Eric Dusch, Chief Commercial Officer, Equipment Finance, GE Capital, Corporate Finance
Oct. 29, 2012
The equipment finance industry continues to be a powerful engine for the US economy, driving manufacturing and service sector supply chains across the country. In fact, the Equipment Leasing and Financing Association (ELFA) estimates that in 2011 US businesses, non-profits and government agencies financed $628 billion of capital goods or fixed business investments, up 21% from the year before when financing totaled $521 billion.
In other words, a healthy US economy needs a healthy equipment finance sector to fuel growth. Yet, just how robust will the industry's performance be over the next 12 months given the many economic and political uncertainties in today's business landscape? Global financial pressures - such as the euro zone crisis and a growth slowdown in China - are bound to affect capital investment decisions, as will the political environment in the US, where a presidential election, expiring tax cuts and a debt ceiling debate are all on tap.
It's an environment where middle market executives are understandably cautious, which could dampen demand for equipment financing. According to research by the National Center for the Middle Market (NCMM), a partnership of GE Capital and The Ohio State University Fisher College of Business, only 15% of 1,000 executives surveyed are confident in the US economy. Main concerns include the cost of health care (92% of respondents said this was challenging or somewhat challenging), the cost of doing business (88%), the ability to maintain margins (86%) and uncertainty about how government actions will impact the business (81%).
Despite all this, there are three trends that factor into continued, healthy growth in equipment finance over the next 12 months within the forest products sector: aging equipment; the pace of innovation; and, the need for liquidity.
The replacement and upgrade clocks are ticking
Back in the middle of the last decade, just before the financial crisis, there was a surge of financing. Since then many forest product companies - the ones that have survived - have slashed payrolls and delayed capital expenditures. Even with the recovery gaining some steam, many of these companies remain very conservative.
Equipment that is not heavily used or at risk of obsolescence can often be kept in use for 12 or 15 years. But a forklift or logging equipment, for instance, can only run so long. There comes a point when the cost of maintaining a piece of equipment outweighs the cost of investment. If such a piece of equipment was financed five years ago, its useful life may rapidly be drawing to a close.
It is difficult to pinpoint when this surge of replacement activity will commence - for example, for sawmills that have not been working to full capacity for some time due to a sluggish housing market, or packaging converting facilities that could use upgraded equipment. However, the industry seems increasingly confident that a steady uptick may be in the offing. Those competitors that prudently invest in preparation for the upturn will enjoy attractive returns. In fact, the ELFA's 2012 report forecasts nine percent growth in investment in equipment and software in 2012. Those findings are reinforced by the NCMM survey, which found that 34% of middle market companies would allocate additional cash to capital expenditures such as new equipment or facilities. Among manufacturers, for instance, the number was 38%.
Innovations drive decision making
When the time comes to replace equipment, most companies upgrade to the newest technologies available in order to be as efficient and competitive as possible, but there are tradeoffs that drive decision making. In many cases these new technologies often come with greater upfront costs that need financing.
For example, scanning technologies and increased speed that allow sawmills to increase yield and output from sawlogs are becoming necessary to reduce cost, increase efficiency, reduce waste and remain competitive.
Whether it is a sawmill outfitting its operation with curve saws, a veneer mill upgrading to a new lathe or a converting facility upgrading equipment, newer technology can often provide increased automation, faster throughput, less waste, increased product flexibility, and greater productivity. Even in tough times, smart business leaders are continually weighing the cost benefit of updating and upgrading equipment.
Portfolio companies seek liquidity
The year 2011 was the strongest for buyout activity in the overall market since 2008. The deals announced had a total value of $277.7 billion, a 15.3% increase from the same period in 2010, according to mergermarket, an independent mergers and acquisitions intelligence service. Typically, these buyout or private equity firms use their own capital, clout and connections to set up a senior credit facility for a portfolio company.
But capital is precious, and once sponsors put their initial equity into a company they are often averse to putting in more. During the sponsor's holding period, usually four to five years, the firm expects a portfolio company to "stand on its own" and begin to grow the business. Sometimes this requires additional sources of liquidity. Equipment finance is proving a very effective strategy for portfolio company CEOs to tap more liquidity and keep the sponsor happy since it does not require renegotiating the entire credit facility.
The macroeconomic and political uncertainties hanging over the markets are substantial and will influence executives. However, to some extent this uncertainty and volatility has become a fact of life for decision makers since the financial crisis. The good news for companies looking to finance equipment, even if they are operating in a challenging commodity market, is that lenders have cash on hand to lend and are eager to put their money to work.
Eric Dusch (firstname.lastname@example.org) is Chief Commercial Officer, Equipment Finance at GE Capital, Corporate Finance, specializing in providing commercial loans and equipment finance to mid-size companies for growth, acquisitions, turnarounds and balance sheet optimization. gecapital.com/Americas; email@example.com
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