Equipment rental revenue, comprised of the construction/industrial and general tool segments, is expected to grow by nearly 10 percent in 2022 to reach a record total of $52.3 billion, topping the $50.9 billion recorded in 2019, according to the latest forecast released in early November by the American Rental Association (ARA).
To better understand the factors leading to this robust forecast, Rental Management questioned Scott Hazelton, director, economics and country risk, IHS Markit, Andover, Mass., the international forecasting firm that compiles data and analysis for the ARA Rentalytics™ members-only subscription service as part of a research partnership with ARA.
Rental Management: Looking ahead to 2022, it seems like several factors are lining up to create a banner year for equipment rental companies. Would you agree?
Scott Hazelton: Yes, that is the most likely outcome. Home construction in general, especially home improvement spending, will taper off next year. However, kinks in the supply chain in 2021 will get resolved in 2022 — our U.S. industry forecast has shifted the expected strongest growth into 2022 from 2021. In addition, we expect global economic recovery to jump-start exports, adding more potential to manufacturing. We should also see some nascent recovery in nonresidential structures, particularly the institutional buildings that rely on state and local revenues. Then there should be the first fruits of the infrastructure bill.
Rental Management: The ARA quarterly forecasts released in 2021 have been fairly consistent in expectations for equipment rental revenue growth in 2021 through 2025. Why?
Hazelton: We are expecting a staged economic recovery. We first have the emergence from recession, which is driving year-over-year growth for 2021. Over the next few years, we expect incremental improvements in nonresidential construction, manufacturing and infrastructure. Each phase will provide sustainable improvements for rental revenue growth.
Rental Management: What are the driving factors behind the positive outlook? How much of a factor are inflation and increased rental rates?
Hazelton: Inflation is a two-edged sword. It allows you to raise prices, but it also increases the cost of doing business. The IHS Markit view is that inflation will average 4.4 percent in 2022; higher at the start of the year and tailing off in the second half. We are used to an economy running with about 2 percent inflation. Inflation is not uniform — it is highest in certain areas such as food, fuel and motor vehicles, for example. So, equipment rental company costs may not reflect the economy’s average. However, for purposes of rough estimates, if equipment rental companies can pass on the average increase in cost, that would amount to 200 to 250 basis points of rental revenue growth in nominal terms.
Of course, inflation is only part of the story for rate increases. There also is improved utilization and expanded fleet. It can be difficult to tease these impacts apart. However, we know that getting additional equipment is difficult and that utilization was rather strong coming out of 2020 given de-fleeting earlier in the year. Consequently, one can expect that revenue growth also is coming from rate increases.
Rental Management: What does the passage of the Infrastructure Investment and Jobs Act mean for the equipment rental industry?
Hazelton: One needs to think of the core infrastructure bill of $1.2 trillion as three separate revenue streams. Of the $1.2 trillion headline number, only $548 billion is new federal spending. The other roughly $650 billion assumes the re-authorization of the “Highway Bill,” currently called the FAST Act, in 2021 and 2026. The $548 billion will be available for spending starting in January 2022. Furthermore, the mechanics of large infrastructure projects require substantial upfront work — surveying, engineering, public input, bidding, procurement, etc. Significant impacts of the new spending would not accrue to rental until 2023 with peak spending in 2024 and 2025 as these things ramp up. The current outlook for 2022 should not change much in the next quarterly update to the ARA forecast in February 2022, but you will see the infrastructure spending phased into the outlook for 2023 and beyond.
Rental Management: When end users can’t buy needed equipment because of backorders, they often turn to renting. Is this a factor in the forecasted growth in rental revenue? When equipment is more readily available, will that mean a decrease or slowed growth for the rental industry?
Hazelton: Over the next year or so, yes, it will be a factor in rental revenue growth. Supply chains are so tight that a machine ordered today may not be delivered for six months or more, especially if it is electrically powered. If a contractor needs equipment, there are very few choices other than rental. It is an option to buy used, but demand is such that used equipment is often carrying a pricing premium, and rental is a better financial choice. This assumes that rental companies have equipment, and since many de-fleeted to some extent in the recession of 2020, demand is tight across the economy. As such, rental companies can benefit from penetration but also the ability to raise rates.
The good news for rental is that as equipment becomes more available next year, we should also see improving demand for that equipment. We will see some early effects of the infrastructure package, but we also expect an improved nonresidential construction market. The expectation is that while there will be more fleet available, it also will be deployed on more sites. While the net effect would reduce significant upward pressure on rates, utilization should remain high enough to support some rate improvements. More importantly for the outlook, there will be more equipment in the field generating revenue as well.
Rental Management: What about the impact of mergers and acquisitions (M&A)? United Rentals, Sunbelt Rentals and Herc Rentals all have been more active recently with plans to expand greenfield and specialty rental locations as well.
Hazelton: Mergers and acquisitions all by themselves have very little impact on the outlook. Essentially, the assets and revenues of one company is integrated into another with no change to the market size. Of course, M&A can create efficiencies which improve the profitability of the combined operations in the short run. In the longer run, M&A usually does increase the rental industry market size as the larger company has more resources — fleet options, service capabilities, marketing breadth — to increase rental penetration. Greenfield expansion has the greatest impact on market size, although that’s really new investment, not M&A.
I would note that the new infrastructure spending could accelerate the acquisition of specialty rental. The new spending is only about 20 percent earmarked toward traditional roads and bridges. Most of the spending is targeted for mass transit improvements and the buildout of vehicle electrification recharging, broadband technology and water works, including drought remediation. The equipment needed for some of these activities may not be in wide circulation of rental fleets today. Just as the fracking boom incentivized rental companies to pick up specialty oil services equipment operations, the new spending could create the impetus for companies specializing in equipment for working at height for broadband towers and trenching, shoring, boring, etc., for water and drought amelioration.
Rental Management: The forecast for Canada seems to again mirror what is happening in the United States. Why?
Hazelton: Canada and the U.S. are both recovering from the pandemic-induced recession, they have extensive trade linkages, and both are battling with the same global supply chain constraints. However, Canada has a stronger 2021 outlook than the U.S. with slower growth in 2022. The U.S. should see its strongest growth in 2022. This difference is arising from the construction sector. Both countries have extremely strong housing markets, which is mostly of benefit to general tool rental. However, Stats Canada data suggests that its nonresidential construction sector also is recovering rather strongly, while the U.S. counterpart remains in the doldrums. There is some risk that the Canadian historical data for 2021 will ultimately be revised downward — that is not uncommon with construction data. If so, we would need to re-assess Canada’s 2021 equipment rental outlook, but it will remain quite positive with any revisions likely just moving some growth into 2022.
Rental Management: Is there anything that could significantly change the forecast for 2022?
Hazelton: There’s not a lot that can go wrong for early 2022 at this point. The forecast is rather optimistic, and there’s nothing obvious that would create stronger conditions. Nonresidential construction could pick up more than we expect, but we have a pretty strong leading indicator in the Architects Billing Index that informs how strong that market could be over the next 12 to 18 months.
The larger concern is that supply chain disruptions and inflation last longer than expected. There are good reasons to believe that supply chain disruptions will ease by the second half of 2022. Much of the problem reflects excessive inventory depletion. We entered 2020 with inventories in balance, and with just-in-time metrics, that was already pretty thin. With the sudden, deep recession, manufacturers of commodities in the early part of the supply chain cut back production, assuming a prolonged downturn. What happened instead was a rapid, strong recovery. Inventories simply weren’t there, and we are playing catchup. Left to its devices, the free-market economy is very good at rationalizing resources to meet demand over time.
However, inflation also is assumed to be transitory, diminishing in the second half of 2022 as tight supply chain induced price increases are negated, although not necessarily reversed. It is also assumed that agriculture and energy markets return to balance, removing inflationary pressure. This is our best case scenario, and that of the U.S. Federal Reserve. However, there are indications that inflation could prove a more lasting problem. As inflation gets priced into labor contracts, for example, companies face a continuing need to raise prices to meet what is often their largest expense — employee compensation. The primary job of the Federal Reserve is to preserve the value of the currency. If inflation remains considerably above the comfort band of 2 to 2.5 percent for a sustained period, the Fed would need to raise interest rates. In that eventuality, the impact is felt most heavily by investment-centric industries like construction and durable goods manufacturing — the core of equipment rental demand. The good news is that rates are already historically low, so any increase will not be as traumatic as if rates were higher. It’s also not the most likely outcome, but inflation is the metric to watch over the next six to 12 months as a possible disruptor of the outlook.