How Global Supply Chain Delays and Inflation Affect Asset Management Strategy
by By Carl Chrappa, Ian Robertson & Juan Neil Dodds Jan/Feb 2022
Carl Chrappa of The Alta Group sits down with colleagues Ian Robertson from Europe and Juan Neil Dodds from Latin America to discuss the forces asset managers will face in 2022 across the globe, including supply chain disruption, inflation and secondary market considerations and the rapid development of technology.
Carl Chrappa, Senior Managing Director & Leader of Asset Management, The Alta Group
The job of an asset manager is always challenging. There’s no normal in a field subject to the whims of global governments, supply chain issues, inflation and a myriad of other concerns. And lately there’s been a perfect storm of issues for asset managers to consider when financing and working out the end-of-lease life of equipment.
In December, Carl Chrappa of The Alta Group sat down with his colleagues Ian Robertson from Europe and Juan Neil Dodds from Latin America to discuss the forces asset managers will have to weather in 2022 across the globe.
Supply Chain Slowdowns
Supply chain slowdowns are delaying equipment finance deals and the core asset management functions supporting them. In some cases, equipment isn’t even being delivered intact. But end-of-lease profits and residuals are proving to be bright spots, along with used equipment.
Carl Chrappa: Supply chain delays are on everyone’s minds. Some of our clients’ deals are
being delayed as a result, which means we must delay our appraisals and residual analysis for them. Companies are ready to finance, but there’s no equipment.
JUAN NEIL DODDS: We’re seeing this, too. Equipment is being delivered not to 100% standard in terms of completion. For example, tractors and harvesters are delivered without tires. That creates the need of an additional checkpoint to make sure the full equipment has been effectively delivered at a point in the future. The harvest cannot be delayed waiting for a tire.
Ian Robertson: This is a consistent story across industries and worldwide. There’s good profit to be made at end-of-lease, and residuals are holding up well. We see that in all sorts of verticals. All of us have experienced it in terms of cars on a personal level. But, if you can’t get new equipment, you’ll have to use used. It is quite universal. I was talking to executives in New Zealand this morning, and they, like many others worldwide, are having trouble with new business volumes simply because they can’t get their hands on new equipment.
Inflation and the Secondary Market
Many asset managers have never experienced an inflationary market before. Extra care is needed when setting residuals, and asset managers should be mindful of the global market when deploying equipment internationally. There may also be more end-of-term disputes.
Chrappa: Inflation is affecting all verticals. Since 2020, the price of new open top barges has increased by 50% to 60%. Here in the U.S., used ag tractor prices are up 50% to 55%, and combines are up 15%. Used automobiles have increased in price by [more than] 30%. It’s amazing — used Class 8 truck tractors are at record levels each month and continue breaking records, up 80% year over year for used trucks. Container prices have over doubled. Used construction equipment has increased anywhere from 15% to 50% depending on the kind of equipment. A box ship reportedly sold for $7 million in January and then $14 million in June. How’s that for a return? Not only that, but the price of new cars is up by 12%, and used cars have increased by 32%. If you are a lessor, you are in the driver’s seat.
A lot of things are happening that we haven’t seen for many years, especially end-of-term disputes. Two times in the last month, we’ve worked on arbitration panels. Once a dispute emerges, the lessee has its appraiser, the lessor has its appraiser and then a third appraiser may be appointed.
Dodds: We’re seeing that in transportation. The secondary market is, not surprisingly, very strong. It’s not 80%, but 25% in several models, [which] is not surprising. We have to be careful not to take this particular moment as normal for residual value setting. We are facing a balloon that might not take too long to deflate.
Robertson: It’s important to be aware of the long term — what’s sustainable? What’s the future value going to be? One of the big unknowns is inflation and it is relatively new for the younger generation of asset managers. Many people aren’t familiar with an inflationary market.
Chrappa: When setting residuals in a balloon like the current one, it’s important to revert to the mean over time. Looking out, the next one or two years will remain high, but in three years it may start to revert to the mean. So, don’t go 100% high on a residual for the next 10 years. That would be reckless. Average annual inflation is projected to increase to 5.2% in 2022, up from around 4.8% in 2021, then fall to 2.5% in 2023. Inflation is going to be around for a while. There’s just so much money chasing too few goods.
Dodds: In Latin America, when discussing values, we of course have to consider inflation but also the origin of the equipment. A large portion of capital goods are imported. Is this asset Euro or U.S. dollar denominated? The exchange rate needs to be built into the equation. The mean, inflation and the exchange rate projections.
Robertson: That’s a good point. Not everyone works where multicurrency is considered, but they need to be mindful of the global market if assets are not being deployed locally. Moreover, there’s a long-term shift occurring geopolitically. People want to be less dependent on China. And nearly every economy wants to take better control of its critical infrastructure. And along with this, there is massive technological change occurring.
Rapid technology changes are making it more difficult to set residuals for certain equipment. But technology is also the asset manager’s ally. It can ease inspections, asset tracking and fraud detection and help meet increased demand for lifecycle management and remarketing.
Robertson: For some technologies, the end state is unclear: how long development will take, when it can be delivered and how competitive it will be. It makes setting residuals difficult, especially on longer tenures.
Recent fraudulent activity in several markets has focused attention again on the importance of asset validation and inspection. There are some great technology solutions to help minimize these risks. These areas aren’t especially sexy and it’s not going to win sales awards but do it properly and invest going in to save yourself pain later. Risk management is a big part of asset management, and in boom times, some people and businesses can take their eye off the ball.
Dodds: Yes, these are internal things that can help. There are a lot of new technologies for asset tracking and checking the value and state of your asset. It offers a high contribution to fraud detection, and you can keep more accurate track of the asset value of your portfolio. Clients are also demanding more professional lifecycle management. A lot of companies are delayed in adding technology because they think this adds costs. But technologies are doing a good job to reduce cost of managing the assets.
Robertson: And playing into that are subscription costs. Many of these services are plug and play and that has greatly reduced upfront cost compared to former times. And supply chain management and remarketing, which were traditionally the second cousins and not given the attention they deserve, are made easier. They’re getting a lot more attention.
We also see great attention on exploiting IoT. It’s been spoken of for a long time, but we really see this coming to the fore and driving significant value creation.
Chrappa: I agree with Ian’s assessment. Technology also provides shortcuts to inspections. We’ve done two virtual inspections recently at large can-making facilities. We can see the asset as if we are there, and, as we know, inspections are how you detect fraud. There’s an old saying I remember from banks back in the 1980s: “If we don’t have someone who can touch it, we don’t finance it.”
Major takeaways for asset managers in the new year from Alta experts :
Asset managers will still have to deal with an inflationary market. Be patient: Don’t do deals before the equipment is there.
Asking “What if” is a powerful thing. What if this would happen? What if that would happen? It always boils down to fundamental economics at the end of the day. Keep an eye on fundamentals and see what variables shift your model.
Paying special attention to second life models will be very lucrative in 2022. It can contribute a lot of revenue to lessors’ bottom lines.
Carl C. Chrappa is an asset management expert with The Alta Group. He is senior managing director and leader of its asset management practice in the United States.
Ian Robertson is an asset management expert with Invigors, part of The Alta Group worldwide. He is executive director of worldwide coverage and is based in Europe.
Juan Neil Dodds is an asset management expert with The Alta Group Latin American Region. He is leader of its management consulting and vendor financing services.
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