2023-07-24 12:32:08 ET
Summary
- U-Haul is considered a strong long-term investment due to its flywheel effect and efficiency of scale, which have helped it maintain its leading position and growth for decades.
- The company's tangible book value has grown by an average of 16.25% per year since 2003, demonstrating its long-term compounding potential.
- The company's reliance on home movers is a concern in the current macro environment, with high mortgage rates reducing the number of people moving homes.
- The company is very capital intensive and thus has taken on large amounts of debt to grow. As interest rates have gone higher this will drastically raise the company's interest expense.
Overview
U-Haul Holding Company ( UHAL ) & ( UHAL.B ) is the biggest North American moving and storage company. Since this is a well-known company I won't go into too much detail on the business here.
I find this company to be an interesting long-term investment due to the moat that it has. The most significant moat of this company is the economies of scale and the flywheel effect.
This has allowed U-Haul to keep its top position and grow for decades showing that this company has longevity and long-term compounding.
On the other hand, there are some serious issues with the current macro environment. The biggest of which is that U-Haul is heavily dependent on those who move homes. With the current macro environment where mortgage rates have gone up and will likely continue to stay at elevated levels, those who already have a home are unlikely to move. Fewer people looking to buy a home will find it affordable to do so
Along with this, the high leverage of the company has me worried.
In the end, I'll go over what it would take for this to turn into a buy.
U-Haul: Long-Term Compounder
The key thing that stands out about U-Haul is that it is a long-term compounder.
Below is the tangible book value since being taken public:
Seeking Alpha
Initially, the stock didn't fare well due to internal struggles within the family that managed and owned the biggest stake in the company. It wasn't until 2003 that the current management made a transformation into what U-Haul is today. If we look at tangible book value per share from 2003 to 2023, which is from when U-Haul made its transformation into what it is today to the current day, its tangible book value has grown by an average of 16.25% per year.
Its ROE has been around the same amount over the last 20 years:
Seeking Alpha
I have also added ROA and ROTC for comparison. I will talk about the issue that these two metrics bring up later in the article.
This is a decent compounding rate. It is nowhere close to the 40%+ that many hyper-growth investors would look for, but is still higher than the market average, and most importantly it shows longevity in compounding.
The main reason for long-term compounding is insider ownership from the Shoen family. The current CEO's father started the company; the Shoen family owns around 40% of the outstanding shares.
I prefer to see founder-led companies as founders are the ones who originally built the company up and started its growth, so if they continue to lead the company they will continue to drive the growth trajectory. On top of that founder lead businesses have large amounts of insider ownership, so shareholders are aligned with the management, and the management is forced to think long-term.
In my view, this is far preferable to a company where new management is constantly being brought in, changing the business plan and with little stake in the business, forcing them to think short-term.
Flywheel Effect
A flywheel effect is defined as a product or service gaining value the more people use it. I do believe this is the case with U-Haul and will explain the reasoning below.
For example, if you are making a one-way move from say California to Florida, what U-Haul will allow you to do is to take their truck one way and drop it off at a location in Florida. Then someone from Florida can take the truck and move to California.
One of U-Haul's competitors might only have locations on the west coast and not a single location in Florida; in that case, one would have to make a round trip and then a one-way trip to Florida. This makes it a no-brainer to use U-Haul. Even if the other trucking company has a location in Florida, it might not be that close to where the individual is moving. For these reasons, more people use U-Haul, as it saves time and money for the consumer.
This causes a flywheel effect in that as more people use U-Haul, they will open more locations(due to the high demand from consumers), causing even more people to use U-Haul(due to it saving time and money as I described in the scenario above), causing U-Haul to open up even more locations; the cycle continues to repeat itself; so as more people use U-Haul, the company becomes more profitable and they are able to pass this on to the end consumer, which causes the end consumer to use U-Haul over a competitor, and the cycle continues to repeat. My belief is that this is the reason that U-Haul is able to keep the majority market share in the DIY moving business, and is in a monopoly-like situation.
The only way a competitor could take over in this scenario is if they had enough capital to build more locations than U-Haul.
To visualise this I've shown two location maps below. The first is of Penske, a major competitor to U-Haul, and the other is of U-Haul. As can be seen, U-Haul has far more locations allowing convenience and cost savings to the end consumer, which causes a flywheel effect.
Penske Locations (Mitsui)
As can be seen, the rate per mile is the same, but U-Haul offers a clear edge in the number of locations. Also, U-Haul is also known for the lowest minimum day rate in the industry at just $19.99, which is often seen advertised on the side of a U-Haul Truck.
Positive View On Management
I have a positive view of the management and believe that when times get tough they will be able to maneuver through it.
First off, the management is founder-led. The main advantage of founder-led companies is that the founder or founding group has a large stake in the company. In this case, the Shoen family has a 40%+ stake in U-Haul. This directly incentives the management to see things from the viewpoint of an investor, since they are the biggest one. This also incentives them to think long-term.
This is in comparison to a new management team which often has little personal capital at risk and is instead usually getting upside from stock options only. New management teams will often have pressure on them to think short-term because they are usually only brought in during a crisis event when old management is removed; this crisis event forces new management to quickly make changes which may put a bandage on an immediate issue but might create more long-term issues. On top of this new management teams will feel the need to "prove themselves" to shareholders and thus will make short-term decisions to make the stock price increase at the expense of long-term growth; in comparison, seasoned management will have already "proved themselves" due to decades of prior experience, so they will focus long-term with little regard to short term sentiment.
The current CEO, Joe Shoen, has been in this role for over three decades and has compounded earnings at a high growth rate and has taken advantage of downturns.
Below are the net income and revenue since 1995:
In June 2006 the company did $2.11 billion in revenue then by September 2009 revenues were $1.95 billion. That is a peak-to-trough drawdown in revenue of less than 10%, and net income continued to stay positive in the depths of the GFC. This is quite low seeing as though the GFC has a large direct impact on the moving industry.
Another plus I've seen from the CEO is his willingness to take advantage of opportunities during a downturn. In the last downturn, U-Haul made a massive expansion to its self-storage vertical. The self-storage model that U-Haul uses can be thought of like a REIT where the company buys large amounts of real estate, then builds self-storage, and then rents it out. This model has the advantage of little maintenance having to be done in that once a facility is built, little has to be done to keep it going. With the growth in profitability over the last 15 years this has turned out to be a no-brainer.
The CFO actually touched upon this in the last earnings call:
Well, on -- once you open up the facility, most of the costs are pretty well fixed. So, much of that is going to run through to the bottom line. It's probably somewhere north of 80%.
Here the CFO mentions how self-storage facilities have a large cost to start up, but once started the cost is fixed and all else goes to the bottom line. With the current environment we're in with fewer people moving I think that self-storage will become more important.
For these reasons, I believe that in a downturn the current management team will be able to pivot to find a way back into profitability, and I have far more faith in the current management than I would in any sort of new management or activist investors.
Capital Intensive
The biggest issue with U-Haul's business model and what I believe will hurt it the most over the next few years is how capital-intensive it is. Earlier in the article, I included the following chart and mentioned that it shows some issues:
Seeking Alpha
This chart includes ROE, ROA, and ROTC. While ROE is at around 15%, ROA is only a measly 3%; and ROTC which measures returns on the full capital stack has historically been 6%. These returns have been very low and can only be elevated with large amounts of leverage.
The company currently has an ROE of 15% and a ROA of 3% with a debt-to-earnings of 12x and a financial leverage ratio of around 3x.
A 12x debt-to-earnings ratio brings far too much risk, and it makes the EV/Earnings ratio 23x. Once I looked at it this way I quickly concluded that the valuation is far too high and the risk too much.
A ROA of 3% might be fine when the cost of capital is very low, but we're now in an environment where the risk-free rate of return is 5.5% and growing. In this environment, a 3% ROA is a money pit. Because of that, I believe that the company will be forced to instead focus on paying down debt and making operating expenses slimmer.
The Housing Market Is Frozen
The biggest source of revenue for U-Haul is from those who are moving long distances.
In the current interest rate environment most homeowners have locked in very low rates, so they are unlikely to move and let go of their low rate. This means that the amount of used homes on the market is very little . At the same time, there were already very few newly build homes on the market. So this has caused real estate prices to go higher.
Some potential buyers of homes are priced out of the market due to higher rates, but some are still buying due to a strong labour market. This has caused real estate prices to go higher as rates have gone higher.
Over time more and more buyers are being priced out and sellers aren't selling.
Here's an interesting stat from Redfin on the number of homeowners who've locked in a low mortgage rate:
More than nine of every 10 (91.8%) U.S. homeowners with mortgages have an interest rate below 6%. That’s down just slightly from the record high of 92.9% hit in mid-2022.
Redfin
Here's the U.S. Existing Home Sales:
Trading Economics
As can be seen, existing home sales have gone down to the March 2020 level, and if rates continue to go higher then existing home sales could even plummet to the lows of the GFC.
Coming Years Of Low Shareholder Returns
My view is that over the next few years, there will be low shareholder returns.
The first reason for this is plummeting earnings. Last quarter the company did around $1 billion in revenue and $110.7 million in EBIT. The revenue was down slightly, but margins contracted from around 30% EBIT margins to only around 10% EBIT margins.
This is due to two main reasons. The first is because of the high operating leverage of the company's business model, whereby even if revenue goes down, the cost of revenue and operating expenses will continue to stay the same. We know this is the case because we can compare the previous quarter's cost of revenue and operating expenses to this quarter.
Q4's cost of revenue was $940.2 and operating expenses were $114.2mm, while Q1's cost of revenue was $935.8 and operating expenses were $142.1.
The revenue of the company was down from $1.375 billion to $1.188 billion, which might not seem like a lot, but because of the stable cost of revenue and operating expenses along with the slim net margins, a small drop in revenue causes a large drop in the bottom line.
CFO Jason Burg discussed why the revenue was down last quarter in the earnings call :
April and May are continuing to -- on the equipment rental business are continuing to trend down compared to last year at this time, which was relatively strong. So, again, I'm trying to keep things in perspective. We haven't come close to giving back all of the gains that we picked up over the last couple years, but we're certainly giving back some of what we had last year.
The second reason for margin contraction in the most recent quarter is that operating expenses were up slightly.
The following was said by CFO Jason Burg about the increase in operating expenses:
Operating expenses increased $38 million for the fourth quarter. We saw fleet repair and maintenance lead the way again, up $32 million. We continue to increase our internal capacity to do more repair work ourselves. We also expect to increase the rotation of older trucks out of the fleet this year that would certainly help, and we are in a good shape with the fleet going into the summer months.
This increase in operating expenses was relatively small because even without this the EBIT margins for last quarter would be less than 10%. This operating expense increase only seems to be temporary for one-off repair work on older trucks.
It's hard to predict what next quarter's earnings report will look like as it will be the summer moving season. It will likely be lower than last year for the reasons previously mentioned, but it's hard to tell how low. With that said, even if the company continues to maintain its TTM trailing EBIT, I don't think it will be enough to have meaningful earnings because the interest expense will become higher.
U-Haul issues debt directly to the public through its investor club. Because of this, their cost of capital is very low. Currently, they are issuing bonds with rates of around 5%. It used to be that rates were as low as 1.5%.
Current bonds issuances:
U-Haul
Previous bond issuances:
U-Haul
Going forward I expect that U-Haul's debt will have to be refinanced at higher rates. The current prime rate is 8.5% and most investment-grade bonds are going for a yield of over 6%. If U-Haul had to pay 8.5% on its total debt of $11 billion that would be $935 million in annual interest expense. Seeing as though its trailing EBIT is around $1.448 billion, that leaves $513 million in pre-tax profits, which would be $405 million in net income once a 21% corporate tax is accounted for. A net income of $405 million compared to the current market cap of close to $11 billion, would make for a P/E multiple of 27.5x on the net income relative to the market cap and an EV/Earnings of 39.5, which is of course a very high multiple for a low growth company like this to be valued at.
This reduction in earnings provides the company will little margin for error; its total trailing TTM revenue has been $5.864 billion and with an expected net income of $405 million, the net margin is less than 10%. As previously mentioned, U-Haul has very high fixed costs, so a drop of just 10% or so in revenue could wipe out the net income. For these reasons, I believe that shareholder returns will be negligible for the next couple of years.
The non-voting stock also trades at 1.5x to book value per share. For companies that are efficient with their capital, they can trade at a premium to book; but with a ROA of 3% in a rising rate environment, while earnings are likely to drop 60%+ with my conservative estimate, I see a substantial discount to book value rather than a premium. I don't think that shareholders have priced this in yet as TTM earnings are still high, but if we see a drop in earnings over the next few quarters then the market will likely reprice the P/B ratio down to a deep discount.
What It Would Take For Me To Buy
My view is that mortgage rates will continue to stay high for the foreseeable future. This will continue to put pressure on the company's revenue.
I do believe that since the management has been around for a long time and they have a large stake in the company, they will find a way to cut costs as revenue goes lower.
The two main things I would need to see are higher ROA and lower leverage.
Lower leverage could be defined as having a more reasonable debt-to-equity ratio. It could be debated what reasonable is, but I would put it around 1.
In the future with higher rates, the interest rate paid on U-Haul's debt will have to be higher than it currently is. In my calculations below I've used a 5% cost of debt capital, which is actually low seeing as though the fed funds rate is higher than this; I choose to apply a lower rate though as the market is pricing in rate cuts over the next few years combined with the fact that historically U-Haul has got below market average cost of debt capital due to its method of directly issuing secured debt to retail investors.
I also plugged in an ROE of 20%. This is higher than its average of 15% over the last 20 years, but interest rates are the highest they've been in 20 years, so the hurdle rates that investors expect will be higher.
I put all these figures into a variation of the DuPont Formula below:
ROA = [(Liabilities*Cost of Debt Capital) + (Equity*ROE)]/Total Assets
This figure expands the ROA formula: ROA = (Net Income + Interest added back)/total assets; it essentially expands on the net income + interest add-back part of the formula.
ROA = [(9.062bn*0.05) + (9.062bn*0.2)]/Total Assets
ROA = (453.1mm + 1.8124bn)/Total Assets
ROA = 2.2655bn/18.1246bn
ROA = 12.5%
To get the ROE up to 20% with a debt to equity of 1, then the ROA would need to get up to 12.5%.
Here the debt($9.062bn) to earnings($1.8124bn) would be ~5X, which is higher than I would like, but is still within an acceptable range for a higher-quality company like this.
If you as the reader don't agree with any of the figures filled in like debt to equity, cost of debt capital, ROE etc. then you can fill in your own into this formula to see what kind of ROA would need to occur to get to your desired figures.
Along with a higher ROA and lower leverage, I would like to see a lower valuation, both to book value and a lower P/E multiple. This will likely happen if we go into a recession which causes an equity market crash.
If these things happen then I would consider buying the stock. Till then though the headwinds present along with the high leverage make U-Haul stock a sell for me.
For further details see:
U-Haul: Major Headwinds On The Horizon