The Road Ahead: Materials Handling Could Face a Sluggish 2020
by By Dave Mirski Nov/Dec 2019 2020
Pacific Rim Capital continued to enjoy its record-breaking MHE originations in 2019. But, as Dave Mirsky writes, a less than optimistic economic forecast could mean a slower start to 2020.
Like all CEOs, I use my impressions of what the future will bring to decide how to deploy our resources. So, when doing our business planning at Pacific Rim Capital (PRC), I generally consider three things. First, I pay close attention to our actual interactions with customers. We learn a lot from our clients, both through bids and via conversations. Second, I look at economic reports from sources that I respect. Third, I examine trends in the types of equipment that our clients are ordering.
We have enjoyed consistently strong business in material handling equipment (MHE), with PRC’s originations at record levels for the last three consecutive years. 2019 looks like it will be another good year for us, as we anticipate that our MHE lease originations at year-end will again set a record. Based upon our personal experience, we have not seen any signs that the market is slowing in our sectors, which is why it can be hard to wrap our minds around the possibility that this growth may come to a (temporary) end. However, as we are often reminded by investment professionals, past performance is no prediction of future performance.
The economists we follow have been consistently correct over the years, so when we see predictions from numerous sources that business in MHE will slow, we take it seriously. The most recent Momentum Monitor puts MHE in the lower left-hand quadrant, which is a new location for our favorite asset. While we are not seeing much slowing or sluggishness from our client base, other economists agree with the Momentum Monitor, with many not at all sanguine about 2020. According to many reports, we will be experiencing the natural downside of the business cycle. ITR Economics in its October 2019 Trend Report examined the current business climate and believes that the world will be feeling “downside business cycle pressure into and perhaps through the first half of 2020.” The US Purchasing Managers Index is signaling a mid-2020 low, though with a business cycle rise for the second half of the year. Trade wars and tariffs will also likely exacerbate this trend and put downward pressure on CAPEX. For now, there appears to be little that we can do to avoid this part of the slowdown, and, as a result, we expect a slower environment.
That said, there has been one trend that may mitigate the slowdown of new orders. The combination of a strong economy and shaky confidence in its longevity has created an unusual, counterintuitive situation. Most manufacturers have not expanded their production capabilities to keep up with demand. PRC’s backlog of orders has ballooned to as much as two years of normal business. This MHE has been placed on order and is waiting to deliver. We have seen lead times for delivery of new orders stretch from four weeks to six weeks to as long as 36 weeks. As a result, fulfilling these deliveries will mask a slowing order rate for some length of time. Nevertheless, it appears that for the next few quarters our segment of the leasing industry will have to grow by gaining new market share, rather than from a rising tide of economic growth. As usual, a slowing economy will lead to increasing competition and worsening spreads. Market knowledge and value adds, which are always important in this segment, will become even more of a focus as competition increases in the MHE space.
There is good news, however. Our economic sources forecast a much better economy when we extend our time horizon to the end of 2020 and into the following several years. Despite the expectation that the U.S. economic outlook will decline into early next year, forecasts predict business conditions will improve through the latter part of 2020. And as manufacturing and consumption pick up, orders for MHE will follow, as they usually do.
In addition to personal experience and the predictions of economists, PRC always examines the type of equipment clients are ordering and what those trends could mean for residual values. The world is very focused on sustainability and reduction of environmental impact, and rightfully so. There have been more orders for electric trucks and further development of robust electric equipment that can do the type of work that was formerly reserved for liquified petroleum gas or diesel-powered MHE. There have also been great strides made regarding battery technology. We will see more use of electric forklifts and related equipment in the near future. Another trend that we have noted is an increase in the employment of fuel cell batteries in MHE. Fuel cells are very clean, but often require the installation of an expensive recharging infrastructure. We have leased such infrastructures many times in the past and expect to do more of it in the future. However, some problems with fuel cells will have to be worked out for this technology to really spread. We are also seeing new lithium batteries come to market, including some that are purported to last as long as 10 years. On the other hand, fires and exploding batteries continue to pose downside risks for these assets.
Finally, we expect to see more use of automated guided vehicles (AGVs). As robotics and AI continue to advance, and as it becomes easier to remarket these assets, more AGVs will be used (and leased) in factories and distribution centers. One impetus for this trend is a severe shortage of drivers. We have been told that as many as 10,000 drivers are needed right now both for private industry and the armed forces.
For 2020, I am expecting a business cycle slowdown in new orders that will be masked somewhat by the large backlog of unfilled orders. In addition, I think that we will see growth in electric and battery powered MHE to the detriment of gas and diesel ones. Since I expect that any slowdown will be temporary, Pacific Rim Capital will be maintaining its usual aggressive posture towards gaining market share. •
Vice President of Financial Services,
Corcentric Capital Equipment Solutions
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