Asset or liability?

The coming year sees operators facing a number of challenges. Higher interest rates, increased fuel costs, long lead times on new vehicles and a scarcity of property are all front of mind. Perhaps it’s time to think again about the most appropriate financial strategy to meet these challenges.

Back in the 1980s there was a big move away from outright ownership towards leasing or off-balance sheet finance such as contract hire. Today, many companies have adopted some measure of off-balance sheet finance.

However, warns Andrew Galliers, director of accountancy firm Menzies: “There is effectively a potential time-bomb underway for those who have chosen not to buy assets outright on day one.

“With interest rates rising, the chances of businesses being able to renew fleets on rates similar to those they already pay are slim. This will drive up the costs of the services they provide, which will need to be passed on – and margins in the sector are already extremely tight.”

Galliers also points out that there are proposals out there for the UK accounting standard to move towards international standards around the treatment of leases. “Currently in the UK these are ‘off book’, but the proposal is that these are brought into the accounts by way of recognising an asset and corresponding liability,” he says.

We have looked at the accounts of the Motor Transport Top 100 companies to get an indication of their approach to ownership of assets and the impact on their financial performance.

Last year, freehold accounted for 19% of all new warehouse deals, according to Kevin Mofid, head of EMEA industrial and logistics research at Savills: “Historically (pre 2015) freehold accounted for around 25% of all new warehouse deals but it has been trending downward since 2016. In 2021 it was 13%, 2022 is back up to 19%, but that is still down on historical norms.”

However, he adds: “In terms of who likes to freehold, it tends, in the most part, to be either budget retailers or manufacturing companies.”

Andrew Galliers of Menzies adds: “For property, our client base has been caught up in a very strange market. Demand for space (warehouses) skyrocketed in the lead-up to Brexit, and while this has calmed somewhat, there are still above pre-Brexit demand levels being seen as the impact of Covid and global shipping networks return to normal.

“In terms of owning these spaces, where clients can, they are snapping up opportunities. Outside of that, those clients with spare capacity are tweaking their operating models and now providing rental properties in their own right, or a storage/handling/shipping service to meet the extra demand.”

Mofid expects the proportion of freehold deals to continue to fall. “In the most part this is due to the fact that much of the deliverable land bank is in the control of the warehouse developers who prefer to lease space,” he says. “Moreover, there is a good reason for this from an occupier’s perspective, as the constraints of the planning system mean that it is becoming harder and harder to achieve planning permission on new sites.

“It is a fundamentally risky and expensive process with no guarantee of success. For many occupiers, it is important to take a new site and be operational quickly, which is why over 80% of the deals are leased.”

For this analysis we have used three metrics: the ratio of capital employed to turnover (CETR), return on capital employed (ROCE), and operating profit margin.

The CETR is the ratio of sales to capital employed and gives an indication of whether a company is investing its own capital in equipment and property or using off-balance sheet finance. The Top 100 have an average CETR of 3.7. The higher the ratio, the more asset-light the business.

ROCE gives an indication of the return that investors are getting for the money they have invested in the business. The average ROCE for the Top 100 is 18.9%.

Operating profit margin gives an indication of the profitability of the operations as it excludes factors such as interest payments and tax. The average operating profit margin for the Top 100 is 5.7%.

The chart, not surprisingly, shows that the more assetlight operators tend to have a better ROCE than those that rely on outright ownership. What is perhaps ➜ 18