U.S. Nonresidential Construction Surges: According to an October 2015 report issued by Fitch Ratings, the first eight months of 2015 showed strong activity for U.S. private nonresidential construction, with the rate of spending expected to remain relatively robust through 2016. During the January-August 2015 period, private nonresidential construction spending grew 12.1% over the prior year, following an 11.3% improvement during 2014. Construction spending was especially robust for the manufacturing, office and lodging properties sector, and Fitch expects spending in this area to advance 8.5% in 2015 and 7% next year. Another bright spot has been public construction spending, which has also picked-up over the past year. Public construction spending was up 5.8% through the first eight months of 2015 and 5.3% for the trailing twelve-month period. Fitch anticipates that public construction spending will increase 4.3% during 2015, with highway and street spending possibly advancing at a faster pace. The expected growth in this latter sector is somewhat tempered by the uncertainty as to whether a long-term highway funding program will be approved.
Long-term Highway Funding Program: With the specter of insolvency again looming over the federal Highway Trust Fund (HTF) along with the impending August congressional recess, on July 30 Congress passed the $8 billion Surface Transportation and Veterans Health Care Choice Improvement Act of 2015. This act extended the HTF’s authority to provide transportation funding to the states through Oct. 29, 2015. It is the third such short-term extension since the expiration of the most recent reauthorization bill, the Moving Ahead for Progress in the 21st Century Act (Map-21), passed in July 2012 and originally due to expire in September 2014. On July 30, the Senate also passed a long-term transportation funding bill, representing the first such multiyear legislation to be passed by any full chamber of Congress since MAP-21. This proposed Developing a Reliable and Innovative Vision for the Economy (DRIVE) Act is a six-year reauthorization bill, but it contains only enough funding for the first three years. There appears to be momentum to get long-term transportation legislation over the finish line this fall. Stakeholders are hopeful for bipartisan consensus resulting in the first long-term transportation bill in a decade. Whether Congress is successful will hinge on the ability of its members to reach a compromise on the appropriate funding mechanism.
Improvement Seen in Rental Equipment Utilization: Earnings for equipment rental companies are generally driven by rates and utilization. The results of a recent survey taken by Thompson Research Group of the largest U.S. private equipment rental companies showed that while there continue to be near-term headwinds from lower oil and gas activity and related fleet absorption issues, during the third quarter the industry experienced sequential improvement in utilization with most of the rise in rental activity seen in nonresidential construction. This improvement was attributable in part to “catch-up” work stemming from unprecedented wet weather last spring. During the same period, rates were generally flat as a result of weaker utilization trends; however, Thompson believes that rates will increase over the longer-term in order to compensate for higher equipment costs. Most of the companies surveyed expect flat utilization and rates over the remainder of the year. Thompson’s view over the longer-term continues to be positive. Looking ahead, longer-term growth levers for the equipment rental industry include: (1) improvement in construction and industrial activity, (2) market share gains for larger players due to economies of scale, and (3) the continued secular shift to equipment rental vs. equipment ownership.
Asset Values Affected by Oil Price Volatility: Over the past 12 months, the price of oil has declined dramatically due in part to uncertainty in the European and Asian markets, coupled with OPEC’s reluctance to decrease production. The adverse impact on asset values was slow to take shape and has occurred in several stages. As oil fell below $100 per barrel, new drilling activity began to fall off, while the demand for maintenance services experienced a smaller decline. When oil prices dropped to $70 per barrel, purchases of oilfield equipment became more need-based as opposed to opportunistic and equipment buyers were having a much harder time securing funds to close deals. As oil prices continued to drop it became clear that the midsized companies were more leveraged and more susceptible to market forces. This trend escalated as oil fell below $50 per barrel, forcing many highly leveraged midsized companies to liquidate assets or file bankruptcy. Despite these circumstances, lenders have been slow to foreclose on assets. They have been willing to “amend and extend” loan terms in the energy sector, knowing that the alternative would be to attempt to sell assets into an extremely soft market. What is clear is that oil prices remain extremely volatile and are subject to dramatic swings. While there is little to be done to control fluctuations in oil pricing and their impact on asset values, investors can limit their risk exposure by monitoring market shifts closely and analyzing possible exit strategies based on the market environment.
Tier 4 Emission Standards: On May 11, 2004, the U.S. Environmental Protection Agency (EPA) signed the final rule introducing Tier 4 emission standards, which are being phased-in over the 2008-2015 period. The Tier 4 standards require that emissions of particulate matter (PM) and oxides of nitrogen (NOx) from new, non-road diesel engines be further reduced by about 90%. Such emission reductions can be achieved through the use of control technologies (including advanced exhaust gas aftertreatment) similar to those required by the 2007-2010 standards for highway engines. Diesel exhaust gas aftertreatment enables the quick diagnosis of diesel particulate filter and selective catalyst reduction problems, and explains related maintenance procedures. Since diesel powered vehicles have gained market share during the last six consecutive years, the knowhow to fix them expediently has become vitally important. When the full inventory of older non-road engines are replaced by Tier 4 engines, annual emission reductions are estimated at 738,000 tons of NOx and 129,000 tons of PM. By 2030, it is estimated that 12,000 premature deaths will be prevented annually as a result of the implementation of the new standards. The cost for added emission controls for the vast majority of equipment is estimated to be 1-3% of the total equipment price. For example, for a 175 horsepower bulldozer that costs approximately $230,000 it would cost up to $6,900 to add the advanced emission controls and to design the bulldozer to accommodate the modified engine. Additionally, the EPA estimates that the average cost increase for 15 ppm S fuel would be 7 cents per gallon. This cost should be reduced to approximately 4 cents by anticipated savings in maintenance costs due to low sulfur diesel. The above information was obtained from DieselNet, an internet forum dedicated exclusively to the exchange of information on diesel engines, fuels and emissions.
Trends in Used Equipment Values
Equipment prices over the last five to six years have passed through several distinct phases. First, as construction spending dropped during the recession, the demand for used equipment declined and prices fell dramatically. After hitting bottom in 2009, equipment prices showed substantial improvement through the first half of 2012. Price increases over that two-to-three year period were driven by a number of factors, including: (1) a shortage of supply due to reduced production by OEMs through the recession; (2) Tier 4 emission requirements, which encouraged the purchase of used rather than new equipment; (3) emerging market demand and (4) incrementally better domestic demand. Used equipment prices have now recovered beyond their prior peak and many analysts believe the rental industry has since entered a phase of relatively more stable pricing, albeit with recent softness due to lower oil prices and a stronger U.S. dollar. Over the longer-term, analysts continue to call for modest improvement as nonresidential and industrial activity picks up. The results of a recent nationwide survey of private equipment auction houses and appraisers taken by Thompson Research Group continues to indicate that the majority of contractors are experiencing increased bidding activity and sureties are experiencing increased bonding requests. These important leading indicators point to improving end-markets that remain on track despite lower oil prices.