About a year ago, I wrote that Ashtead Group PLC (LSE:AHT, Financial), the equipment rental specialist, was on my watchlist. Today, I take another look at the company that just reported a year of record performance.
In the last six months, shares have fallen from 64 pounds ($77.10) to 37 pounds and now trade on just 12 times expected earnings, when over the last five years this metric has averaged around 17 times. It would be easy to predict a collapse in industrial demand, cut rental rates and a rapid fall in earnings, but to do so would be lazy. We are not in the same position as the recession that followed the global financial crisis in 2008.
Investors have ignored Ashtead’s bullish guidance and instead priced in a recession for the group’s core market, the U.S. Management is confident enough to guide for an increase in U.S. rental revenue of between 13% and 16% this year and 12% to 14% annual growth in rental revenue at the group level.
With the return of live events and the restarting of construction projects, demand for heavy equipment is on the rise. Supply chain disruptions everywhere favor suppliers like Ashtead who have large fleets. This means the company, which owns Sunbelt Rentals, can take market share from smaller competitors.
In the last year, Ashtead has been able to achieve higher rental rates, compensating for the inflationary challenges the group has faced with rising wage and energy costs. Still, the company was able to increase capital expenditures last year on the back of the Covid recovery and reported an impressive increase in its pre-tax profit margin to 21% versus 18.6% last year.
CEO Brendan Horgan is bullish and announced an ambitious capex target of $3.3 billion to $3.6 billion for the coming year, compared to the $2.4 billion spent last year. The priority for investment is opening new hire facilities. This will eat into free cash flow this year, which is expected to drop to $300 million from $1.1 billion last year.
However, this reach for scale in the largest regional markets should help Ashtead achieve both economies of scale and the ability to supply more types of equipment, which it reckons means customers will be willing to pay more for the convenience this brings. Prior to the pandemic, rental rates in markets clustered together were just over 2.3% higher than in areas more sparsely populated. Revenue per customer was 15% more and margins 4.3% percentage points higher in areas the company had greater presence in.
Even if the risk of an economic downturn is real, Ashtead’s stock price is modestly undervalued according to the GF Value. It has a decent Altman Z-score of nearly 3 and a strong Piotroski F-Score of 8. Also, I believe the company has some ability to counter any economic downturn; it can cut its capital expenditure, which would preserve cash and freeze the fleet size, enabling it to focus on protecting the equipment utilization rate, which would help cash flow.
Financially, Ashtead is stronger than before. Leverage is at a near record low, with net debt at 1.5 times Ebitda. This is down from 1.8 times in 2019 and 2.7 times back in 2007. Cash available via its debt facility is just over $2.5 billion.
Management’s objective of putting more focus on specialty tool rentals and reducing its relative exposure to the commercial construction sector looks to be a smart move in case construction slows down on the back of higher interest rates. Currently, the construction sector makes up 45% of Ashtead’s revenue. Credit must go to the company for diversifying over the last few years as construction made up about 90% of revenue during the 2008 global financial crisis-driven recession.
Last year, the company changed its presentational currency from sterling to U.S. dollars to allow for greater transparency in its performance for investors and other stakeholders and to reduce exchange rate volatility in reported figures, given that about 80% of its revenue and about 90% of its operating profit originate in U.S. dollars. This also paves the way for a potential change in listing from London to New York, where industrial goods and services companies are often more highly valued. It feels like Ashtead could be a target for an activist investor to push for this move, just like what happened with Ferguson (FERG, Financial), which announced last month that its primary listing is now on the New York Stock Exchange and not the London Stock Exchange after Trian Fund Management pushed for the move after taking a sizeable stake in that company in 2019.
Stronger now
Ashtead’s financial strength has improved with its Altman Z-Score at the highest level in 20 years.
Meanwhile, the stock’s valuation at 29 times the Shiller price-earnings looks much better valued compared to just last year, when its ratio was above 50.
The stock has a profitability rank of 10 out of 10 according to GuruFocus. The company appears to be attractively valued and certainty could be an interesting investment opportunity.
