May 20, 2019 - 5:23pm EST by
2019 2020
Price: 123.97 EPS 19.50 21.55
Shares Out. (in M): 79 P/E 6.3 5.7
Market Cap (in $M): 9,744 P/FCF 0 0
Net Debt (in $M): 12,200 EBIT 4,470 4,715
TEV (in $M): 21,944 TEV/EBIT 4.9 4.6

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Investment Overview: We believe the shares of United Rentals (URI) represent good value for long-term contrarian type investors and have used recent periods of volatility in the share price to initiate a position in the shares. While clearly a cyclical company, URI is a best-in-class industry leader with a large TAM that has established an excellent track record of execution, growth and improving shareholder value across the cycle for more than a decade and is benefiting from a couple of powerful secular tailwinds.


The shares have been neglected and are unloved by both investors and sell-side analysts and have underperformed the general market, due to the common wisdom mentality (unsupported by economic and trade data) that the industry is in the last innings of an economic expansion coupled with concerns associated with the price and integration of major acquisitions that URI made in 2017/18. During this time, management has been focused on continuing to evolve the business model into a stronger more resilient company, successfully integrating recent acquisitions and delivering strong profitability and cash flow, which has increased URI’s intrinsic value.


Noteworthy, the shares are trading at roughly the same level as in mid-2014, despite the fact that profitability, FCF, returns, KPI’s and recently leverage have improved significantly in the interim. By comparison, URI’s major competitor (Ashtead Group), who has a very similar business model and operates in the same industry, has about doubled in the same time period. Additionally, in about the last year, since March 2018, the shares have declined about 30%, compared with a slight increase of 2%-3% for both the S&P 500 and competitor Ashtead. Noteworthy, during this time period, URI reported four quarters that met or exceed expectations and raised future earnings and cash flow guidance.


Currently, URI is valued at an EV/EBITDA and P/E multiple of 4.9x and 6.6x consensus FY19 forecasts respectively. Notably, despite URI’s best-in-class industry standing, the shares EBITDA multiple is modestly below the group average of 5.3x, while its P/E multiple is significantly below the group average of 11.6x. Additionally, when viewing URI’s EV/EBITDA multiple across the cycle from 2006 to present, the valuation is at the lower end of the historical range. This suggests that investors are already somewhat discounting the risk of an economic downturn on the business despite the fact that most industry leading indicators and barometers suggest favorable market conditions looking out at least 12-18 months. Furthermore, there is evidence to support the belief that both URI and the industry in general are better prepared, compared with 2008/09, to weather a downturn in the cycle. Thus, for longer-term contrarian value investors, we believe the shares will offer good value thru the cycle over the next 3+ years.


Consensus EPS and adjusted EBITDA forecasts are ~$25/share and $4.9 billion for FY21. Assuming a re-rating of the P/E multiple to 9x (still below the group average) shows upside to roughly $225/share while assuming an increase in the EV/EBITDA multiple to 6x (on 2.5x leverage), shows a valuation of about $220/share; both implying upside of ~80% during the period. Noteworthy, some possible catalysts on the horizon in the future which could increase investment sentiment and support a rerating include management reducing its leverage ratio targets and the passing of a proposed $1.5 trillion infrastructure bill.


Key Investment Points: The following are some key factors that support our recommendation. Some of these have been discussed in past write-ups (and recommend interested investors review them), given that a number of years have passed since these reports, we felt it would be helpful to update them and provide a base for anyone new to the story.


Three Favorable Secular Trends Fueling Rental Industry Growth: As illustrated below, over the last 20 years the industry has grown at a 5.3% CAGR across the cycle and a 6.6% CAGR coming out of the recession since 2009.





The latest five-year forecast from the American Rental Association (ARA) calls for equipment revenues in North America to surpass $61.5 billion in 2019, up 5.3% compared to 2018. The industry is expected to grow 4.8% in 2020, 5.0% in 2021 and 4.8% in 2022 to reach $64.4 billion. Other market forecasters also call for continued healthy growth over the next few years.




                                                                                                                                                      Source: ARA / IHS Global Insight as of February 2019


Over the last 20 years there have been two favorable secular trends in the equipment rental industry that favor URI, which are: a shift from owning equipment to renting and the consolidation in the industry where the big are getting bigger. More recently, the increased availability of specialty products offered via rental has helped fuel growth, enhanced margins and helped reduce the cyclical nature of the industry.


Shift To Rentals vs. Purchases: A multi-decade industry trend is the move by customers to rent equipment versus purchasing. Renting offers the opportunity to free up capital, control costs and access the right equipment, when and where it is needed. It also doesn't require additional staff to maintain the equipment, spare parts on hand or storage of the equipment. Data from the American Rental Association shows that within the US, renting has increased from about 40% of equipment usage to 53.5% currently. Note, this still trails Europe and Asia, where rental constitute about 70%-80% of equipment usage. Moreover, drilling down into the data shows that in more general purpose categories (as opposed to large equipment categories), the number is meaningfully lower. As a result, it is expected that the rental mix of all equipment usage will continue to increase in the future. In addition to pure economics, where it only makes sense to purchase if the equipment will be utilized for most of its life, other factors driving this trend include the increased availability of equipment for rent as well as the broader diversity of product available for rent. As illustrated below, this trend has and will continue to help the equipment rental industry to grow in excess of the overall market.



As illustrated in the below comments, management believes there are further opportunities for rental penetration to grow in the future:


“I think there's still more opportunity for penetration in North America when you think about right here in the U.K., where penetrations are reported at over 80%; or in Japan, similar. You think about North America. ARA, as quoted in January at the annual show, that it was about 53% penetration. That number would have been in the high 30s when I started in 1990. So when we think about the opportunities, there are some specific end markets that we think really not penetrated at all, whether it's government, manufacturing. So there's actual whole segments that have not been penetrated yet, and we think there's a lot of opportunity. And then the continued penetration in some of the plants that we operate in, we continue to find new ways to get customers to realize the value of rental. And there are very few times where the rental opportunity and the math doesn't paper out, where then a customer would try rental and then go back to purchasing. Unless you're going to use a piece of equipment for a consistent amount of time, doing a consistent task for multiple years, you're never going to get the utilization opportunity out of it worth the paper. And I think what we've proven as a rental industry, not just United Rentals, is that we are a real trusted and reliable option. And pre '09, people may not have believed that. They may not have believed that the access to the fleet was going to be quick enough or the reliability of the fleet was going to be at the same level, and I think the penetrations occurred because they've been pleasantly surprised.”


Matthew J. Flannery President & COO


BofA Merrill Lynch Conference March 20, 2019


Industry Consolidation: The second secular trend is the consolidation in the industry, where the largest companies, both individually and as a group, are gaining market share. As illustrated in the chart below, the top 10 rental companies have increased their combined share of market from 10% in 2010 to 30% in 2017.



There are a number of reasons for this trend, similar to other asset-heavy industries, scale and financial benefits play a major role. In addition to brand and reputation, having a large and broad asset base of equipment (including specialty products) and locations, combined with investments in software, enables equipment to be deployed from one location to another when critically needed. These factors create high barriers, which is especially true as you move up in scale to the largest infrastructure jobs, which makes it hard for all but the largest companies to be competitive. Also, given the asset heavy nature of the industry and the large capital requirements needed for new purchases, the financial strength of the leading players gives them an advantage. The growth in market share is occurring both organically as well as thru acquisitions. Thus, financial strength provides capital to make market share expanding accretive acquisitions. URI is the market leader and as a result of these factors, URI has been able to increase its market share from about 9% in 2010 to about 13.3% currently and is larger than its next 2-3 competitors combined.





The highly fragmented nature of the industry creates a large TAM for URI to continue to gain significant market share through both organic growth and via acquisitions. As illustrated below, in the last few years URI has used its robust cash flow to make a number of large acquisitions, which has helped it share grow. We believe that URI will continue to look for accretive acquisition to complement its organic growth in the future (especially in specialty products), in the near-term any will be more bolt-on type deals as it continues to digest recent larger deals.



The Increased Availability Of Specialty Products Provides Stronger Growth, Higher Margins & Less Cyclicality: A trend in the industry that appears to have accelerated since the 2008/09 downturn is the move to offer greater availability of specialty products. As illustrated below, these products include trench support/safety, power & HVAC, fluid solutions and other specialty products.



These product categories offer superior growth, higher margins and have attributes that make them less cyclical in nature. Given that these non-mainstream products require healthy capital investments, they are not broadly carried across the rental industry. Thus, they offer higher margin opportunities and better returns for those larger companies, like URI, that have the financial resources and network size to provide them to customers. The less cyclical applications that these products address has makes them attractive as well. URI has increased its revenue mix of specialty products from 7.2% in FY12 to 21.4%, including the run rate from the recent acquisition of Baker Corp. in 2018.



We believe that specialty products will be a major focus of URI’s acquisition efforts in the future. Additionally, we believe the growth in specialty products has made URI a stronger more resilient company thru the cycle, which may not be fully appreciated by investors, and should bode well for the company be accorded a higher multiple.


URI Has A Healthy & Improved Business Model And A Solid Track Record Of Execution Thru The Cycle: Over the cycle from pre-recession years to the recent period, URI has created an excellent track record of execution and improved its business model. Over the last 15 years, through the cycle, URI has grown adjusted EPS by a 25% CAGR. As illustrated below, the 10-year track record shows a CAGR in revenues of 9.4%, adjusted EBITDA of 13.7% & adjusted EPS of 18.6% CAGR.


An important aspect of URI’s financial performance has been the improvements it has made in the last decade since the last downturn in 2008 to become a stronger, more resilient company. These factors include building a more diverse customer base (less exposure to oil & gas and residential construction), increasing its mix of specialty products and improving its asset management and utilization in the field. The following comments from management highlight some of the transitions that have taken place over the last decade:




“I think what it boils down to is, all of those structural changes which give us a very different starting point should the downside come or should the downturn come from where we were before. And with that, the flexibility that we have now and the choices we have now that we didn't have before. So you know Matt mentioned, our capital structure, we have a much stronger balance sheet at this point. The next closest is maturity is in 2023. We generate full -- free cash flow full cycle in years where we were also investing significant amounts in CapEx. And so while we can't pin a timing, tell you how long it will last, how severe it will be, we believe that we have strength across the business now, that we just didn't have before, that makes us much better positioned. We talked about the structural changes from the last cycle to where we are now, I mean, there's been over 1,600 basis points of improvement in margin, right? So again, when you think about where you're starting from and when the downturn comes is just a very different place……… I think I just want to put an exclamation point on one thing Jess said, we've been generating free cash flow here in the growth cycle. That has not been the history of this company or this industry. It's always been that you can generate robust free cash flow once you turn off that capital spigot as you get into a down cycle or a delay or whatever you want to call it. So I think that's a significant change in how the company will look through any part of the cycle.”


Matthew J. Flannery President & COO and Jessica T. Graziano Executive VP & CFO


Citigroup February 21, 2019


As a result of the improvements to URI’s business model, profitability, returns and cash flow dynamics have all improved notably from pre-recession levels. Adjusted EBITDA margins have improved from 31.5% in 2007 (prior to the cyclical downturn) to about 48% currently. As part of this improvement, gross margins have grown from 35.3% to 42.5%, which provides great downside protection in another downturn. Additionally, as illustrated below the increased profitability has helped improve cash flow dynamics over this period.