ASHTF - Ashtead Group: Improved Business Warrants A Higher Valuation

2023-03-08 15:27:36 ET

Summary

• Ashtead Group plc has increased its capex and revenue growth guidance for FY23 and FY24.
• Despite supply constraints, inflation, and a lack of skilled workers, Ashtead Group is still gaining market share and benefiting from increasing rental penetration.
• Ashtead Group plc's less cyclical nature, higher margins, and better cash flow profile make it a superior business today than in the past.

Overview

After a successful Q3 2023 , Ashtead Group plc ( ASHTY ) increased its capex and revenue growth guidance for FY23. Although an increase in both revenue and earnings was widely anticipated, the FY24 capex guide was quite surprising, which suggests a revenue run rate ahead of the standing consensus. This, in turn, I believe is likely to lead to upgrades to FY24 consensus earnings estimates. What I found most interesting and promising was management reaffirming their optimism regarding performance for the coming quarters. This gives me hope, because in prior quarters, despite the strong growth, I had doubts about the longevity of the growth. For FY24, it's encouraging to hear that a growing fleet, favorable interest rates, and contribution from M&A should all contribute to meeting or exceeding targets set for the year.

After reviewing the 3Q23 results, I am even more convinced than before that ASHTY is a superior business. I think ASHTY is less cyclical now and has higher margins and a better cash flow profile than it did in the past. In essence, it is easier to underwrite investing in ASHTY stock today than in the past. In particular, I think that the period of rapid growth for ASHTY has probably come to an end.

However, what is more significant is that the business is a lot lesser dependent on market cycles. I think ASHTY can sustain its growth in the current market while keeping its margins and returns healthy and expanding its free cash flow. Most importantly, I think ASHTY has shown much greater resilience than in previous downcycles, with improvements to the business model today. From a valuation perspective, an increased multiple is justified by the fact ASHTY's growth is now more predictable, its earnings are stronger, and it is less cyclical. That being said, I think ASHTY will keep on performing in FY24, and the market should re-rate the stock upwards as a result.

Strong U.S. Market

It's fantastic to hear that the 3Q call's strong performance has been consistent across all regions and service offerings. However, despite the favorable supply and demand ratio, supply constraints, inflation, and a lack of skilled workers are still issues. Perhaps most importantly, and this is related to the point I made earlier about a more effective business model in this market, ASHTY is still gaining market share.

What's most important to remember amidst all of this is that the market is undergoing fundamental changes, with rental penetration increasing to the benefit of a handful of dominant players like ASHTY. In my opinion, ASHTY should use this time to its advantage by streamlining its operations and consolidating as much market share as possible so that it will be better prepared to compete for market share when the economy improves. Regarding pricing, management anticipates that rate increases will continue throughout the industry in FY24.

As for U.S. construction, both the Dodge momentum index and the number of new construction projects are still at robust levels. Investors should take note that factors such as reshoring and federal spending acts have significantly uncoupled the non-residential cycle from the residential one. Management also remarked that future market demand would be robust because of the quantity of construction already known and forecasted. Because of this, I believe ASHTY will continue to benefit for quite some time.

New EQ Lead Time

The bad news is that the CAPEX guidance does not suggest increased equipment availability. Lead times are still extremely long, and the constraints are not easing. However, management did note that the larger and more astute players are securing a larger share of equipment by coordinating with the OEMs at an earlier stage.

FY23 & '24 Guide

U.S. rental revenue grew 27% in 3Q on the back of high utilization rates and rising rates for rental vehicles. Because of this, management has increased their growth forecast for rental revenue in FY23 from 20-23% to 23-25%, and they are confident that this positive trend will persist in the near future. Despite the dilutive effect of greenfield additions and ongoing M&A, 3Q saw a solid improvement in EBITDA, which is also encouraging. Management has stated their confidence in continued growth into FY24.

The new FY24 guidance of $4.0-4.4 billion in gross capex and guided rental revenue growth is significantly higher than what was previously expected by the market. I expect the stronger rental growth and high incremental margins to continue fueling ASHTY's upward earnings trend. Constraints on supply, inflation, and a lack of skilled workers should also continue to drive out smaller players and benefit large service providers like ASHTY.

Conclusion

3Q23 results for Ashtead Group plc have been impressive, with increased revenue growth guidance for FY23 and a surprising capex guide for FY24 that suggests a revenue run rate ahead of the consensus. Management's optimism regarding performance for the coming quarters is also encouraging. Importantly, ASHTY's less cyclical nature, higher margins, and better cash flow profile make it a superior business today than in the past.

Although the period of rapid growth may have come to an end for Ashtead Group plc, the company's increased predictability and resilience in downcycles justifies the current elevated valuation multiple (compared to the past). Overall, I believe that Ashtead Group plc's strong performance in the current market, along with its promising outlook for the future, makes it an attractive investment.

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