MGRC - McGrath RentCorp: Bullish Amid Strong Demand For Modular Buildings

2023-10-28 06:02:53 ET

Summary

• McGrath RentCorp reported its Q3 earnings, which beat estimates while management revised guidance higher.
• Strong demand for portable office buildings and temporary classrooms is helping the company gain market share.
• We are bullish on the stock as a high-quality small-cap with a positive long-term outlook.

McGrath RentCorp (MGRC) just reported its latest quarterly results, highlighted by an impressive earnings beat and positive guidance by management. Shares rallied on the report and we expect more upside ahead.

McGrath stands out for its relatively unique business-to-business rental model focusing on modular buildings beyond a separate unit for related industrial equipment leasing. Turns out the demand for portable office buildings, temporary classrooms, and even pop-up retail sites has been very strong.

The idea here connects with what remains a challenging real estate market making these types of module solutions a compelling alternative for many applications. We like the stock which is supported by overall solid fundamentals and what we view as long-term growth tailwinds. MGRC is well-positioned to climb through 2024.

MGRC Q3 Earnings Recap

MGRC Q3 EPS of $1.65 came in $0.48 ahead of the consensus, and up 32% from $1.25 in the period last year. Total revenue of $244 million, climbed by 21% year-over-year, and was also above estimates. Approximately half of the growth is attributed to the impact of acquisitions made earlier this year including "Vesta Modular" which closed back in Q1. Nevertheless, the understanding is that the underlying trends are positive.

Within that top-line figure, the core rental business saw revenues increase by 22% from Q3 2022, representing half of the total. That said, the bigger picture here is the ongoing shift in the mix with services up by 44% and "sales" up by 74% y/y gaining momentum.

This is important as these segments support higher profitability . The firm-wide adjusted EBITDA margin reached 39% compared to 37% last year. Overall adjusted EBITDA climbed by 47% to $95.3 million.

We mentioned the mobile modular segment of McGrath which now accounts for 80% of the total business including the addition of Vesta. Comments by management suggest "robust" growth across commercial and education customer end markets.

There is also an impact here from pricing initiatives with revenue per unit shipped, up 13% on a trailing twelve-month basis. Performance indicators here include a higher average monthly rental yield and rental rate over 2022.

We can also bring up the smaller electronic test equipment segment covering specialized communications and network devices through the " TRS RenTelco " brand. In this case, rental revenues are down by 10% y/y but balanced by stronger sales where they disposed of previously leased products. The understanding is that while the group still contributes to positive earnings, McGrath is pivoting to focus resources more on the mobile modular portfolio.

In terms of guidance, the update here is a modest revision to the revenue and adjusted EBITDA by essentially narrowing to the forecast range with higher low-end estimates. The target for revenue is between $820 and $830 million compared to a prior midpoint forecast closer to $817.5 million.

McGrath now sees 2023 adjusted EBITDA trending towards $316 million as a midpoint estimate compared to $313 million previously. Drivers here include capturing financial synergies from the integration of Vesta.

MGRC is a Dividend Champion

McGrath ended Q3 with a net cash position of approximately $1.3 million. We view the balance sheet as a strong point in the company's investment profile.

Keep in mind that the company is a "dividend champion" recognized for 32 consecutive years of increasing the shareholder payout. The current yield of 1.9% considers the latest distribution of $0.47 although investors can look forward to an expected hike into Q1 2024. With the earnings momentum, we see room for a dividend increase in the 5% range consistent with the trend in recent years.

Notably, MGRC scores well within Seeking Alpha's dividend scorecard, earning an A- in safety, for its ability to continue paying out the current distribution along with a B+ in terms of the dividend growth rate relative to Industrial sector peers. We agree that MGRC is an overall solid dividend stock.

What's Next For MGRC?

A major theme for McGrath is its dynamic of capturing market share within the mobile modular business. The addition of Vesta which was previously a smaller competitor with a strong regional presence has allowed McGrath to expand its national footprint which provides both logistical synergies while also enhancing customer relationships. The sense is that there is some pricing power in the segment and the company has strengthened its competitive moat.

We mentioned the environment of strong demand for these types of rentals. A large part of that is connected to infrastructure construction projects that typically require temporary offices for administrative purposes. Here the Infrastructure and Jobs Act from 2021 is expected to add upwards of $550 billion in new spending over the next decade which is seen as mitigating near-term macro headwinds.

Management projected confidence in the trends into 2024 while also citing the education business where schools look to expand their classroom space with modular solutions. From the earnings conference call :

I feel very confident about how we're going to end this year. In looking at 2024, I would say that, based on what I just said, our - since our quote volumes are healthy, our commercial activity is steady. We are seeing just very high levels of funding for construction projects across the country. The Infrastructure and Jobs Act, has funded projects across all 50 states. We're seeing the benefit of that in road and bridge and airport and other government projects. And we expect this to be a tailwind well into next year and beyond.

Overall, we're looking at MGRC as an earnings growth story where the latest quarterly report was good enough to push higher expectations into next year and beyond. The market revising estimates higher should be positive for the stock.

In terms of valuation, we see MGRC as attractive trading at a forward P/E of 20x or just 10x on an EV-to-forward EBITDA basis. The biggest shift here is the refocused operating strategy that likely provides upside to margins by adding to the earnings potential.

Final Thoughts

We're bullish on MGRC as a high-quality small-cap that benefits from several positive market segment dynamics. With MGRC continuing a rally that has been in place since 2020, our call is that the trend should continue as the company continues to execute.

At the same time, it's worth covering some of the risks facing the stock and its outlook. While we believe there is a defensive aspect to the business that may even be counter-cyclical with modular solutions an affordable alternative compared to per-management construction options, it's clear McGrath remains exposed to broader economic conditions.

A deterioration of the economic outlook would likely impact demand and force a reassessment of the operating backdrop. Monitoring points over the next several quarters include performance metrics like rental utilization and revenue yields.

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