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Ashtead angst overdone

Tool hire group Ashtead has exhibited spectacular earnings growth, but we think there is still more to be had.
August 20, 2015

Shares in equipment hire group Ashtead (AHT) have fallen by more than a fifth from their early-summer high, as investors have focused on warnings from rivals, fretted about overcapacity in the US - where Ashtead generates 85 per cent of its revenue - and worried that margins may have peaked. There have even been some broker downgrades, which is not something Ashtead shareholders are used to following five years of phenomenal growth that have taken EPS from 0.2p in 2011 to 60.5p last year. But with the shares' rating now at a three-year low and strong growth still expected from the buoyant US construction sector and a recovering UK, we think the sell-off looks well overdone.

IC TIP: Buy at 951p
Tip style
Growth
Risk rating
High
Timescale
Medium Term
Bull points
  • Rapid organic earnings growth
  • Historically low price-to-earnings ratio
  • Buoyant end markets
  • Increasingly high margins
Bear points
  • Heavy investment in fleet required
  • Thin dividend yield

Equipment hire businesses are inherently cyclical. This helps explain the severity of Ashtead's recent sell-off despite a lack of company-specific negative news and the "high" risk rating we're attaching to this tip. When things go well for hire companies more equipment is rented out at higher rates, and it is possible to sell on old kit at better prices. As operating costs and the cost of new equipment tend to remain relatively constant, these positive factors have a big impact on earnings. However, if the cycle turns the same factors work in reverse, as happened savagely following the credit crunch. What's more, the huge amount of capital that hire companies necessarily have to tie up in equipment means they can also embody significant balance-sheet risk.

 

But while nervousness about this type of business is understandable, we don't think there is nearly as much to worry about with Ashtead as the recent share price fall suggests. The non-residential construction market in the US, which accounts for about half of Ashtead's stateside business, still looks strong. Meanwhile, fears about overcapacity in the US market are questionable. While some commentators have pointed to fleet investment approaching peak 2006 levels, broker Berenberg points out that, adjusted for inflation, fleet investment remains 45 per cent below the peak.

 

 

Another of the market's capacity-related fears centres on rental equipment being redeployed from the struggling oil and gas industry - a market Ashtead has limited direct exposure to. Indeed, rival US operator United Rentals (US:URI) recently warned it would be hit by the slowdown in the sector. While this risk cannot be written off, we feel it would also be wrong to overplay it. What's more, there is major structural change afoot in the relatively immature US market, with construction companies continuing to switch away from owning and managing their own fleet towards outsourcing this balance-sheet burden to hire companies.

Existential angst aside, Ashtead's US division, Sunbelt, has been doing very well. It increased operating profit by a third last year to £521m. The US equipment hire market is still fragmented and Sunbelt has benefited from taking greater market share from its smaller competitors. Key to this has been investing in its existing stores by expanding and renewing its fleet. Expanding through existing stores requires far less spending, which has helped boost operational efficiency. Last year cash profit margins improved by 200 basis points to 47 per cent, while stores open for more than a year saw a whopping 67 per cent of revenue drop through to cash profits. Ashtead is also opening new stores which could drag on profitability and some brokers fear margins may have peaked. However, the company is also increasing exposure to higher-margin equipment, and along with its strong operating nous, we don't think there should be too much to worry about.

Meanwhile, on home turf, Ashtead's A-Plant business is trading strongly. Rental-only revenue grew by a fifth last year to £238m and margins soared by 460 basis points to 33.9 per cent. The growth of both A-Plant and Sunbelt is being assisted by bolt-on purchases - acquisition spending more than doubled last year to £236m.

ASHTEAD GROUP (AHT)

ORD PRICE:951pMARKET VALUE:£4.8bn
TOUCH:951-952p12M HIGH / LOW:1,231p878p
FORWARD DIVIDEND YIELD:1.8%FORWARD PE RATIO:11
NET ASSET VALUE:221p*NET DEBT:152%

Year to 31 DecTurnover (£bn)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
20131.3629031.47.5
20141.6340946.611.5
20152.0449062.713.5
2016**2.4860774.915.0
2017**2.8171888.717.0
% change+13+18+18+13

Normal market size :2,000

Matched bargain trading: SETS

Beta: 0.92

*Includes intangible assets of £609m, or 121p a share

**Numis Securities forecasts, adjusted EPS and PTP figures