While it’s a truism that any economic trauma has winners as well as losers, the recent recession had a devastating effect on a wide swath of companies. Still, some well-situated businesses have managed to extract an upturn from the collective downturn. Take Ryder System, a commercial truck leasing and rental giant with $7.5 billion in assets on its balance sheet and $5.1 billion in 2010 revenue. As companies struggled to maintain their liquidity during the financial crisis, many sought to lessen their operating costs by outsourcing their trucking fleets to companies like Ryder. Further, since Ryder tends to work on the basis of five- or six-year leasing contracts, it can ride out a recession — and maintain its appeal to banks — thanks to its solid cash flow.
Ryder has also benefited from recent regulatory changes. While companies in other industries have found compliance with new environmental rules to be nothing but a burden, Ryder has jumped at the chance the new regulations offer to put some miles between it and its competitors. Because the company buys in bulk, it can retrofit its vehicles with required antipollution equipment more cheaply than the average company can, gaining a competitive advantage. Art Garcia, the company’s CFO since September 2010, explains how Ryder is capitalizing on such opportunities.
While no company ever admits to being recession-proof, your business model has certainly served you well during the past three years. Can you walk us through it?
In a recessionary environment we’re a cash-flow story, and in a growth environment we become an earnings story. We saw this during the recession of two years ago. We have a long-term contractual business: our five- or six-year renewable leases. We sell equipment at the back end when it comes off the lease.
We don’t buy the equipment until we sign a lease with a customer. In terms of the cash flow for a lease, we can spend $125,000 up front for a piece of equipment and recoup it over a six-year life. We generate cash throughout. In 2009, in the depths of the recession, we generated a record free cash flow of about $600 million.
In 2009, 2010, and in the first half of this year, we saw our lease fleet decline, excluding acquisitions. But now our forecast is that our fleet will start to rebound during the second half of this year.
Why the optimism?
We’re in an increasing-demand environment relative to a year ago. In transportation overall, we’re now going through a replacement cycle. The recession caused customers to try to keep their equipment as long as they could, or at least longer than normal. If you look at the fleet ages for trucks and tractors, they’re higher than they’ve been in the last 30 years.
But your fleet is not an asset you can keep using forever. Just as in the case of your car, you can try to keep it an extra two or three years. But as it gets older, maintenance costs get higher. You run the risk of significant breakdowns, and the equipment is not as reliable. So you have to start the replacement cycle, and we think that is something that’s approaching now.
But companies that in the past would have owned the equipment are more open to looking at leasing now, largely because the equipment costs more, and there’s more residual risk attached to it.
Where are those cost and risk increases coming from?
Over the last couple of years the Environmental Protection Agency has mandated some engine technology changes to improve air quality. That’s added significant cost to the equipment. For a piece of equipment you’re trying to replace that you bought six years ago, the price has gone up 50%.
With the change in technology to reduce carbon emissions — which concerns any new truck built since 2010 — not only does a truck cost more, but it’s also more complex and thus harder to maintain. So you’ve got to train your guys and make some changes in your shops. All those things are trends that benefit outsourcing that weren’t there before.
What are you doing in response to the uptick in the replacement cycle?
This year we’re going to spend $1.7 billion on capital expenditures. Typically, we spend around $1.5 billion. A good chunk of that will be in our rental business, since what we’ve seen is a turnaround there since about the first quarter of last year. Our fleet rental business was up 19% in Q2.
In 2010 we spent $1.1 billion [on capex], and in 2009, which was the year when we were in the depths of the recession, we spent about $600 million.
Even CFOs who anticipate growth in the months ahead have been slow to expand hiring. How are you addressing that?
We’ve been hiring as the business has been growing, and have done no firing. Obviously there’s natural turnover that occurs from time to time, but that’s it.
What challenges do you face in terms of managing your working capital?
We bill our leases at the beginning of the month, which helps from a collection standpoint. One of the big challenges we have in managing working capital concerns fuel. We sell fuel and provide fuel services as well as buy it. Typically we provide customers fuel services over the course of our normal lease agreement. On the back end, however, our vendors typically require payment within a week. So we can be subject to a working capital squeeze — especially when prices move up a lot.
We’re in a situation now where a lot of companies have healthy amounts of cash on their balance sheets. What’s your first priority in terms of deploying excess cash?
Our model is different than for companies [that might accumulate] tons of cash. When we generate excess cash, we pay down debt. That’s what we do in our business.
Our target leverage is 250% to 300% debt-to-equity. It’s high because we have to borrow to supply equipment to both lease and rent. [As of September] we’re at about 220%. Prior to our recent acquisitions, we were at 108%. So we were underleveraged as a company. (For more on corporate cash, see “Sitting Comfortably on a Cash Cushion.”)
You went on quite an intense buying spree starting in December 2010.
Yes, that was my biggest challenge in my first year as CFO. We did five acquisitions in six months totaling about $550 million. That requires the kind of due diligence that has you working long hours to make sure you’re doing the right things.
Some businesses continue to say that credit is tight. Despite your cash-flow advantages, have you found that to be true?
That’s obviously critical for us as a leasing company — we want to have as much access as we can to various forms of financing. Typically, we issue medium-term notes. We go into the public markets and issue unsecured debt. And then, on a short-term basis, we have a revolving credit facility that backstops our commercial-paper program.
We’re a BBB+-rated company, which is what we think we need to be. Recently, we re-upped our revolver, a $900 million facility, and increased the amount a little bit. That’s pretty good compared with the last time we did it — in April 2009, in the depths of the crisis. The overall view is that credit is still clearly tight for small businesses. We think that’s actually a benefit for us. We’re in an environment where trucks cost a lot more, and it’s harder to get credit nowadays. Those are things that could lead companies to lease rather than buy.