Equipment Financing & Leasing-market overview, emerging trends, challenges, and way forward

Devendra Kumar Vyas, CEO, Srei Equipment Finance Ltd

Mr. Devendra Kumar Vyas, CEO, Srei Equipment Finance Ltd

The Infrastructure sector is a key driver for the Indian economy and is largely responsible for propelling India’s overall development. The government is focused on initiating policies to ensure the creation of a world class infrastructure in India. From April 2000 to March 2017, according to the Department of Industrial Policy and Promotion (“DIPP”), Foreign Direct Investment (“FDI”) received in the infrastructure development sector stood at ₹1,580 billion. The government has fixed a higher fiscal deficit figure of 3.2% in Fiscal 2018, with a structural decline in primary deficit. This decline in primary deficit implies an improvement in the quality of expenditure anticipated by the government. Out of the total capital expenditure, the majority of the increased allocation is towards areas such as railways (increase by approximately 19% year on year), roads and highways (increase by approximately 24% year on year) and urban development (increase by approximately 5% year on year). This increase is expected to have a positive impact on the economy.

Srei Equipment Finance Ltd

All this bodes well for the Construction, Mining and Allied Equipment (CME) segment which is already riding the massive infrastructure push by the government. The CME sector experienced a period of de-growth from Fiscal 2013 until September 2015. The industry has witnessed a good revival in the last two financial years following the previous three year decline. The overall Indian CME industry grew by 32% in Fiscal 2017 compared to Fiscal 2016. The last quarter of Fiscal 2017 showed a good surge in overall equipment sales and the industry sales surpassed the volumes achieved during Fiscal 2012. This is largely attributed to the positive movement in select sectors such as national highway roads, irrigation and railways. These sectors have experienced a lot of drive from the government in the last two years. For example, in the national highways sector, key reforms introduced by the government have helped the sector move beyond what was anticipated.

Construction equipment finance caters to all types of earthmoving, concrete, material handling, road construction, material preparation, tunnelling and drilling, and warehousing equipment. As the segment requires large capital expenditure, financing accounts for approximately 80-85% of the total equipment purchased, and in the case of overseas purchases, it accounts for approximately 90%. Most financing is procured through loans while leasing is the second most common mode of financing. 80-85% of earthmoving construction equipment users who opt for finance are Micro, Small and Medium Enterprises (“MSMEs”). The total CME finance disbursement for Fiscal 2017 was estimated to be approximately ₹280 billion. Over the last five years disbursements to the sector have grown at a CAGR of 5.9%.

CME finance in India is offered mainly by NBFCs, banks and captive or private financiers. Among the NBFCs and Banks, NBFCs account for 59% of the overall CME finance market. The market share of NBFCs reduced from 70% in Fiscal 2013 to 59% in Fiscal 2017. Though the share of NBFCs have declined over the last few years, market leaders like Srei Equipment Finance Limited (“SEFL”) benefitted by increasing its presence in the industry. NBFCs, apart from regular financing for contractors and medium companies, are more active in segments like FTBs and FTUs for equipment such as backhoe loaders, excavators, and pick and carry cranes, which have been traditionally underserved by banks. During the cyclical stages of the CME finance industry, only SEFL has been able to retain the number one position in the CME finance segment and its revenue has grown at a CAGR of 7% in Fiscals 2014-2017. SEFL leads the construction equipment finance market with a market share of approximately 32.7% in Fiscal 2017.

In India, construction equipment leasing is still at a nascent stage accounting for 6-8% of the overall construction equipment market as of Fiscal 2017, whereas the global average for leasing is 50-60% of the overall construction equipment business. The penetration of leasing and equipment rental is fairly high globally. Compared to countries like the U.S., China and Japan, India’s leasing and rental business is still at a nascent stage. Unfavourable tax treatment of leasing in India has been a key reason for such condition. The introduction of GST is expected to clarify the ambiguity on the tax front. The market sets to become more organised. Another major advantage of GST will be the enhanced mobility of the asset. Interstate movement of such assets and re-deployment at multiple locations on multiple projects will be easier and thereby ensuring optimal utilisation of the asset over its economic life. Leasing, as a financial tool will be key for the infrastructure growth of the country.

Srei Equipment Finance Ltd
Another facet of CME financing in India is a highly unorganised market for used equipment is. In Fiscal 2017, the market for organised used equipment financing is estimated to be approximately 8%-10% of the overall disbursements by finance companies in the CME segment. This figure does not account for cash transactions and the market catered for by private financiers (which are mostly unorganised). In Fiscal 2017, the current value of the organised used equipment financing accounts for roughly ₹25-30 billion. The unorganised component or finance could account for an additional ₹10-15 billion. The market is dominated by products such as backhoe loaders, excavators, pick and carry cranes, accounting for more than 70% of the used equipment market. Companies have also engaged in the direct import of equipment from countries such as China and Japan. However, OEMs have urged the government to regulate the import of used equipment. Growth opportunities for the used equipment include increasing awareness among customers on the value of ‘used equipment’ to reduce capital expenditure investments, online portal which helps facilitate used equipment business, technology intervention like telematics which helps in identifying the accurate working and operation conditions of the machine and financiers can come up with operating lease products in used CME with resale valuation framework developed by industry body and with good service support from the OEM/dealer.

The construction equipment finance industry is expected to grow at a CAGR of 19% for the next three years. The overall construction equipment industry is expected to reach 125,000 units by 2020 and the market for new equipment finance market will continue to have a share between 87-90% for the next three years. With the current announced projects, demand will continue for the earthmoving equipment industry, which will have a share between 68-70% of the overall CME finance market. Banks and NBFCs are expected to have an equal share in the CME finance industry for the next one to two years with the equipment leasing industry expected to grow at a CAGR of 26% for the next three years.

Major Trends in the Financing Industry

Going forward, revolutionary trends appear to be emerging in the equipment financing sector. These include:
  • Integrated offerings: Dealers and OEM’s are expected to offer customers integrated choice which will include the equipment finance (and could also cover the life cycle financing of the equipment).
  • Automation of process: Current equipment financing takes anywhere between 5-30 days before the machine is handed over to the customer. Equipment financing companies to need to move to the automation route, to sustain and survive in this technology-led market. A major differentiator could be transparency with a process to manage documentation, including, for example, EMI payments.
  • Platform-based offering: Currently, there are few companies which provide a platform for equipment owners and customers to interact and avail of equipment services. This is more like the “Uberisation” of the equipment industry. This could be a good opportunity for finance companies to participate and ensure that all finance needs are met.
  • Managed services: Customer demand for greater flexibility and convenience will augment the use of non-standard financing agreements. Shifts in customer preference for managed services (bundling equipment, services, supplies and software), pay-per-use leases and alternative financing will encourage equipment finance companies to find innovative ways to meet the demand.

Key Challenges of the CME Financing Industry

The construction equipment financing market in India is still in its development stage and continues to face various issues which act as a deterrent to growth including lack of access to finance, unfavourable regulations and higher NPAs among lenders.

Lack of access to finance - Most equipment manufacturers do not have captive financing arms and engage in short term tie ups with banks and NBFCs. FTBs are prone to high margin requirements (nearly 20-30%) and shorter payback periods.

Unfavourable regulations - Most finance users are MSMEs that depend on third party payments to make financing repayments which in turn leads to delay in collection and defaults. Further, most finance business comes from NBFCs who experience poor collection penetration due to lack of regulation. Further the depreciation allowable on the equipment is 15% which is low in comparison to the decreasing asset life-cycle caused by ongoing technological advances.

Lower rental penetration - Rental penetration in India was as low as 8% in Fiscal 2017. Used equipment and secondary sales are also unpopular in India because of lack of established trading platforms and buyback schemes from OEMs. The preference for ownership of assets also leads to lower penetration for rentals in India.

Repossession of the equipment in the case of customer defaults - Tracking of equipment movement is a challenge currently faced by the finance industry. Though initiatives have been taken by some OEMs such as Caterpillar, Volvo, Kobelco, Komatsu, tracking the retail customer segments like contractors and hirers which account for a substantial portion of the market, is a key challenge currently faced by CME financiers. Therefore, OEMs should share location information through their service channel and assist financiers in repossession, if required.

There is also a need for a proper registration process for all construction equipment (off-road equipment included) which will help to develop and sustain the organised used equipment market and assist with calculation of the residual value of equipment on resale.
NBM&CW February 2018
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