Beware of Opportunistic Foreign Manufacturers from Emerging Markets

According to Craig Paylor, former JLG president and aerial industry veteran, equipment rental businesses should hang on to their aerial work platforms for a longer period of time than in the past. The reasons go beyond the future of available financing and center on the need for U.S. equipment rental businesses to build value in their existing fleets.

With the rental market depressed and no sustained recovery expected until sometime in 2012, the environment is not conducive to buying new equipment, Paylor notes. Even more daunting is the prospect of obtaining financing when the economy does finally bounce back. "If the market returns in even marginal terms sometime within the next six to 18 months, what is the likelihood that you can take your balance sheet and cash flow statement and get any kind of reasonable financing rate without having to sign your life away as collateral? The answer is: not very good," says Paylor.

With this in mind, it doesn't make sense to sell off every underutilized piece of equipment that's sitting in the yard, because it will be hard to replace. "Sure, a certain amount of equipment can and should be sold if you can make a reasonable return. But what is reasonable in a market like this?" Paylor says. "You can almost be assured that any piece of equipment you sell at auction will end up being something you have to compete with in the future, as a rebounding marketplace always creates opportunities for new startup companies."

As the economy recovers, manufacturers will see the cost of commodities go up as soon as producers can justify an increase. "Steel, rubber, engines, hoses, motors, pumps and everything in between will start up in price long before the job starts are plentiful enough to allow rental rates to climb back to levels with reasonable returns," Paylor predicts. "This means pressure will be on all manufactures to raise their prices so they don't have to absorb this margin hit. Most manufacturers will try to push the price increases out as long as they can, but in the end, the commodity companies will demand the price increases or [manufacturers] simply will not get any material."

The result, Paylor says, is a virtually inevitable price increase to the distribution network. "How this is handled will be determined by the stage of recovery for each manufacturer," Paylor says. "But as these prices put pressure on margins at every point along the value chain -- vendors, manufacturers, rental companies, end users and finance companies -- you could see the basis for a perfect storm."

The perfect storm to which Paylor refers is an ideal setting for new manufacturing companies – most likely emerging from Asia, India and other markets -- looking to enter the giant markets of North America and Europe. "Think about a Chinese company that decides to build a product that looks a lot like any one of the market-leading products in any rental category. They will have a product designed so much like the existing one that the service parts fit either the original or the new one," he predicts. "It will be built in an area of the world where labor costs are a fraction of the cost of U.S. or European rates. They have trillions of dollars to finance any possible purchase by new distribution, even if it is backed by their own government. Maybe most important, they are not worried if they make any money on the sales for some period of time, possibly years, because all they really want is to have their product become accepted by the rental customers and end users as reliable."

He continues, "So these new manufacturers have a lower price, plenty of capacity, almost unlimited finance capacity in a market where finance will be extremely restricted, and a mindset that success is going to be judged not by profit but by acceptance of the product, which is a much longer-term proposition. In a time when so many U.S. manufacturing companies are or have run to China to build their products in order to take advantage of the low labor rate or to allow them to compete in the Asian marketplace, their new hosts are building similar products to come to this market with advantages few U.S. manufactures can match."