HRI - United Rentals: Secular Trends And Internal Growth Can Push Higher
2023-10-12 15:12:10 ET
Summary
- United Rentals is the market leader in equipment rental with a 17% market share.
- The company has shown consistent growth in revenue, EBIT, and EPS over the past 10 years.
- The favorable market conditions and strong financial performance make United Rentals a buy.
United Rentals, Inc. ( URI ) is the market leader in equipment rental with a 17% market share. This figure represents a position of certain privilege which is also supported by consolidated competitive advantages and a sufficiently strong balance sheet. 'Growth' is probably the term that best identifies the path undertaken by the company and the following article was based on this.
If it is true that Revenue, EBIT, and EPS have grown by double digits in the last 10 years, the challenge and also the main bet concerns URI's ability to maintain these ratios for the future. From this perspective, the main budget parameters were analyzed which underline (in addition to revenue growth rates) a good corporate ability to generate FCF and, overall, a great ability to invest in terms of Capex for the future. A high level of debt is a bit worrying but it has always been high over the last 10 years and this has not prevented growth.
The share price seems high and probably already incorporates high future growth rates but, if we assume that these can continue, the expected return on the investment seems adequate.
The greatest risk, in my opinion, is the outlook on market conditions which could be unrelated to macroeconomic factors as they concern secular trends that are already underway (such as the switch between property and rental) rather than those that are starting (such as investments in energy and electrification). Precisely for this last reason, it may be correct to hypothesize business continuity at the current ratios also in the next quarters.
Lastly, it is worth pointing out that the company began to distribute a small dividend in 2023 and that it has defined a program for the buyback of its shares. All this should create additional value for shareholders of as much as $1.4 billion.
The favorable market conditions and company ratios make me rate a Buy.
United Rentals at a Glance
United Rentals is the greatest equipment rental company in the world. It operates in the U.S. and Canada, but also (with a little presence) in Europe, Australia, and New Zealand.
URI can count on a very strong Brand Recognition which represents a competitive advantage capable of attracting new customers and retaining existing ones.
United Rentals operates in three major market sectors: industrial (48% in terms of sales); commercial construction (47%); residential construction and remodeling (5%).
One of the most interesting aspects of the company strategy of the last 2 years concerns the ability to cross-sell all services or products similar to the core product sold to the customer. This commercial flagship called "specialty business" together with all the onsite support tools allows URI to become the single reference for all needs. An example of this strategy is also highlighted by the acquisition of General Finance Corporation.
Another very important aspect concerns the long-term trend that pushes customers to move from ownership to rental. This macro-trend allows URI to strategically invest in new technologies, and infrastructures which in turn allows it to leverage the cross-selling discussed in the previous paragraph. Ultimately, the M&A strategy also fits very well with this context and is allowing the company to grow further in the reference markets.
The following figure shows the impressive data of URI. Beyond the financial aspects that will be discussed below, note the widespread presence in North America and the depth of product categories.
Favorable Market Conditions
Demand conditions at the moment point to a series of favorable developments which can be grouped into two macro areas of interest.
On the one hand, there are structural currents that have started or are starting: the electrification of vehicles requires a substantial change to the infrastructures both on the producer and user side but also the entire semiconductor industry (in great production growth) requires and will require more and more structural changes.
The US in recent years has also begun to modernize its infrastructure after decades of hiatus. If we look at the Infrastructure Investment and Jobs Act , investments of $500 billion or more have been foreseen over 5 years.
These currents only concern the medium term (5 years) while other aspects could favor development in the decades to come as represented in the tables below.
The other aspect of a less general nature but which characterizes a long-term trend is the growth of equipment rental which slowly but steadily (5.1% CAGR in 10 years) represents an element of sure interest for URI.
Financial and Highlights
Revenue and Marginality
if we exclude 2020 we can certainly say that in the last 10 years, the company has grown revenue constantly and more precisely by 10.3% [CAGR]. EBIT, on the other hand, has always been limited to a range of around 5 points and this underlines the great stability of the business in terms of operating margins. Even in the event of significant changes in revenue and the long term, we can affirm that URI can produce margins above 20% (in terms of EBIT).
2022 and 2023 also mark the maximum peak both in terms of revenue and EBIT (28.1%). This identifies particularly positive momentum for the company. Regarding revenue, the company has managed to grow a lot thanks also to an increase in demand as we can hear in the latest earnings call :
"Non-res construction was also up double-digits. Within this, our customers kicked-off new projects across the board, including numerous CV plants and semiconductor plants, solar power facilities, infrastructure projects and for the Buffalo Bill fans out there, a new stadium."
To the exogenous growth in demand must then be added the benefits of the acquisition of Ahern, the integration of which has yet to take place and whose properties will be able to be sold in the next quarters.
As regards margins, the last two years have seen an improvement of approximately 4 points and these are attributable for 3 points to an improvement in the gross margin and 1 point to operational efficiency linked to general expenses.
We can therefore define that growth as a mix of factors linked to demand but also to acquisitions and the margins were achieved following internal efficiency improvements.
Return on Capital & Capital Turnover
One of the most monitored parameters in the company is the Return of Capital and if we consider the capital employed in the company we can see how (yellow line) the trend is particularly growing in the last 3 years (from 2021). Previous years have seen a flat trend and therefore do not mark major changes in the management and optimization of the capital employed when referring to sales. Going into detail we can see that the improvement especially in 2023 is not only due to the growth of EBIT (blue line) but also to the growth of Capital Turnover (which measures how many sales are produced by $1 employed in the company).
It must be said that the value of this parameter has always been around 0.5 (every $1 invested in the company produces $0.5 in sales) and this does not imply a very efficient company in the use of capital (the value should be close to or higher than 1) but we must still report an improvement in 2023 where 0.6 was reached which is the maximum in the last 10 years. In fact, for the first time, a significant increase in sales has been recorded with the same capital employed and this is a good sign from a financial point of view.
Free Cash Flow & Capex
One of the best financial characteristics of URI is that of generating a very generous operating cash flow and the graph highlights this well (blue bars): the FCF/Share is consistent every year and follows the growing trend of the EPS. A discordant note is that of 2020 where even in a phase of EPS decline the company was able to generate an even higher FCF. That is, in countertrend. The reason for this phenomenon is to be found in Capex spending: in 2020, in fact, Capex practically dropped to zero and all operating cash was transformed into FCF. The blue bars exceed the gray ones in all years in which Capex spending has decreased and become lower when Capex increases (e.g. in 2022 and 2023).
Again excluding 2020 (the year of COVID-19), the graph shows a growing and constant trend and this is an excellent sign of health as regards FCF.
Moving on to analyze the Capex ratio on depreciation we can see how this has a particularly high value of even 7.74 in 2023. This implies a great spending capacity of the company in investments in the fleet. Even in this case excluding 2020, the trend is also growing for this parameter and this instead could be a sign of excessive spending, although it must be said that in a moment of strong demand, it is correct to hypothesize an increasing investment.
Debt
URI is certainly a heavily indebted company. The debt-to-asset ratio is constantly above the 50% level and this identifies a high risk at the debt level. It should also be noted that starting from 2019 the figure which stood at 65% began to drop to 50% in 2023. We are therefore witnessing a virtuous trend that aims to limit risk. The debt to FCF also had high values above 20 in 2013 and on average around 10. Even in this case, the data highlights a certain degree of risk. Interest to cover (which measures the company's ability to pay interest on debt) has exceeded the value of 5 since 2021 and this implies a positive figure.
In any case, despite high levels of debt, the company has demonstrated over a sufficiently long period (10 years) that it can increase revenue and margins. We can therefore deduce that such high debt levels do not affect the quality of the company in any way.
Price share evaluation
We've seen how the company has been able to produce consistently increasing EPS and FCF over the years. We have also seen how Capex plays a fundamental role in determining how much FCF is used in the company. Since these are high levels of Capex, I believe it is incorrect to use mathematical models such as EPV (Earnings present value) to estimate the intrinsic value. Since it is also a consolidated but rapidly growing company, I believe it is more appropriate to use a mathematical model that takes the growth factor into account predominantly.
EPS Growth Model
I decided to use the EPS growth parameter equal to 5% (conservative but realistic over a long period of 7 years).
The Formula is (by popular investor Benjamin Graham):
Intrinsic value per share = EPS x (8.5 + 2 g)
Where
EPS = earnings per share
g = EPS growth rate = 5%
Example of calculation for 2023:
Intrinsic value per share = EPS x (8.5 + 2 g) = 28.45x(8.5+2x5) = $526.33
The last intrinsic value of $705.33 for 2029 underlines an annualized return of 7,8% as the current share price is $448.8.
7.8% is the figure and is the annualized expected return for my investment in URI.
Peer Comparison
To compare URI with similar companies in the same Trading Companies and Distributors industry I have defined the following peers:
Using Seeking Alpha's Quant Ratings we have a ‘Strong Buy’ rate related to the ‘Buy’ rating in HEES and a lower rating for HRI and MGRC. These ratings highlight a favorable moment for URI if compared to its peers.
From the Quant Factor Grades point of view, we can see how URI is outstanding in Profitability and also in Momentum (which further underlines the favorable moment for the company) and has all green labels in the other Factor Grades.
HEES is the only peer that has a better rating in Growth and Valuation while it is less attractive when viewed from the point of view of Profitability and Momentum and share price evaluation. The other peers seem to be far from URI in all Factor Grades.
It should be noted that from this year URI also defined the release of a dividend (first year) and we can see the 1.32% Yield is lower than all competitors but which in any case underlines the commitment by the company to start to return value to shareholders also with the detachment of a coupon.
The main risk is represented by future growth
URI is a solid, consolidated market leader. The growth rates of recent years have been important both in terms of revenue and above all in terms of margins. The current price as well as the expected return on investment are mainly based on the company's ability to maintain in the future what has been done in the last 2 or 3 years and this can happen organically and through M&A. The management has demonstrated that it can manage investments, contain costs, and increase market shares on the one hand while demand seems likely to remain high in the coming years. The combination of these two factors could spell out a rosy path for URI's share price which already incorporates some of the future growth. However, if growth rates turn out to be lower than 5% in terms of EPS, the price could suffer a heavy setback. The risk could therefore be represented by an unfavorable conjecture in terms of demand that could occur in the event of a heavy market recession.
Bottom line
United Rentals could grow and even beat the market over the last 10 years. Today it represents an undisputed leadership position and has managed to erect important barriers that allow it to have structural advantages over its competitors (both technical and marketing). We have seen how in 2023, compared to competitors, all the main parameters of Profitability and Growth are favorable to URI and we have also seen how in the US the equipment rental industry has been growing linearly at a rate of 5% per year for decades now. There does not appear to be a high risk that this growth may be interrupted in the next few quarters. The share price is high but in line to guarantee further returns in the next year. My rate is Buy.
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United Rentals: Secular Trends And Internal Growth Can Push Higher