2023-11-13 10:00:00 ET
Summary
- Herc Holdings had a strong Q3 with positive pricing and volume growth, despite challenges in the studio segment.
- Fleet growth is driving revenues, but organic factors are supporting too.
- Already funded megaprojects lie in the pipeline, and there's no real sign yet of a slowdown in activity.
- Could be interesting at current multiples.
Herc Holdings ( HRI ) had a decent showing thanks to continued strength in pricing and volumes. Despite construction end markets, there doesn't seem to be any cyclical pressures, and the management continues to indicate and disclose that pricing is positive and the general commercial/industrial real estate pipeline is robust. The performance even outweighed some headwinds in studio. Overall, the business continues to compound favourably and the multiple actually looks compellingly low.
Q3 Breakdown
While Buffett invests in homebuilders, we like equipment rental a little better. The multiple assume a downcycle incoming, and while those fears are somewhat founded, there's no sign of it, and both pricing and volume for the business looks good with the fleet comfortably growing and compounding.
Free cash flow remains negative as the company invests in fleet growth. Supply chain issue last year means that probably more CAPEX is incoming to catch up. Although there are apparently still troubles in getting the full extent of wanted equipment.
Fleet growth is meaningful and is helping drive revenues, especially as re-rent takes a bit of a hit in their studio end-market, but organic factors also remain strong. Both volumes and pricing are up, 6.9% and 11.5% respectively.
The studio segment is important to mention. Both writers and actors strikes contemporaneously have been an issue for the industry, and activity of equipment used for sound stages and so forth is substantially down. This end-market used to be 5% of rental income and now it's 1%. While this will eventually go back to normal, Herc is also taking the moment to put the business on sale, as apparently consolidation of the real estate for production in the industry is developing an appetite to own the equipment in house rather than giving up margin to equipment rental companies like Herc. The company seems pretty confident that they can make a sale to a strategic buyer. Why not.
Pricing continues to remain positive into October, with typical seasonal pricing lift kicking in as normal, and there doesn't seem to be any divergence between demand on national and more local accounts. In particular, the company says that a lot of megaprojects in non-consumer driven end-markets are continuing to progress, and more coming down the pipeline is likely to keep their machines engaged for a while longer. Apparently there are plenty projects that can occupy them for a while longer that are already fully funded, so cost of capital and other financial disruptions are probably not going to have a major bearing on HRI's activity in the near term from here. Analysts fishing for signs of weakness are getting nothing from management, and we see no reason to believe that a major slowdown is really happening yet, though realistically, and the market agrees, a slowdown is possible.
Bottom Line
The EV/EBITDA is below 5x. Net debt has grown over time thanks to the fact that they invest ahead of their operating cash flows, but the general compounding effect is pretty desirable at this point in the business' development. The multiple is pretty low for a business that is maintaining a good degree of momentum and is achieving solid results, likely acknowledging that the higher cost of capital environment could eventually take its toll. Also, while demographics have a more direct translation on demand for developing residential property, the greater focus on non-residential markets may also be concerning prospective investors.
We do think that HRI might be considering a change in capital allocation strategy. While they are continuing to reinvest cash flows in growing the fleet, we think the doubling of interest costs that has been stymieing net income growth may encourage some more deleveraging efforts. We think that would actually be a nice change of pace, for the company to become more a deleveraging play. It may take till next year for them to decide, as that may be the make or break moment for the Fed rate hike regime, but turning into a deleveraging play at current multiple, where a deleveraging following by an eventual turn in the cycle and improvement in the multiple would be great for shareholders.
Overall, a margin of safety multiple, demonstrated resilience and momentum all indicate that HRI, which has declined 10% YTD, may be worth consideration. However, we do note that the worst may still come for any businesses with underlying cyclicality. It may be better to wait for potential latent macroeconomic factors to show themselves first in order to open oneself to the opportunity of buying in even lower.
For further details see:
Herc Holdings: Minor Studio Headwinds Outweighed By Megaprojects