is viable and whether it can be sustained over time. As the saying goes, the proof is in the pudding. Can these businesses generate enough profits to attract the huge amounts of investment capital necessary to run the business? We have summarized selected financial information for as many of the nationals as possible. Several are private or are a part of a larger operation, as is the case with Hertz, which makes it difficult to obtain detailed information on every company.
Wall Street investors are primarily interested in the amount of a company's earning power. The benchmark most often used to measure that is EBITDA (earnings before, interest, taxes, depreciation and amortization) on the theory that management has control over interest rates paid, the tax rate of the company, and depreciation and amortization schedules. It appears that in 2004 the eight companies for which we have data had relatively healthy EBITDA performance. Interestingly Hertz, which has been in the business the longest, had the highest EBITDA.
Besides equipment dealers who participate in both the rentals and sales segments of the market, there are at least two companies that have been merging the two business models into one organization — NationsRent and H&E. NationsRent has been operating for some time, but in the past two-and-a-half years has been adding equipment, parts and service sales to its rental model. H&E Equipment, which calls its business an “integrated model,” has also been in business for some time, and recently filed with the U.S. Securities and Exchange Commission its intent to become a public company.
(in millions)
My question is: Will H&E or NationsRent, both companies that are pursuing integrated business models, be more or less profitable than pure rental companies. Figure 5 (page 91) shows no difference between the two models. H&E had some extraordinary expenses in 2004 that lowered its EBITDA. NationsRent appears to be returning a healthy margin to investors, which is consistent with a company that specializes in rentals-only.
(millions of dollars)
The crystal ball
In 2001 I made five predictions about rentals. Let's see how I did.
2001 Prediction: The growth in rentals will slow to single digits in 2001 and possibly for part of 2002, but most likely will return to its double-digit trend line in mid-2002 and 2003.
Growth of rentals in 2001 was zero compared with 2000 and turned to a minus 4 percent in 2002 compared with 2001. The industry was still declining in the first half of 2003 but turned up enough to offset the decline and ended the year plus 1 percent. I estimate that the market was up 11 percent in 2004 compared with 2003.
In analyzing the results, I missed the turning point of the market by six to 12 months. I believe I missed the turning point because I underestimated the importance to rental revenue growth of non-residential construction. U.S. non-residential construction declined throughout 2001 and 2002, and didn't hit bottom until early 2003. This construction segment grew slightly in 2004 and is expected to be up 6 percent in 2005. Non-residential construction projections for 2006 are for 12-percent growth. Non-residential construction often recovers later in the economic cycle as it has this cycle.
I feel confident in predicting that 2006 U.S. rental revenues will grow in the double-digit range (see Figure 6 on page 92).
2001 Prediction: Users will continue to increase the amount of equipment they rent.
I estimate that today 30 to 40 percent of new equipment (unit volume) is sold into rental operations. In 1991 I estimated that the figure was 5 to 10 percent. I'm convinced that as the rental market continues to develop and as equipment users begin to recognize the advantage of having someone else assume the financial risk of ownership, then the North American ratio will continue to increase. I estimate that the ratio could go as high as 50 percent within 10 years.
I don't see any reason to change this prediction. The amount of new equipment sold into rental fleets is growing about on track with my prediction in 2001.
2001 Prediction: Brand preference will continue to diminish as rentals increase. I don't have a current measure of the importance of brand preference.
I made this statement based on the 2001 study results. Stories abound that many manufacturers jumped back into selling directly to rental company's in the past two years, after having withdrawn from direct selling during the market downturn. Based on those stories, one can assume that the importance of brands has diminished. If brand were extremely important, manufacturers would not be able to be in and out of the market as they have been.
It makes sense to me that when someone calls a rental company to rent a skid steer or a compact excavator he's not as concerned about brand as he is about whether the company has a machine available.
Many manufacturers may disagree with this view, but it's a recurring theme throughout most of the research we conduct. I do believe, however, that brand is very important when a user decides to purchase a machine.
2001 Prediction: Manufacturers will continue to straddle their bets on rental vs. retail by establishing the rental channel as part of their permanent distribution strategy. That strategy may include ownership of a rental chain.
During the bottom of our most recent equipment market recession, many manufacturers withdrew from the rental market. When they sell to rental companies, the profit margin is generally lower than if they sell their products through their dealers. Toward the end of the recession several manufactures reactivated their direct-selling strategy for rental companies or began selling to the rental market through some other means, such as agents.
To the best of my knowledge, no companies other than Atlas Copco own a rental chain or are trying to purchase one. Caterpillar has continued to encourage its dealers to establish rental stores and Volvo is continuing to expand its CE rental franchise network.
At this point in time I think it's unlikely that a manufacturer will purchase a rental company. There doesn't appear to be any financial leverage to gain because the financial resources necessary to be in the rental business (sales/dollar of assets) is nearly the same as for manufacturing.
2001 Prediction: The lines of distinction between distributors and rental centers will continue to blur.
Of all my predictions this is the one that is definitely coming to fruition. In this report I've cited H&E and NationsRent as two examples of companies that have a real mix of a rent-to-rent business and a traditional dealer business. H&E uses the term integrated model, which is as good a description of this type of mixed business as I've seen anywhere.
I believe that due to the capital requirement to be in the rental and distribution business we will begin to see more integrated-model organizations. In the next 10 years we may witness the emergence of national distributors with operations all across the country.
Frank Manfredi is president of Mundelein, Ill.-based Manfredi & Associates, a marketing information firm that specializes in the construction, mining, farm and material handling equipment industry.
