The highly cyclical tool hire sector has performed well over the past six months, as the US and UK construction markets continue their recoveries. But since the upturn is still in its early stages - or at least, perceived to be - housebuilders and other players in the construction industry are still nervy about investing in capital equipment. Presumably, companies will become more inclined to actually purchase equipment once they become convinced that the recovery has become entrenched. For now, however, they remain circumspect over its durability. This has created ideal trading conditions for specialist tool hire groups such as Ashtead (AHT), Lavendon (LVD) and Vp (VP). But given recent events, investors might also be justified in wondering whether the sector's recovery is beginning to slow.
Relative performance has been solid enough: Ashtead has outperformed the FTSE All-Share by 18 per cent over the past 12 months, while Vp was 12 per cent in advance of the index over the same period. But it hasn't been plain sailing for all the sector constituents; in recent weeks, both Speedy Hire (SPY) and recently listed HSS Hire (HSS) have issued profit warnings. The question is, of course, were these warnings predicated on company-specific issues, or are they harbingers of a broader industry decline? We plumb for the former on this score.
HSS Hire only began trading on the main market in February, but has already lost more than a third of its 210p listing price. The shares fell off a cliff following management's pre-close trading update ahead of its interims, which are due next month. A slow second quarter across some of its key accounts - which service the needs of larger construction companies - led to performance lagging well behind management's expectations. Hardly ideal if you had got in at the IPO, but management insists that business has now returned to more normal levels.
Nevertheless, the weak second quarter, combined with the cost of an extensive branch rollout programme, means that the group's adjusted cash profits for the first half are now expected to be flat on the previous year. The group also had to contend with stalled building activity due to uncertainties over central government policy ahead of May's general election. This undoubtedly contributed to a decline in hire activity.
As a consequence, analysts at Numis subsequently lowered their forecasts for full-year cash profits for HSS by around 5 per cent and adjusted EPS by almost a fifth to 10.1p. It is also worth remembering that HSS Hire also came on to the market trading at a substantial premium to peers - that obviously now seems wholly unjustified given subsequent events.
Yet prospects for rival equipment hire group Speedy Hire are even bleaker. A shock profit warning earlier this month revealed a slower-than-expected start to the 2016 accounting year. Management now expects that results for the full year will be "materially below" the previous year. Management blamed a lack of available equipment during its network optimisation programme, not enough focus on its small-to-medium sized businesses and poor customer service - the latter problem exacerbated by disruption brought about by the implementation of a new IT system. Admittedly, IT problems aren't peculiar to Speedy Hire, but the shortage of available kit for hire is simply damning in terms of management's performance. Worse still, negotiations for the sale of the group's oil and gas business in the Middle East - previously described by then-chief executive Mark Rogerson as "the number one priority" - were also revealed to have fallen through.
Even before this news, the group had been dealing with the aftermath of the much-publicised discovery of accounting irregularities at its international division in late 2013. The subsequent restructuring of the division, closure of its operations in Egypt and Qatar and the sale of its Oman business resulted in a series of exceptional charges and a near-75 per cent drop in pre-tax profits last financial year. Shares in the group are now trading at their lowest level since the close of 2013.
On the opposite end of the spectrum is US-focused Ashtead Group. Those invested in the group will have seen their investment increase by a fifth since this time last year. The group has benefited from a buoyant US construction market via its Sunbelt business, which has boosted its operating profit by a third to £521m. Ashtead's UK A-Plant business is following suit, upping its operating profits by a fifth over the same timeframe. The group has also benefited from an substantial increase in the price it has received for the sale of equipment that has reached the end of its rental life. Last year, Ashtead gained 13 per cent in additional revenues from the sale of used equipment - and that percentage is set to improve further still.
With a network of 640 rental stores across the UK and US, Ashtead has also been able to take advantage of scale benefits. This is reflected in successive profit increases over the past five years. In the US, around 70 per cent of the group's profits typically derive from 'same-store growth', which is defined as increasing the fleet size in stores that have been in existence for at least a year. Last year, same-store revenue grew by almost a fifth to $247m. Overall, Ashtead invested £1bn in increasing the size of its rental fleet and has earmarked the same amount for investment this year. Yet, this has also meant the amount of debt on the group's books has also ratcheted up to around 150 per cent of its net assets, or £1.7bn.
Fellow equipment hire specialist Vp has also experienced a run-up in its shares recently, which have risen 18 per cent since the start of June. The group's business model is more diversified than Ashtead's. Vp provides scaffolding, lighting and power systems for use in construction, as well as small tools and specialist equipment for industry. Its Hire Station business increased its operating profits by more than three-quarters last year to £8.7m. Management has already moved some of its provincial depots to larger premises and opened new sites in London to meet increased demand.
IC VIEW: We reckon investors should not let recent profit warnings from HSS Hire and Speedy Hire deter them from investing in the tool hire industry. The recovery in the UK construction market looks set to roll on, making further earnings upgrades likely. While the price of some of the best performing groups in the sector have increased over the past year, there is still value to be had.
