The equipment rental business is having one of its best years since I began tracking this increasingly important segment of the equipment market. The public rental companies for which we have good data have reported 2006 revenue gains of between 9 and 37 percent, compared with 2005.
Non-residential construction projects such as strip malls, hospitals, hotels, office buildings, schools, and most importantly, manufacturing operations, are stoking the flames in the market. These are typically late-cycle projects, that is, they usually occur in the second half of a growth cycle. Almost 30 percent of the non-residential category is made up of manufacturing facility construction. During the first half of a national growth cycle manufacturers spend money inside their plants to improve efficiencies and processes. When they've done all they can inside the plant they usually start building more facilities, which is what's happening right now.
In order to take advantage of revenue gains, rental companies have had to increase their fleet sizes. It is estimated that in 2006 the 10 largest rental companies spent more than $3.6 billion purchasing new equipment, up about 10 percent compared with 2005, and up more than three times the spending levels in 2002 at the bottom of the cycle.
Fleet utilization rates have increased steadily throughout the past two years. Most of the larger companies report rates as high as 75 percent on a dollar utilization basis. When utilization rates get higher than 75 percent, a rental company will start losing business. That's why they've been spending so much on new equipment. In addition, I've noticed that the rental companies are not selling off used machines at their normal pace, which expands their fleet sizes as well.
Another reason rental revenues are expanding so rapidly is that rental companies finally have pricing power with their customers. In other words, they are able to raise prices and make them stick. Reported rate increases are anywhere between 5 and 11 percent, probably a substantial jump compared with the cost increases that manufacturers have passed on to their customers in the past year or so.
All of this good news has also caused a lot of investor interest in the rental industry. Most pundits are predicting that we are at the peak of the market. As a result, the supposed smart money is staying away from the consolidation game because strategic acquisitions of rental companies are purportedly not smart at the moment.
We've seen financial investors enter the market in a big way. The Carlyle Group purchased Hertz Corp. about a year ago. Hertz, of course rents automobiles, but it also owns Hertz Equipment Rental Corp., the oldest equipment rental company in the United States. Carlyle successfully bought the Hertz business from Ford Motor Co. and recently sold off a piece to the public in an initial public offering that some viewed as less than successful. After the purchase from Ford, Carlyle loaded Hertz up with debt and gave itself a $1.4 billion cash dividend before the IPO, which reduced the share price the public was willing to pay.
Atlas Copco successfully sold off its Rental Service Corp. equipment rental operation to Ripplewood and another private equipment firm. Atlas Copco pocketed more than a $1 billion on that deal. Neff was purchased by a private equipment group, which then took it public, marking the third time that Neff has been a public company. H&E Equipment Services, which was previously known as Head & Engquist, which merged with ICM Equipment to form H&E, was taken public in a very successful offering.
Sunbelt's purchase of NationsRent in 2006 is an example of a strategic acquisition. Sunbelt, owned by United Kingdom-based Ashtead, which also owns several rental operations in the U.K., is now the second-largest equipment rental company in the U.S. Greenwich, Conn.-based United Rentals is still the largest.
In addition to the public companies, privately owned equipment dealers, many of which are authorized selling dealers, also own substantial rental fleets. For example, I estimate that the total rental fleet owned by Caterpillar dealers is nearly as large as that owned by United Rentals. If you add up the rental fleets of all the authorized selling dealers they would be as large, or maybe even larger, than the public companies that we know so much about.
So, where is the rental market going in the next 12 to 18 months? I believe that we will see continued growth in 2007 compared with 2006 — maybe on the order of 10 to 15 percent — but not as robust as the 20- to 25-percent growth we saw from 2005 to 2006. Non-residential construction and heavy construction appear to be the primary drivers of rental equipment demand, and I expect those segments of the economy to remain strong in 2007. Even if I'm wrong and we have a slowdown in 2007, history tells us that equipment rental companies benefit from the early stages of slowdowns or recessions, because equipment users prefer to rent rather than buy when markets are uncertain.
Nothing in the equipment business is a slam-dunk, but I feel very confident that the rental market will do extremely well in 2007.
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.
