Chain Reactions: Managing Assets in an Inflated Marketplace
by Carl Chrappa Vol. 48 No. 7 2022
Months of supply chain disruptions and rising prices have made asset management more challenging than ever in 2021. Carl Chrappa of The Alta Group provides an overview of the effects of these issues on different equipment types and gives advice on how to prepare for the opportunities that will develop in the next few years.
Carl Chrappa, Senior Managing Director, The Alta Group
It’s not often that equipment finance and leasing is front and center on the world stage, with everyone from stock traders to your average consumer stopping to take notice of the going rate for shipping a container. However, a complicated confluence of COVID-19-related shutdowns, labor shortages and equipment scarcity has driven prices up throughout the supply chain, meaning the purchase price of a shipping container and related shipping costs are contributing to the increase in the price of oranges and other goods.
But that’s the world we’ve been living in lately, and in this world of near-constant inflation, equipment lessors need to take notice of the inherent risk of funding equipment now while prices are so high. The current state of disruption will continue to be tricky for asset managers, but a few key concepts will help you appropriately fund equipment and make the best out of current leases.
Wait Times and Price Increases
Inflation at the producer wholesale level climbed 8.3% this past August from the year before, according to the U.S. Department of Labor. That’s the biggest annual gain since the department started calculating the number in 2010. Those prices are passed on to consumers, with the Consumer Price Index for All Urban Consumers from the U.S. Bureau of Labor Statistics rising by 5.3% over the past 12 months.
The fact that global shipping continues to be snarled at ports is a contributing factor to these trends. In fact, the waits to enter the port at Long Beach, CA, are so long that more than 40 ships are often in a queue, waiting for days on end to unload. This is further compounded by outbreaks of COVID-19 at ports, which can stop shipping altogether.
Keep in mind, about 80% of traded goods travel by shipping container. Transporting a 40-foot steel container by sea from Shanghai to Rotterdam now costs a record $10,522, which is nearly three times last year’s cost, according to Drewry Shipping. Overall, in the last year, the cost of containers themselves has increased by 130%.
That’s where we are seeing supply chain issues. Rates to ship are also gumming up the works. Shipping from China to the port of Long Beach, CA, can cost up to $24,000 per 40-foot container. Just a year ago, the price to ship the same container was $2,000. That is an increase of more than 10 times the usual cost.
This rise in cost has driven up the price of just about everything — from toys to steel coils — resulting in an increase in manufacturing costs and sales prices. Supply chain disruptions are even slowing down the production of microchips, and the price of some items at Dollar Tree has gone up from $1 to $1.50! Meanwhile, in just the past year, the price of gasoline has increased by 45%, and, even worse, the price of natural gas has spiked by 175%.
These increases have been particularly disruptive in the case of hard-to-come-by equipment.
Impact on Equipment Classes
I’ve been in the equipment finance industry for around 50 years and this is the only time I’ve seen inflation spike as it has recently and affect equipment across the board.
Containers, obviously, are a really hot item with their current prices and they are impacting the supply chain in a brutal way, essentially holding goods for ransom. On the bright side, the global new container output will increase 40% this year, expanding the global fleet by 6.5%. That will be a big help, but there’s so much congestion, and with the pandemic, shipping prices are really being affected. I’ve seen container deals done this year, and they’ve gone for very high prices. This will become an issue for asset management because, in a year or two, the price of these assets will revert to mean. Marine bulk carriers and tankers are up, too, with the former up 50% to 80% and the latter up 5% to 15% from the mean.
The same holds for construction equipment, especially for trucks. Back orders for new trucks are well into 2022 for delivery. Used trucks are backed up as well, with sales price averages at auction up 35% to 80% and in retail up 50% to 80%. In addition, sleeper trucks are going for 80% more than last year’s value, with many selling at record levels.
Another part of the puzzle is raw materials. Think about what equipment is made of — mostly steel and aluminum. The price of aluminum is up more than 65% year over year and steel is up 275%.
However, some asset classes are down. Rail has had a tumultuous couple of years and aircraft values are down 5% year over year. Helicopters are hurting, with assets down around 30%, partially because logistics work for helicopters has dried up almost completely. Oil and gas exploration equipment faces the same situation.
Meanwhile, bus owners are hurting but recovering and holders of live event equipment, restaurant equipment and any other industry affected by social distancing measures have been hurt as well.
In addition, rail took a beating in 2020. Normally, a 1% to 2% change in rail carloads shipped is a big deal, so the 7% decline in 2020 was a huge deal. However, the sector is recovering, with container shipments on rail increasing year over year by about 10%.
In equipment finance, there’s always an element of luck. You have to be lucky to be in the right sector of equipment when there is a significant market shift. Thinking back to the financial crisis in 2008 and 2009, equipment was selling for far less than its long-term value. Those who were able to park items like construction equipment, trucks and aircraft for a year and make deals later were in a much better position and were rewarded for their patience. If you find yourself in a similar situation and are able to hold on to devalued equipment, then you should do so.
During the next year or two, those with valuable equipment at the end of its lease will be in the driver’s seat. There are many companies willing to buy out end-of-lease assets for the temporarily high prices because they have an immediate need for trucks, containers and construction equipment. This creates opportunities because if you sell to a third party, you may be able to keep the entire upside of a deal or split the upside with the third party. Of late, end-of-lease stick rates have spiked, and returned equipment is selling for historically high prices, creating a win-win for leasing companies.
But when financing new equipment, be careful about basing the financing terms (e.g., assumed residual values) upon inflated values. When the supply chain issues settle, prices will revert to the mean. It will be especially beneficial to forecast out a few years when managing in an elevated risk environment. Funding in 2021 and into 2022 is not and will not be business as usual. Significant inflation created initially by the pandemic is currently interrupting the market, but that has snowballed with additional issues like chip shortages and weather challenges. The market is pressed right now and it’s affecting all areas of the economy. Retail sales of new construction equipment and manufacturing utilization rates are all being affected.
At The Alta Group, we publish forecasting residual value matrices of more than 200 types of equipment for leasing and finance companies. It’s been difficult to forecast exactly when the market will return to normal, but we know years one and two of our most recently published matrix will remain high. So, 2023 will likely still be high by historic standards. But looking long-term, the economy is growing and transportation looks like a particularly good investment.
Try to make equipment deals based on projections of real dollars rather than percentages of original cost. Remember that we deal with long-lived assets and continuing to fund under current conditions (percent of cost) will have ramifications at the end of a lease. If your company has records of deals, remain at the normal level and be careful jumping up 100% over your historical prices. You can also consult with a third party to gain insight into current market conditions and future ramifications. The market will return to normal when supply is restored to meet demand. Those with a feel for that will respond appropriately. Those who don’t, won’t.
We are not doing business as usual, and the equipment finance industry is experiencing incredible inflation due to labor and equipment shortages.
Understanding the inherent risk in financing at inflated asset prices will be critical, so be careful about jumping up 100% in value for equipment deals and residuals.
Be patient and be prepared to wait out problems you may have at this time, especially if you have assets that can be parked and maintained. This approach may be less applicable for sectors like high-tech that depreciate quickly. When the market rebalances, businesses will again see more typical supply and demand patterns.
Important Note to Readers: This article was written in October and market conditions may have shifted between then and the publication date.
Carl C. Chrappa is senior managing director of The Alta Group and head of its asset management services. He holds senior appraisal accreditations with the American Society of Appraisers, the Royal Institution of Chartered Surveyors and the National Association of Independent Fee Appraisers. He can be reached at firstname.lastname@example.org.
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