HEES - Herc Holdings: Still Appealing Even Though Shares Are Underperforming

2023-09-09 11:49:26 ET

Summary

• Herc Holdings has seen strong financial performance driven by good management decisions and a strong economy.
• Revenue and net income have increased significantly, and the company's profitability metrics have improved.
• Despite the market's failure to fully appreciate the company's success, it presents a good opportunity for bullish investors.

I find it amazing how long the market can misunderstand a company before finally coming to terms with how attractive said company is. The firm that I am speaking about right now is Herc Holdings ( HRI ), a business that generates most of its revenue from renting out equipment to companies and individuals who need it. Financial performance achieved by the firm over the past couple of years now has been incredibly robust. This has been driven by good decisions from management, as well as by a strong economy. Supply chain issues and inflationary pressures that resulted also proved bullish for this space. And that strength has continued into the present day. Shares of the company also look cheap on an absolute basis, while being reasonably priced compared to similar firms. And yet, the market has really failed to fully appreciate how well this enterprise is doing. Although this might be a letdown for those who have invested in the firm, it does mean that those who are bullish regarding the company have plenty of opportunity to build up a position in it.

Growth continues to impress

It has been well over a year since I last wrote about Herc Holdings. In my last article on the company, published in April of 2022, I found myself taking a bullish stance. Strong growth on both the top and bottom lines, as well as attractively priced shares, led me to keep the company rated a ‘buy’. This is a rating that I assign for companies that I believe should outperform the broader market for the foreseeable future. Well, over the past year or so, things have not gone as I would have anticipated. While the S&P 500 is up 5.3% over that time, shares of Herc Holdings have generated upside for investors of only 1%.

Before we get into the more recent data, it would be helpful to show just how strong 2022 was for the enterprise. Revenue for that time came in at $2.74 billion. That represents an increase of 32.1% over the $2.07 billion management reported one year earlier. The largest chunk of this sales increase came from equipment rental activities. But the firm did see revenue rise across the board. The sale of rental equipment, for instance, reported a revenue increase of 11.1%. Sales of new equipment, parts, and supplies, jumped 18.9%, while service and other revenue activities shot up 32.3%. The increase in equipment rental revenue, it should be said, was driven by higher volume on equipment that was being rented of 31.8%. This came about even as pricing helped the company to the tune of 5.8%. This makes all the sense in the world to me. During times of supply chain issues and rising prices, it becomes even more appealing and, sometimes even necessary, to rent as opposed to own.

As you can imagine, this sales increase worked wonders on the company's bottom line. Net income, for instance, shot up from $224.1 million to $329.9 million. Other profitability metrics followed a similar trajectory. Operating cash flow, as an example, expanded from $744 million to $916.7 million. Even if we adjust for changes in working capital, we saw an increase from $806.9 million to $1.10 billion. And finally, EBITDA for the enterprise grew from $894.7 million to $1.23 billion.

This year is looking to be a bit different, economically speaking, compared to what last year looked like. There are concerns over the economy slowing and supply chain issues are nowhere near as bad as they were last year. Even so, management has been successful in growing the company at a rather rapid pace. Revenue in the first half of 2023 , for instance, totaled $1.54 billion. That is 27.6% above the $1.21 billion reported one year earlier. This jump in sales, according to management, was driven largely by two primary revenue streams. The largest chunk, totaling $224 million of the increase, came from equipment rental revenue. This rise, about 20% year over year, was driven by higher volume of equipment that was rented to the tune of 20% and pricing growth of 7.4%.

Perhaps even more impressive, however, was the $107 million sales increase driven by the sale of rental equipment. This is a 228% surge year over year and it was driven by higher sales of equipment in line with the company's goal to continue rotating its plate in order to improve equipment mix and to manage the age of its fleet. This is also not surprising to me. Selling off older equipment is logical and adjusting inventory to better meet the needs of customers makes sense. And with prices still high, the firm can get top dollar for the equipment that it did sell off. For instance, the margin on sales of rental equipment totaled 34% for the first half of this year. That's up from the 30% seen last year.

Unsurprisingly, the growth in revenue brought with it, once again, higher profitability. Net income jumped from $131 million in the first half of 2022 to $143 million the same time this year. Would have been better had it not been for rising interest expense. This more than doubled from $48 million to $102 million. Given the high interest rate environment that were dealing with, this is also not surprising. And while I am not overly concerned about it, investors would be wise to continue paying attention to what goes on with debt and interest. Other profitability metrics, meanwhile, followed a similar trajectory. Operating cash flow went from $359 million to $516 million. If we adjust for changes in working capital, we would get an increase from $487 million to $552 million. Meanwhile, EBITDA popped from $521 million to $660 million.

For those worried about what the rest of the current fiscal year might look like, I would say that these concerns might be overblown. While it's possible that the economy could change at a moment’s notice, management believes that the rest of this year will end up being rather solid. They forecasted , for instance, EBITDA of between $1.45 billion and $1.55 billion. At the midpoint, that would be 22.2% higher than what the company achieved in 2022. No guidance was given when it came to other profitability metrics. But if we annualize those, we would get net income of $403.2 million and adjusted operating cash flow of $1.34 billion.

With these figures, I was able to value the company. In the chart above, you can see how shares are priced on a forward basis. You can also see how the company is priced relative to the results achieved in 2022. The price to cash flow and the EV to EBITDA multiples for the business are particularly appealing. But it's important to note that there are other prospects that are similarly priced out there today. In the table below, you can see Herc Holdings compared to three similar enterprises. Using our forward estimates, I found that one of the three companies ended up being cheaper than Herc Holdings when it comes to both the price to earnings multiple and the price to operating cash flow multiple. Using the EV to EBITDA approach, our target was tied with one other as being the cheapest. The picture barely changes when we use the 2022 figures. The price to operating cash flow approach results in, once again, only one of the three companies being cheaper than Herc Holdings. For the price to earnings approach, that number increases to two, while for the EV to EBITDA approach, it rises to one.

Takeaway

At this moment, I have no serious reservations regarding Herc Holdings. The company continues to grow at a nice clip. That includes this year. Cash flows are robust and management maintains that the rest of this year will be rather solid. Management is doing a good job of managing its inventory and shares are trading on the cheap on an absolute basis, while being perhaps closer to fairly valued relative to similar enterprises. Given all of these factors combined, I have no problem keeping Herc Holdings rated a ‘buy’ at this time.

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