Q. What's the advantage of leasing equipment when you're backed by a corporation that can borrow working capital at interest rates well into the single-digit range?
A. "On some of these machines the initial purchase price has gotten really high, and we don't want to use all our capital on equipment," says Ron Rapp, equipment manager with Milestone Contractors. "When the cost to buy equipment and the cost of the lease are very close, we often lease because we can use our capital to greater effect in other areas of the company."
For example, the firm recently leased seven excavators.
"The cost difference between leasing and outright purchase was very, very close. Taking into account the accelerated depreciation that's available, purchasing was very close to an advantage," Rapp says. "Corporate was indifferent at the time because the analysis was so close, but here at the company level we opted to lease.
"We were considering some other places to use our capital," Rapp explains. "We're always looking at growing our business, usually by buying other construction companies."
Milestone was formed by its parent corporation, The Heritage Group, in the middle 1990s when five midwestern highway-and-heavy firms were merged. The firm's fleet size doubled during the period.
"We were pushing the fleets we had acquired to do considerably more work and, as we evaluated that equipment, we found much of it didn't meet our standards or fit with our fleet," says Rapp. "We had auctioned off a lot of less desirable equipment and needed to refit ourselves with some good newer-model equipment."
So, in 1997, Milestone leased 48 machines on five-year terms through Cat Financial. In 1998 they leased another 40 machines. Rental expenses dropped 40 percent.
Caterpillar caught Milestone's attention with some attractive lease rates at just the right time. The firm secured a much-needed infusion of fresh equipment without dipping into working capital. They needed both the horsepower and the capital to start up an unprecedented number of projects. Leases also greased the skids on dealer support that was becoming crucial.
"On the first lease with scrapers and dozers and compactors, we did half of the machines with service contracts and half without to compare their costs and ours," Rapp says. "We confirmed that we could maintain those machines at a lower cost. At the end of those lease periods we dropped the service contracts.
"But our numbers only beat theirs by just a little. We would consider service contracts in the future, depending on the capacity of our maintenance department and the size of the fleet."
Service contracts lightened the workload on Milestone's maintenance department at a peak in the construction cycle. The first leases reached term just as Milestone's pace began to slow. Rapp negotiated second leases on some machines, left off the service contracts, and was able to keep Milestone's maintenance people fully employed.
Choosing to lease some machines for the second part of their life, after the first lease term is complete, is an example of the option's flexibility.
"We look at how technology in the individual category of machinery has changed," Rapp says. "Excavators, for example, are not items we normally look to release—the technology keeps changing and we want machines that are at the leading edge of performance. Plus, excavators are one of our highest-utilized pieces, so they've usually been worked over pretty hard.
"On the other hand, on a tractor like a D8, the technology is not changing a lot, and they're very rebuildable. Those we release.
"The asphalt pavers we own, we try to keep going for a long time," Rapp says. "If we're leasing, though, there's enough change in fumes collection systems, grade controls, and electronics that we'd want to lease new ones."
The flexibility of a lease can improve the agility of the firm's business decisions. If, for example, earthmoving rates fall and the company decides there's not enough profit there to warrant such a large earthmoving fleet, Rapp can return leased earthmovers relatively easily and get Milestone out from under their cost. On the other hand, with the firm's commitment to asphalt, Rapp purchases its plant equipment and most of its paving spreads.
Milestone has taken full advantage of leasing's financial benefit—reserving capital for more profitable investment. The firm has also extracted leasing's key operational advantage—acquiring the use of a machine without committing to the cost for more than five years. And the firm has done it without raising equipment costs.
"Experience shows that operating costs are the same for a leased machine and one that we own," Rapp says. "The difference between the cost to lease and the cost to buy is determined completely by our cost of capital."