URI - United Rentals: How It Unlocks Value For Its Customers

2023-05-23 18:05:06 ET

Summary

• In the highly competitive construction industry, few companies help builders unlock as much value as United Rentals helps them.
• With lower capital requirements, construction companies are able to reduce debt levels, reduce interest expenses, and return more capital to shareholders.
• United Rentals has been one of the strongest-performing stocks in the market over the past decade having increased by 512%!
• Over the past 12 months, United Rentals has deployed $1.05B on share buybacks.

Introduction

In the highly competitive construction industry, few companies help builders unlock as much value as United Rentals ( URI ) helps them to. How so?

Whereas in the past construction companies had to invest vast sums of capital into depreciating machinery they only used for part of the year, now they can offload that burden to companies like United Rentals who then loan them the machines for a fraction of the cost.

Headquartered in Stamford, Connecticut, United Rentals is the largest equipment rental company worldwide with operations spanning North America all the way to New Zealand. They serve many different industries including the aforementioned construction industry as well industrials, utilities, and municipalities. The company lends expensive equipment like forklifts, compressors, and aerial work platforms.

And while you may not presume it to be the case, despite the simple business model, United Rentals has been one of the strongest-performing stocks in the market over the past decade having increased by 512%!

Within this article, I’ll discuss what I believe makes United Rentals such a great business, I’ll also dive into their financials, and business performance, and I'll discuss where I believe shares could go from here.

A Phenomenal Business Model

But first, let's back up a bit to help you understand what makes United Rental’s offering so attractive to its customers.

Let me share a hypothetical example…

Imagine you own a construction company and you need a forklift. Because of the timing of the projects you are on, you only need the forklift for the first 6 months of the year. In the past, you had to buy the forklift up front and the forklift was likely to just sit in storage for half the year. In today’s world, United Rentals, and companies like it, are able to provide them with that forklift for just the 6 months that they need it and they no longer need to worry about selling it when the projects dry up. In other words, they can reduce CapEx.

With lower capital requirements, companies are able to reduce overall debt levels, minimize interest payable, and, if they chose to, return capital to shareholders.

And while this is a great arrangement for their customers, it’s also great for United Rentals because they are able to focus exclusively on managing/financing those assets. And then, in exchange for that service, URI charges its customers a small premium.

Sound Familiar? It Should!

Well for those familiar with a basic grasp of commercial real estate it should!

In the past, it was commonplace for retail store operators and small business owners to own their own store/office. To do so required large amounts of upfront capital, and knowledge of the local real estate market.

Now, sale-leaseback transactions are commonplace as they allow business owners to free up that capital once again. Realty Income ( O ) is one such company that specializes in these deals... it's clearly worked out well for them too.

Perhaps, Real Estate is not your thing, well the business model works in other industries too, for example, it's the basis of enterprise software. Tech companies are able to build a product that solves problems for multiple customers who no longer need to invest in building their own solutions. All benefit.

For example, Unity ( U ) and Unreal have built video game engines that enable developers to use pre-existing software instead of requiring them to develop their own from the ground up. This greatly reduces the costs involved with creating a new video game.

Operating Leverage

While equipment ownership is inherently capital-intensive United Rentals has proven it can still be scalable. As United Rentals grows and takes more share, it’s able to lend the same equipment to a wider number of customers, which gives them stronger negotiating leverage with manufacturers, which increases operational efficiency and reduces overhead costs.

It's because of that scalable business model, that despite the cyclical industry in which it operates, United Rentals has continued to increase its margins over time. Sure, they take a hit when construction slows, but due to their scale, they are able to scale as soon as the economy picks up steam once again.

And while a 27% operating margin is impressive, its gross margins are actually even more impressive at 42%. Caterpillar ( CAT ) and Deere ( DE ), two of the largest equipment manufacturers, trail United Rental's gross margin by 10%.

Capital Allocation

One area where I think United Rentals has room to improve in the future is its returns on invested capital.

In the past, ROIC has been highly variable, driven by cyclical economic cycles. But over the past few years, ROIC has been creeping upward despite a highly uncertain macro environment, this suggests to me that operational efficiencies are allowing the company to do more with less as the business scales.

Part of these lower returns on invested capital may have something to do with their buyback policy. Over the past 12 months, United Rentals has deployed $1.05B on buybacks alone. As an investor, I like to see management rewarding shareholders, but I can't help but wonder whether there might be more room to spend to grow the core business, either organically, or through horizontal M&A.

Debt Load

One potential cause for concern to investors is the company's growing reliance on debt. In years past, interest rates had become so low, that one could argue taking on more debt was a no-brainer.

But that world is now long gone, with much of the US treasury yield curve now at north of 5%.

As an equipment owner, United Rentals frees up capital for its customers, but United Rental itself must invest capital to buy those products which leaves them exposed to risks from higher interest rates. As old debt matures, URI may need to take out new loans which may come at a higher interest rate and eat away at net income.

Conclusion

United Rentals, Inc. has emerged as a leader in the construction industry through its innovative equipment rental model. By providing cost-effective rentals, the company offers flexibility and capital optimization for its customers. United Rentals' strong financial performance and operational efficiencies have contributed to its impressive stock growth.

While there are areas for potential improvements, such as returns on invested capital and debt management, the company's global presence and adaptability position it for continued success in the equipment rental market.

Based on analyst expectations for future earnings, shares trade at an 8.8x multiple which works out to an earnings yield of 11.4%. If the economy rapidly decelerates then those earnings may not materialize but given its growth and scalable business model, the company appears to have a decent risk-reward trade-off.

In short, I rate United Rentals a Buy.

Thank You

Dear reader, thank you for taking a small part out of your day to read my article, I hope you gained something from having read it. If you'd like to discuss anything mentioned above, please feel free to chime off in the comments below. Have an amazing day.

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