Change is on the way. A new business cycle for the rental industry is peeking over the horizon and the United States rental industry is changing in two ways. First, 2007 markets are still strong but this will probably be the peak year in the current cycle with 2008 being a swing year. I expect U.S. construction equipment rental industry revenues to top $37 billion in 2007.
I expect 2008 rental industry revenues to be flat to down slightly. In deflated dollar terms, industry revenues are expected to be level with 2007. Rental rates are up marginally; rental companies' abilities to increase prices are peaking; fleet utilization is still high; and rental prices have also reached a peak.
A major rental demand driver is non-residential construction. We are all familiar with the recent meltdown of the housing market, down more than 30 percent compared with 2006. Non-residential construction markets, however, are up 10 to 12 percent compared with 2006. The consensus among construction economists is that non-residential will continue to grow in 2008 albeit at a lower rate. It will eventually be affected by the housing downturn, but components of the non-residential segment are still very robust — with manufacturing up 60 percent, hotel construction up 75 percent and office construction up 22 percent — which leads me to believe it will be OK in 2008. Our estimate of the rental industry is as follows:
The second change is in ownership of the whole industry. I've been following the construction equipment rental industry for nearly 20 years. Equipment industry participants have progressed in their thinking about rentals as a channel-to-market, from denial, to believing that it might be a trend, to outright embracing the rental segment for its business. Participants were at first concerned with the entry of the publicly owned consolidators. United Rentals was one of the first. Prime, which changed ownership and names several times and morphed into RSC Equipment Rental, was among the second wave. NationsRent, started by business magician H. Wayne Huizenga, who consolidated the waste-hauling business in the 1980s, jumped in soon after, but not soon enough to dominate the market as he had hoped.
Rental companies and a fair number of distributors that sold out to the consolidators early got the best prices for their businesses. The more traditional equipment sales companies struggled with understanding the rental business model and then finally began opening rental operations.
Who will actually own these massive businesses? Carlyle owns HERC. Lightyear Capital owns Neff. Ripplewood leads a group that owns RSC. Cerberus made a bid for United, but backed out of the deal. Private equity firms are typically interested in a 3- to 5-year strategy for their acquisition. They buy it, build it up quickly and sell it to the next buyer. The national rental companies that are more stable have private owners or are rental-focused companies that are willing to pursue long-term strategies. Examples in this group are Sunbelt Rentals, Ahern Rentals and Sunstate Rentals.
Clash of the titans
Today the national rental companies on one side of the marketplace have squared off against the equipment manufacturers. It's analogous to a standoff, with both sides facing each other at point-blank range, aimed and ready to fire. Both rental companies and equipment manufacturers are trying to become one-stop-shops for their customers.
Manufacturers are promoting rentals of their products through their “authorized” distributors. It took years for full-line equipment manufacturers to recognize rentals as a new channel-to-market, but the more enlightened ones finally saw it as a means of exposing their products to the marketplace and increasing their brand population.
There is a current effort by manufacturers to have their dealers become one-stop-shops. Caterpillar and its dealers are promoting the Cat Rental Store brand as a means to sell the company's compact products, along with about 70 other brands that they do not manufacture but they believe their customers want. Volvo is franchising Volvo Rents outlets to sell its products and about 70 other allied brands. Komatsu is in the process of promoting its compact products through Komatsu Rents stores.
Also facing off are the national rental companies. They too see themselves as the one-stop-shops for their customers. They're not interested in promoting any one manufacturer's brand. They are promoting equipment utilization. When a customer wants to dig a hole they've got the machine to do it. If it breaks they'll bring out another one. They regard equipment as a commodity. They want the customer to be loyal to their company not a manufacturer. One rental company, Sunbelt, paints all its equipment a bright green color; they are promoting their business as a brand rather than one manufacturer's products.
Large rental companies typically buy large amounts of machinery every year to replenish their fleets. Collectively their annual equipment spend is enough to get the attention of most equipment manufacturers. In 2005, the top 10 rental companies spent roughly $4.5 billion on new equipment (usually called capital expenditures, or cap-ex by Wall Street). It appears that 2005 was the peak year for rental company cap-ex. I expect 2008 rental company cap-ex to come in at approximately $2 billion.
Making large annual equipment purchases gives the rental companies tremendous clout to dictate prices and terms. In fact, in certain categories the national rental companies dominate the market for equipment. For example, they purchase 70 percent of all the telehandlers and aerial work platforms sold in the U.S. Huge up and down swings of capital expenditures like that wreak havoc with manufacturers' factories and their suppliers. Production schedules bounce up and down like a yo-yo. Some manufacturers have reported recently that their sales to rental companies are down as much as 70 percent. What's a manufacturer to do? In response, they're trying to gain control over the rental business.
We can look to other countries for clues as to what might happen in North America. In Japan, where for years 65 to 70 percent of new equipment was sold into rental fleets, the manufacturers have slowly taken over the rental role by investing directly in the rental companies or through their surrogates — the trading companies. In the United Kingdom, another intense rental market, rental companies provide their own service and parts functions. The equipment distributors' role there has been diminished to wholesale activities only.
The U.S. market is not going to change overnight. It's taken 20 years to get to where we are today. I believe the struggle between the rental companies' efforts to dominate their markets and the manufacturers' efforts to control their production, prices and terms is being played out right now.
I'm not ready to predict how long the national rental companies will dominate the U.S. rental industry. It may be forever. But of the top 10 rental companies, private equity firms, which are usually impatient investors, own eight. Manufacturers are increasingly impatient with being whipsawed on price, terms and volume by the national rental companies. I think that in the next 10 years we will witness another reshaping of the channels-to-market with manufacturers attempting to gain more control of their pricing and brands.
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 industries.
Rental industry revenues have increased every year except two in the past quarter century.
