United Rentals Stock: This Capital-Intensive Business Deserves Attention (NYSE:URI)
Unbound rents (NYSE:URI) is a leader in an industry that seems to have fallen out of favor with most investors. Despite being a high-growth stock with hard-to-copy competitive advantages, it rarely makes the headlines and is trading at a low double-digit multiple of expected earnings.
Historically, United Rentals has been a gem for investors, having returned more than 500% over the past 5 years, vastly outperforming its major peers.
Looking ahead, URI is well positioned to deliver superior shareholder returns for a number of reasons. As a starting point, the rental equipment sector is experiencing a strong secular tailwind.
Return to mean
Equipment rental is still a very fragmented sector where high economies of scale can be achieved crucial for success. In this regard, United Rentals’ growth strategy has made the company the absolute leader in the highly attractive United States market.
While the risk of a near-term recession is real, longer-term investors are optimistic about trends of deglobalization that are bringing more industrial production to shore.
The chart below clearly shows how construction spending per capita has fallen below its long-term trend over the past 10 years.
However, this is rapidly changing as more industrial capacity is brought back to the United States. While this already sounds like a cliché, onshoring is happening in the energy, automotive, and semiconductor industries as you read this.
The government plays a key role in this process and has already created a highly supportive environment for further mega-projects in these and other areas.
As the largest rental equipment company, United Rentals is among the best positioned companies in the industry to win major projects due to the breadth of its portfolio and wide geographic reach.
In addition, United Rentals’ customer mix has already shifted strongly towards industry and non-residential construction.
The company has therefore already issued a sales forecast for this financial year, which assumes growth of around 20%. While the recent acquisition of Ahern Rentals also plays a role, organic growth remains high.
Free cash flow is also expected to improve significantly this year, even as the company spends a record amount on capital expenditures (more on that later).
The equipment rental industry relies heavily on scale. On the one hand, the larger companies were able to significantly increase capacity utilization and the proportion of fixed costs. On the other hand, they could also differentiate themselves by also serving more niche areas of the market.
This larger scale translates into a major competitive advantage that also translates into higher margins and a higher return on investment.
As such, you’d expect United Rentals’ return on equity to have skyrocketed in recent years as the company has more than doubled in size since 2013. Unfortunately, however, that was not the case and the ROE is now in line with the company’s historical average.
If we look at the main drivers of ROE, we find that operating margin is now at record highs, while asset turnover is also at its highest level since 2013. However, debt has fallen rapidly in recent years, which has largely offset the stellar operating performance.
Equipment utilization is one of the key metrics behind record high asset turnover and margins. For this reason, United Rentals price-to-book multiple is historically related to rental equipment dollar occupancy.
However, we will likely see multiple re-ratings if utilization rates remain high in 2023 and URI continues to expand its footprint.
cash flow machine
The final piece of the puzzle that makes United Rentals so attractive is the company’s focus on free cash flow and its capital allocation process.
Through its aggressive M&A and organic growth strategy, United Rentals grew very quickly, accelerating its free cash flow.
Anyone who follows my work knows that the phrase “aggressive M&A strategy” usually gives me a big red flag. And that’s exactly what United Rentals has been doing for the past decade.
However, right off the bat, we note that the deals haven’t increased in size over the years, suggesting the company isn’t just pursuing these deals to inflate its near-term top-line growth.
What’s more, United Rentals’ shareholders haven’t been diluted in the process — quite the opposite, and its debt has also come down over the past decade.
This alone is in stark contrast to other aggressive M&A strategies that I have criticized for years that have ended up destroying shareholder value (see here, here, here and here).
Another benefit that comes with United Rentals’ size is that the company could afford to outbid its smaller competitors without overpaying significantly. One such example is the acquisition of Neff, in which the smaller H&E Equipment (HEES) was outbid by URI.
Despite the bidding process, reported goodwill still accounted for a small portion of the total net assets acquired.
A large amount of goodwill and a low amount of individually identified intangible assets after an M&A deal are usually an important red flag.
United Rentals’ prudent M&A strategy has enabled the company to now resume its share buyback program while introducing quarterly dividend payments.
(…) we reactivate them $1.25 billion share repurchase program that we pause as we announce the Ahern deal. We plan to buy back $1 billion of stock this year. And so will we Introduction of quarterly dividends to our shareholders totaling $5.92 per share this year.
Source: United Rentals Q4 2022 Earnings Log
In addition to looking to return cash to shareholders, management is also prioritizing organic revenue growth. This is evidenced by the company’s record spending on purchasing rental equipment relative to its cash flow from operations (capital expenditure).
The acquisition of rental equipment as a percentage of annual depreciation was over 150% in fiscal year 2022, which is by far the highest rate in the past 10 years.
United Rentals’ capital allocation strategy was a masterclass in successfully executing an aggressive M&A strategy. At the same time, management has also prioritized organic sales growth and distributions to shareholders. Most importantly, the company has secured a major competitive advantage that I believe would allow it to maintain its industry-leading profitability and return on investment. Last but not least, the stock still trades at relatively conservative levels, creating a long-term opportunity for anyone willing to weather the short-term volatility in the markets.
Editor’s note: This article covers one or more securities that are not traded on a major US exchange. Please be aware of the risks associated with these stocks.