Asset Financing Australia Report. Summer 2014/15

Asset Financing Australia Report. Summer 2014/15

Maximising return on investment. As more businesses seek to source equipment solutions overseas, we look at the trends and attitudes driving the increase in asset finance growth. Welcome to the latest edition of the Commonwealth Bank Asset Financing Australia Report (AFA). The AFA provides a unique insight into the critical issues and key trends shaping the equipment finance market, based on a wide-ranging quantitative survey and qualitative feedback from selected industry experts. In this report, we continue to work with East & Partners through an in-depth survey of 861 business decision-makers, gathering their views on the state of the market and the factors most likely to influence equipment financing and leasing decisions in the future. While low-rate markets continue to provide great investment opportunities, business owners are carefully analysing their business and purchasing decisions, to ensure they can maximise their return on investment. Our research revealed that while some businesses are confidently investing in innovative and efficient new equipment, others are stretching out the life of the equipment they already have potentially missing out on future productivity gains. For those looking to upgrade, the tendency to buy offshore is continuing to grow especially where it can deliver benefits that can t be matched by local providers. In this report, we showcase one of our clients in the Central West of New South Wales, to learn how their decision to import from Ireland instead of opting for the local solutions has helped them take advantage of new business opportunities. We also welcome CommBank economist Diana Mousina to this edition, as she shares her insights on the current market and discusses whether businesses should consider locking in their Asset Finance facilities now. With more talk in the markets of future rate rises, the next few quarters may be critical for businesses facing these decisions. Enjoy this edition! Bronwyn Yam Managing Director, Asset Finance Commonwealth Bank

Contents Economic update 4 New equipment spending set to rise 6 Businesses continue to look offshore 8

Economic update. The Australian economy expanded by 2.7 per cent in 2013-14, a result just below average, but this should be seen as a decent outcome for an economy in transition. The main uncertainty clouding the economic outlook relates to the transition from mining to non-mining led growth. Solid growth in residential construction and resource exports is on track. But non-mining business capex growth needs to be stronger. The uncertainty in the non-mining economy is in line with the findings from the previous Commonwealth Bank Asset Financing Australia (AFA) report. Interest rates are at record lows, which should normally encourage a pickup in investment. However, numerous industries in the non-mining economy are showing below-average business confidence stretching out the working life of existing equipment, rather than expanding their assets. Businesses appear to be waiting for a substantial increase in consumer demand and income growth before they commit to increasing new investment spending. In our view, the anticipated positive turn in the economy will start to show itself more clearly as growth picks up over 2015. The boom in residential construction has positive flow-on effects to other sectors, including retail. Meanwhile the labour-intensive nature of residential construction should spur jobs growth lowering unemployment and supporting consumer spending. The depreciation in the Australian dollar is very positive for export-exposed industries. And a surge in resourcerelated exports will lift incomes. The Commonwealth Bank is also forecasting inflation to edge higher, towards the top end of the Reserve Bank of Australia s (RBA s) target band over 2015. These outcomes are consistent with a period of stability in interest rates for the near-term. Looking ahead, we expect that an improvement in growth outcomes and rising inflation over the year ahead will allow the Reserve Bank of Australia to start normalising monetary policy again in late 2015. Diana Mousina Associate Director Economics Commonwealth Bank 4 Asset Financing Australia Report

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New equipment spending set to rise. Key findings Many businesses are forecasting large increases in their asset finance balances this financial year. Mid-size businesses are amongst the most bullish, along with businesses in the Personal Services, Transport & Storage and Property & Business Services sectors. Asset lifetime benchmarks have fallen since the start of the year, with larger businesses keeping their assets for the shortest time. Asset finance balances set to rise Businesses look set to increase their equipment spending, with asset finance balances predicted to increase by up to 16.6 per cent leading into June 2015. Mid-sized businesses were the most bullish of the businesses surveyed, with those with a turnover of $150 500 million forecasting an increase in asset finance of 18.8 per cent. This group was also the most sensitive to the current low interest rate environment, comprising 38 per cent of those who cite low rates as the reason for considering new or replacement assets. Across the industry sectors, Personal Services, Transport & Storage and Property & Business Services predicted the highest increases in asset finance balances. Meanwhile, Manufacturing was the most sluggish of the sectors, forecasting a relatively small 7.3 per cent increase. In September, research showed that 31 per cent of businesses surveyed were either in the market financing new equipment right now, seeking quotes now or seeking financing quotes within 90 days. Big business expands as manufacturing lags The AFA survey asked businesses to define the asset finance phase they were in: Expansion looking to increase or upgrade equipment. Replacement keeping the business stable by replacing equipment as needed. Extension stretching out the working life of their assets to reduce equipment costs. Reduction where they were reducing their asset finance needs. Businesses turning over more than $500 million made up the majority (41 per cent) of those in the expansion phase. Meanwhile medium-sized businesses were split between the expansion and replacement phases, at 37 per cent and 39 per cent respectively. In terms of industry sector, Mining and Agriculture, Forestry & Fishing were the most expansionary sectors. But Manufacturing lagged, with this sector making up the most businesses that were reducing or stretching out the life of their assets. Buy or hold? While the picture is uneven, the overall feeling is one of expansion, with asset lifetime benchmarks falling from 4.6 years in the first part of 2014, to 4.4 years by September. Larger businesses work their assets for the shortest period 3.1 years compared with 5.7 years for those turning over between $25 and $150 million per year. When considering purchasing new equipment, Bronwyn Yam, Managing Director Asset Finance Commonwealth Bank, says that businesses need to really consider the opportunities at hand. We hear two different angles of feedback from our clients. Some definitely have the need to upgrade their vehicles and equipment but are stretching out the service life beyond what they normally would. Others are taking advantage of the current low fixed rate environment and are upgrading to the latest models. It can be tempting to hold onto older equipment, and some machinery does have a longer effective life. Businesses should also consider the increase in maintenance and servicing costs, as well as the potential downtime that comes from extending the life of equipment. On the other hand, they should also think about the productivity increases that new equipment can bring to their enterprise. It s not just about the cost of the equipment or the financing costs it s about how hard the machinery can work in the business to generate income. 6 Asset Financing Australia Report

While most businesses are optimistic about the future, others face difficult decisions about whether to upgrade to new equipment, or extend the life of the equipment they already have. Asset Financing Australia Report 7

Businesses continue to look offshore. Key findings w Over the past two years, more businesses have been inclined to look offshore when sourcing equipment and plants. w Larger businesses are much more likely to consider offshore procurement. w Although the value of the Australian dollar has decreased over the past quarter, it continues to grow as a factor in the decision to source equipment from overseas, as businesses seek to tap into the greater availability and variety of offshore solutions. Overseas demand continues to rise As highlighted in our previous report, the latest AFA research showed an ongoing change in sourcing patterns over the past two years, with a growing tendency for businesses to look offshore. This trend was particularly noticeable among larger businesses. For example, in December 2012, 84.1 per cent of plant and equipment were being sourced locally, with just 15.9 per cent directly imported. However, the most recent results from September 2014, show a marked increase in overseas sourcing to 21.7 per cent. Bigger businesses lead offshore trend Larger businesses were also much more inclined to import their plant than smaller ones, a consistent theme running through the research. The June 2014 results showed that in the segment of businesses with annual turnover of $25 100 million, the split was 80 per cent domestically sourced, and 20 per cent imported. On a scale of 1 to 5, where 1 rates the AUD factor as high and 5 as low, the AUD importance rating was at 1.58 in December 2012, and had increased to 1.32 by June 2014. However, when the AFA research began in December 2012, the dollar was at parity with the USD and even beyond but the preference was still for local sourcing. By June 2014, the AUD had fallen to around US90 cents, yet the tendency for importing had increased significantly. While this might be counterintuitive, it should be remembered that the AUD is still travelling well above its average levels over recent decades. Perhaps, over time, businesses that had not considered importing equipment before have changed their view of the potential benefits of looking offshore. Even with the dollar at June 2014 levels, importing is clearly more attractive for many businesses than it was in the past. With the currency forecast to fall further in 2015, all eyes will be watching the research to see if the trend in offshore procurement will continue. Offshore sourcing in action One Australian company that has taken advantage of offshore procurement is Dubbo Sands, a sand processing company in the Central West of New South Wales. Dubbo Sands needed a new wash plant to expand its sand production capacity. By looking offshore they found an ideal solution that s helped them set up the business for the future. For businesses with turnover of $500 million or more, the split was closer to 75 per cent domestic, 25 per cent imported. Australian dollar a driving factor? So what is driving this? The immediate response is to say the value of the Australian dollar (AUD), a view that s supported by the research results. The AFA survey asked businesses to rank the importance of the AUD on sourcing decisions. It found that over the period 2012 to 2014, it has progressively increased as a driving factor. 8 Asset Financing Australia Report

Despite recent falls, the Australian dollar remains strong, prompting local businesses to look offshore to procure plant and equipment with big business leading the trend. Asset Financing Australia Report 9

Businesses continue to look offshore Continued. The challenge Dubbo Sands started in 2003 and as business owner Mardi Colbran puts it had cobbled together a plant, largely using locally sourced, second-hand equipment. As the only sand producing quarry within a 400-kilometre radius, Dubbo Sands products are in great demand in the local building and construction industry. While the current plant was producing enough sand for existing capacity, under the conditions of a new Environmental Impact Statement, the company would soon be able to increase production. The business was ready to expand but the old girl as Colbran calls the original wash plant just couldn t keep up. We were making as much as we were allowed to sell and the plant couldn t make any more, she says. Dubbo Sands faced a dilemma; it could source and assemble the parts of a new plant from different suppliers, as it had done originally, or it could look at an integrated all-in-one plant, produced offshore, by Terex Washing Systems in Ireland. Not that the process was without its teething issues; the plant arrived in eight containers to Sydney, but customs officers held back one of the eight for further inspection. As luck would have it, this was the container with all the nuts and bolts, which meant that plant assembly had to be delayed. The result Now up and running, the wash plant can process more than 200 tonnes of sand and gravel an hour, producing a range of aggregates and concrete sands. Dubbo Sands is now well set up for the next decade, and to take advantage of the expanded business opportunities. There have been huge gains in productivity already, with improvements in handling process doubling our capacity, says Colbran. The type of plant and equipment we needed the whole kit and caboodle just wasn t available in Australia. We had to look offshore and I think we made the right decision. The strategy At Dubbo Sands, Colbran and her husband and business partner Graham, crunched the numbers, including the foreign exchange (FX) component. They realised that not only would it be cheaper to buy the TWS system, but there were other advantages too. If we d gone to different suppliers and used different people, who were we going to go to for service if there were issues? she asks. There were so many variables in doing it locally, and the alternative was a complete product which can be moved, and in fact can be sold as one if we need to do that. This way, if it s not working, we can go to Terex and say fix it!. And the reality is, if we d put all the bits and pieces together ourselves, it would have been more expensive. For Terex, the sale represented their first outside Ireland, helping to open up a potential international market. So to do a deal was in the interest of both buyer and seller. 10 Asset Financing Australia Report

Like many Australian businesses, Dubbo Sands looked offshore to source its plant and equipment. Asset Financing Australia Report 11

For more information on how the Commonwealth Bank Broker & Agency team can help you meet your client s Asset Financing requirements, contact your State BAS BDM. About the Asset Financing Australia Report The Commonwealth Bank has commissioned East and Partners to conduct research and provide insights for this edition of the Asset Financing Australia Report. East & Partners established research methodology has resulted in findings which are statically robust and reflective of actual market experiences. Data is based on direct interviews conducted in July and September 2014 with a structured national sample of 861 businesses with annual turnover in excess of A$25 million. The sample has been structured to directly mirror natural distribution of these businesses by turnover segment, geography and industry. In building the sample frame, the relevant enterprise population demographic distributions reported by the Australian Bureau of Statistics are used, with actual interviewee targets being randomly selected. The sole section criteria used in addition to this natural framing was that the target business had to be actively engaging in asset or equipment financing. About East & Partners East & Partners Pty Ltd, a leading specialist market research firm in the business, corporate and investment banking markets of Asia Pacific, works across 11 countries in the region delivering both multi-client and proprietary market analysis services to financial services providers. More Information For more information on how CommBank can meet your Asset Financing requirements, contact your Relationship Manager or contact our Asset Finance Team on 1800 ASSETS. This report is published solely for information purposes. As this report has been prepared without considering your objectives, financial situation or needs, you should before acting on the information in this report, consider its appropriateness to your circumstances and if necessary seek the appropriate professional advice. The information in this report and any opinions, conclusions or recommendations are reasonably held or made, based on the information available at the time of its compilation, but no representation or warranty, either expressed or implied, is made or provided as to the accuracy, reliability or completeness of any statement made in this report. Commonwealth Bank of Australia ABN 48 123 123 124. AFSL and Australian credit license 234945. CBA3632 251114