As we mentioned in a previous write up on Amerco, lower used truck resale values have been a key short thesis. As we pointed out:

The bear case is that truck resale gains have been a large driver of earnings growth over the last few years, with gains of 33.5mm in 2014, $74mm in 2015, and $98mm in 2016. These gains came with used truck pricing increasing and Amerco turning over a larger percentage of their fleet per year. This, the shorts assert, combined with lower margins due to higher new truck pricing, will continue to cause Amerco to miss EPS estimates over the new few quarters.

Ironically, most fund managers we have spoken to have not been able to state the resale value of these trucks, where the main auctions/sales take place, or have any visibility into real pricing trends besides regurgitating that they are “trending lower”. Many say that they follow the similar pricing outlooks as used cars, tractors, and railcars. We disagree on that point. While used truck prices COULD continue to fall, they have a very different supply/demand curve than cars, tractors, and railcars.

Used tractors/machinery have their own unique economics. In 2010, the IRS amended Section 179, allowing for a one year deduction of up to $500,000 of tangible personal property (including agricultural machinery):

You can elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year you place the property in service. This is the section 179 deduction. You can elect the section 179 deduction instead of recovering the cost by taking depreciation deductions.

This incentivized farmers to purchase new machinery from companies such as Deere (DE), leading to a current oversupply in the used equipment market. Grant’s Interest Rate Observer has consistently pointed out that DE currently leases tractors to farmers on favorable terms, thus holding the residual value risk:

The total allowance for credit losses at October 31, 2016, 2015 and 2014 was $226 million, $198 million and $230 million, respectively. The allowance increased in 2016 compared to 2015 due to higher write-offs, and decreased in 2015 compared to 2014, due primarily to foreign currency translation.

The carrying value of equipment on operating leases is affected by the estimated fair values of the equipment at the end of the lease (residual values). Upon termination of the lease, the equipment is either purchased by the lessee or sold to a third party, in which case the company may record a gain or a loss for the difference between the estimated residual value and the sales price. The residual values are dependent on current economic conditions and are reviewed when events or circumstances necessitate an evaluation. Changes in residual value assumptions would affect the amount of depreciation expense and the amount of investment in equipment on operating leases.

The total operating lease residual values at October 31, 2016, 2015 and 2014 were $4,347 million, $3,603 million and $2,786 million, respectively. The changes in 2016 and 2015 were due primarily to the increasing levels of operating leases. [1]

de-leases

Deere Fin Co may have to impair some of this $5.9bn loan book even further if used equipment prices continue to edge lower.

Similarly, the railcar industry currently has a order backlog of roughly 75k cars (down from ~143k in late 2014). Much of this has to do with lower demand from the energy industry as demand collapsed with prices. Currently, an estimated 22% of the North American railcar fleet is idle (~350k railcars) and demand for tank cars (used by energy industry), could be lower for a long time into the future. Lease rates on crude tank cars have gone from ~$2k/month in 2014 to under $450/month today (and might never recover given transport is cheaper through pipelines). Obviously, these lower lease rates reflect lower resale values of used railcars as well.

Additionally, used car values have continued to fall due to the extension of cheap consumer credit over the last few years which allowed new car purchases to reach all-time highs. New car prices have increased by roughly 2.5% since 2009, and in 2016 new vehicle sales totaled 17.9mm, the highest on record:

Auto loan delinquencies are on the rise as used cars are no longer holding their value. According to a recent Grant’s Interest Rate Observer article, 31% of loans financing new-vehicle sales involved negative equity from a trade-in. Additionally, in 2016 30% of new vehicles purchased were leased, up from 13% in 2009. Many of these leased cars are coming for sale in 2017 and 2018, which will put pressure on both the used and new car market.

The truck (as in U-haul trucks, not pickup trucks) market is very different, with only a few large buyers such as U-haul. While U-haul prefers not to let its fleet age too much, it is able to somewhat control the supply market by aging its fleet slightly and slowing down new purchases. These types of trucks are not subject to the large inventory and order backlogs concerns of the railcar, car, and equipment markets.

Overall, to continue to generate alpha, many funds are going to have to dig deeper into data to help validate and confirm projections used in revenue models rather than simply guessing or talking to other street analysts. Simply hiring ex-investment banking analysts to rip through Ks and Qs like 1000 other value funds is not going to work as well going forward.

A good start for estimating used equipment prices is to use the resources show below:

Data Sources:

  • Machinery Pete - Machinery Pete allows subscribers to view auction price results on hundreds of thousands of pieces of equipment in the US and Canada for a subscription cost of $99.95/year.

  • Machinio - Machinio is a global search engine for finding used machinery and equipment. Machinio’s database contains more active machinery listings than any other website.

[1] https://www.sec.gov/Archives/edgar/data/315189/000104746916017244/a2230400z10-k.htm