Description

Summary

Ashtead is a well-managed and well-positioned construction equipment rental company. ~90% of profit is generated in the company’s US business – Sunbelt Rentals. Sunbelt has grown revenue at 13.5% annually over the last 7 years and has become the #2 player with 12% market share. The company has numerous competitive advantages that stem from scale including bulk purchasing, better network and route density, and differentiated technology offerings that streamline customer workflows. These advantages allow Sunbelt to offer competitive rental rates and drive higher than average machine utilization while having wide and immediate access to equipment their customers need. Over 65% of rentals are made with less than a 24-hour notice, so customer service, responsiveness, and brand reputation are paramount in this industry. Sunbelt’s market remains quite fragmented with many competitively disadvantaged mom + pop operators, and we believe the company is well-positioned to continue to take market share profitably. 

At 15x PE / 8x EBITDA / 9% Maintenance FCF yield on 2023 estimates, the stock is attractively priced given our view of both long-term growth and continued strong ROI. Much of the company’s equipment is tied to non-residential construction, which is at still healthy levels. Predicting the timing and magnitude of construction cycles is extremely difficult, but the influx of construction backlog due to the Inflation Reduction Act, Chips Act, and Infrastructure Act should mute the impacts Sunbelt would typically experience in a recession. Looking beyond the current cycle, we think there is a long runway of growth ahead as rental penetration increases and Sunbelt continues to take share.

Company History

1984: Ashtead was formed to acquire five rental branches in England

1986: Ashtead IPO’ed in the London Stock Exchange

1990: Expanded to the US by acquiring Sunbelt

2000: Acquired Rentokil’s US rental business to double its size

2006: Acquired Nationsrent Inc for $1bn to become the 2nd largest rental equipment company in the US

2014: Entered Canada by acquiring GWG Rentals

2017: Doubled its Canadian business by acquiring CRS

Business Overview

Ashtead provides a wide set of construction and non-construction rental equipment used for projects such as non-residential construction, disaster relief, and climate control. Ashtead’s rental fleet ranges from small handheld tools to large construction equipment. Ashtead generally purchases the equipment directly from the manufacturers, operates the equipment for an average of seven years, and disposes of these tools on the secondary market.

Ashtead’s primary geography of operation is the United States. The Company operates in the US under the Sunbelt Rentals brand with an 12% market share and a number two market position. Sunbelt competes with a wide range of equipment rental businesses, ranging from poorly capitalized mom-and-pop shops to United Rental, a publicly traded equipment rental business with 16% market share. With the exception of two transformational mergers in 2000 and 2006, Sunbelt’s national expansion has occurred via greenfield expansion (organic opening of new Sunbelt stores) and small-sized acquisitions. 

In the United Kingdom, Ashtead operates under the Sunbelt Brand after a rename in 2020 from A-Plant. Sunbelt is the largest national equipment rental company in the UK, with an 10% market share. Its stores are on average larger than those in the US and Canada, as this brand caters more to national accounts. Sunbelt also has expanded into Canada in recent years, and Sunbelt Canada currently has an 8% market share. Ashtead has prioritized the Canadian expansion via M&A, acquiring its toehold position in 2014 and growing rapidly since.

Ashtead’s equipment rental model works as follows:

Purchase: Ashtead purchases an equipment from an OEM at its Original Equipment at Cost (OEC), which is generally discounted by 10-20% due to scale. Orders can take ~6 months for delivery. In periods of significantly elevated demand, Ashtead is more likely to secure supply of equipment than its smaller competitors due to its strong partnerships with OEMs.

Rental: Ashtead’s equipment is used for an average of seven years. Rental assets yield 55%+ of their initial OEC every year (dollar utilization), providing a fantastic return on investment.

Disposal: After seven years, Ashtead sells the equipment on the secondary market. The Company has historically sold its equipment at 35-40% of original cost. Ashtead generally uses equipment auctioneers, such as Ritchie Bros, to sell its fleet, and end buyers are often emerging market customers. Ashtead subsequently replaces the equipment with newer versions, which are generally ~10-15% more expensive than the old equipment’s OEC due to inflation and improved technology.

Returns: All in, Ashtead is able to earn about $4.20 of revenue and disposal proceeds over seven years for each $1.00 spent at acquiring the assets. Meanwhile, the Company incurs general overhead costs, store operating costs, and maintenance and transportation costs. With historical incremental EBITDA margins of 40-50%, Ashtead earns unlevered returns in the low to mid-20’s on its equipment. 

Ashtead’s product line can be divided into two major segments: general tools and specialty items. General tools refer to most equipment usually expected for construction, such as aerial platforms and forklifts. Specialty products are more specialized and include pumps, power generators, HVAC, and scaffolding. Due to the niche nature of these products, specialty items observe less competition from other equipment rental businesses and tend to earn higher margins. Specialty items are also less levered to non-residential construction. Ashtead has consciously grown this product line, which has expanded from 16% of revenue in 2011 to 30% in 2022.

From a strategic standpoint, Sunbelt has pursued a “clustered markets” strategy. Ashtead approaches designated market areas (DMAs) as individual opportunities to rent its equipment via multiple branch locations. In turn, these stores increase the touchpoints with customers, carry a larger and more diverse fleet of equipment, and further differentiate Sunbelt from its competitors. In some of its most successful market clusters, Sunbelt has achieved significant scale, reaching over 20% market share.

Due to Ashtead’s scale, it has invested in technology to offer more services to its customers and reduce costs internally. Ashtead’s customers have access to fleet availability via their smartphones or computers. Customers can also place new orders, request pickups/service, and extend their contracts on the go. A technology-powered subscription service called ToolFlex allows customers to exchange a set number of tools and equipment for a flat monthly fee. Through technology, salespeople can simultaneously respond to customer requests and provide customers with the most appropriate pricing option. Further, Ashtead has improved its delivery management system, which increases efficiency (less paperwork, more coordination among drivers), and reduces costs (optimize routes).

The non-residential construction end-market continues to be Ashtead’s (and the industry’s) most important driver. Non-residential construction is a cyclical industry that was particularly impacted by the 2008 crisis. It is also a lagging indicator of economic health, bottoming about 12-24 months after economic recessions as infrastructure is subsequently finished.

In addition to the multi-year shifts in construction trends, Sunbelt is impacted by construction seasonality. When construction slows down over the winter months, especially in the northern states, the Company generally experiences a decline in physical utilization. Generally, Ashtead aims to maintain company-wide utilization rates at about 70%, which allows for a high utilization rate while providing inventory for the incremental customers. Since over 65% of customers ask for the equipment within one day of their eventual rental, Ashtead needs to maintain unused fleet in its branches. 

Industry Overview

The equipment rental industry is highly fragmented in the United States. The industry can be thought of in a few layers: “mom-and-pop” local operators (generally owned by entrepreneurs or families); regional operators (either owned by successful operators or by a sponsor); and national rental companies (either public or private). Larger operators are best positioned to serve the needs of national accounts. Local operators generally have higher costs of capital, older fleets, are less sophisticated, and as a result, tend to cater to small and medium-sized contractors.

Rental penetration continues to be a positive trend for the industry in the US. Consumers are becoming increasingly accustomed to the flexibility of an outsourced model. According to Ashtead, rental makes up 50-55% of the US market construction equipment usage, compared to around 75% in the UK.  However, this is a broad average, with penetration levels ranging from single digit percentages on floor scrubbers to 90%+ for large aerial equipment. Ashtead sees the potential market penetration for rental equipment to be well above 60% in the US.

The equipment rental market is levered to non-residential construction. Due to the nature of construction contracts, construction experiences a 12-24 month delay from the general economic cycle. Ashtead has geared its business to insulate itself from the cycles of the non-residential construction market: it has diversified into specialty items (30% of sales), kept a young fleet, and a reasonably levered balance sheet. However, it is certainly a risk that future economic cycles can put strong downward pressure on revenue and earnings.

Recently, Congress passed the Infrastructure Bill, the CHIPS Act and the Inflation Reduction Act. All three of these bills should provide significant tailwinds to the construction industry and therefore Ashtead for the remainder of the 2020s. The Infrastructure Bill contained $550bn of new spending initiatives. Market research estimates this should increase construction spending per year by $80bn. The CHIPS Act sets $280bn of funding available for chip manufacturing investments, while the Inflation Reduction act allocates $370bn to green energy manufacturing. We conservatively estimate these bills should lead to roughly $400mm of additional revenue for Sunbelt over the next 5 years and $200mm over the 5 years after, providing a buffer to offset potential decreased demand in other parts of the market.

Management Overview

Brendan Horgan was appointed CEO of Ashtead in 2019. Previously, he was the COO from 2018 and led the North American operations since 2011, when he was also appointed a board director. Prior to leading Sunbelt, Brendan held roles as Chief Sales Officer between 2009-2011, and Chief Operating Officer between 2003-2009. Brendan joined Sunbelt in 1996 upon graduating college. He has been the architect of the clustered store strategy, resulting in a 32% annualized TSR since he became leader of the North American operations in 2011.

Michael Pratt has been the CFO of Ashtead and a board director since 2018. Previously, he worked in various finance roles for 15 years including the Finance Director and Treasurer. He joined the company in 2003 from PWC.

Financial Overview

In the 2021 Investor Day, the company provided a 3 year outlook to grow the overall business at a 10% organic revenue CAGR with mid-50s drop-through EBITDA margins. Long-term, they expect to achieve at least 20% market share. We believe these targets are achievable as they grow same store sale mid-single digits while opening 25 to 50 stores each year, similar to historical levels. As they continue their clustered store strategy, we believe dollar utilization and specialty equipment rentals will increase leading to 50%+ drop-through margins. Further growth will likely come through thoughtful bolt-on acquisitions. 

In the first nine months of 2023 (fiscal year ends in April), the company grew rental revenue 25% YoY with organic growth in the US at 19%, increasing their full year expectations. Thus far, we have not seen many headwinds in the non-residential construction market.

Ashtead stock currently trades at 15x P/E, 8x TEV/EBITDA, and 9% maintenance FCF yield. We believe this valuation does not properly reflect the strong positioning of the business and the likelihood for continued growth and compounding of value over the coming years.

Risks

• Pricing pressure: A continued downward rental rate environment would weaken Ashtead’s returns. This could result from new technologies that create a more transparent pricing environment, state or federal regulation limiting rates on certain equipment happen, or because of increased competition. In recent periods of market stress such as in early 2020, the industry has been disciplined on pricing, learning lessons from cutting price during the Great Financial Crisis with no improvement on volume.

• Operational missteps: If Ashtead fails to operate adequately, or if competitors utilize certain tactics and strategies that materially improve their business standing vis-à-vis Ashtead, the company could underperform.

• Limited construction growth: If non-residential construction fails to grow following the next downturn, due to broader economic stagnation, this would limit overall growth for the company.

• Equipment rental penetration: If the US and Canadian markets arrive at a steady-state rental market share penetration below our expectations, the addressable market for Ashtead would be materially reduced.

• Poor capital allocation: As previously described, Ashtead has many choices on where it can allocate capital. Poor capital allocation – be it over-expansion, poor M&A decisions, lacking debt paydown at appropriate times, not aging the fleet when suitable, etc. – would weaken the investment prospect.

Conclusion 

Ashtead is a strongly positioned and high-quality business operating within a fragmented industry. We consider the current price to be highly undervalued and we expect the company's future growth prospects to remain robust with improving margins. Looking ahead over a 5-year period, we believe an investment in Ashtead presents an appealing risk-reward opportunity.

Catalyst

- Increased construction spend due to legislation

- Market share gains through organic growth and attractive acquistions

- Continued execution of clustered markets strategy

- Share repurchases