The equipment rental sector has been on a turbo charged run from mid November: Ashtead shares have risen over 50 per cent, Speedy Hire is up 40 per cent and Vp and Lavendon are up 17 per cent respectively. For companies that are acutely susceptible to recessions this is slightly counter intuitive, one only has to look to the last global downturn in 2008 to see how badly these companies are hit in a slowdown. So why have investors been switching on to the sector?
Michael Parkinson, support services analyst with Brewin Dolphin said: “For investors looking to play a market rally, there is no better way.” He points out that these business’ are incredibly cheap on an enterprise value to earnings before interest tax depreciation and amortisation multiple. He also adds that this sector has been through a tough three year period of self help since the 2008 crash.
Speedy Hire, the UK focused tool hire firm, is a case in point; it was staring into the abyss in 2009 with a debt mountain of £256m and collapsing earnings as the construction sector downed tools. Shares slumped over 90 per cent as investors feared being wiped out by the debt. However, an emergency £100m equity issue in 2009, combined with cost cutting, slashing capital spend and selling off vast swathes of redundant equipment managed to bring them back from the brink. In a trading update up to the end of January Speedy announced revenues up 7.6 per cent and trading in line with market expectations to return to profit.
Andrew Nussey, support services analyst with broker Peel Hunt, said that many of the actions taken by hire firms after 2008 have set up the favourable conditions today. As firms sold off huge amounts of kit and reduced investment in the existing fleet it has created a lack of tools required to service any recovery in activity, regardless of how slight. The hire firms hand has been further strengthened by a lack of bank finance for construction contractors who would usually look to purchase tools on agreements. As Mr Nussey says, the equipment rental firms are now finding themselves in a “sweet spot”.
Nowhere has this been felt more than the US where the construction sector has been surprisingly resilient despite some concerning indicators last year. This has helped Ashtead, which generates 83 per cent of its revenue through the US division Sunbelt, to record results recently. Ashtead has also been aggressively deleveraging, at the height in 2008 net debt was £1.3bn, but by October last year it was reduced to £889m. Mr Nussey said that once debt is paid down any recovery in earnings goes straight to equity holders, he added: “The outlook continues to look very good in the US.” Certainly US peer United Rentals is confident of growth as it made a $1.9bn bid in December for rival RSC Holdings, if completed the deal will create the largest tool hire company in the US.
In the UK the construction sector has been a cruel mistress for the tool hire firms as private sector construction collapsed in 2008 followed by public sector construction hitting the wall in 2010. Now the outlook for construction is perhaps more benign. The most recent Markit/ CIPS UK Construction PMI posted 51.4 in January, which while low, still shows marginal growth. Chancellor George Osborne has improved sentiment after outlining big infrastructure spending plans in the autumn statement, and with pressure growing for more stimulus nothing fits the Keynesian bill quite like construction. This will help diversified players like Vp which offer specialist equipment to the regulated water industry, road, rail, and oil and gas industries. Management recently announced they expect to beat analyst’s forecasts for the full-year.
Two names that operate a long way from these shores but are listed in London are international power providers Aggreko and APR Energy. Hiring out power generators to developing countries is a proving to be a profitable business. The risk and logistics expertise required to deploy the generators allows both company’s to charge higher rates and as such generate a much higher return on capital than traditional equipment hire, hence the premium share rating they attract. As the developing world adopts our addiction to electronic devices electricity demand should only rise.
Favourites
We like Vp because it offers good sector diversification across the regulated water industry, rail, and oil and gas. The balance sheet is strong with net debt at a manageable 46 per cent and strong cash generation. Vp is also well placed to benefit from any recovery in infrastructure spend, at the half year stage they announced a big rail contract win. In a recent trading update management said they would beat analysts expectations for the full-year. Given the re-rating of sector peers Speedy Hire and Lavendon; the shares at 257p, a forecast PE of 9 times, retain our Buy.
Outsiders
Aggreko has been a stock market darling for many years now and the city never fails to cheer it on to new heights after every trading update. Sure it has never disappointed with its performance and it will receive a nice windfall from supplying power to the London 2012 Olympics. But we believe all this and more is in the price already as the shares at 2,051p have a punchy rating of 21 times forecast earnings per share. APR is the new kid on the block and brings with it a stellar growth record, the shares at 1,051p, a PE of 21.3 times, has all this priced in.
Broker View
2012 looks set to be a much better year for the UK Rental Stocks. Increasing trading stability, self-help benefits, market share concentration (as smaller peers struggle) and management focus on returns on capital should reward investors well. Furthermore, strengthened balance sheets should facilitate attractive investment as end markets recover. We believe that this should provide the potential for further share price upside.
In terms of interesting stocks, whilst always mindful of valuation and balance sheet resilience, we prefer market leaders who have the most to gain from market concentration as well as those with a trading platform capable of delivering more volume for less incremental cost.
Despite a strong performance in 2011, we consider that Ashtead’s recent trading momentum (driven by both increasing levels of fleet on rent and yield) and attractive valuation at this stage of economic recovery could lead to further efficiencies. We also believe that the recent management strengthening at Lavendon as well its focus on driving sustained improvement in returns on capital should be rewarded with a higher rating. We also consider that its broad geographic exposure provides a degree of insulation from any country specific risk.
Finally, we would mention Northgate. Recent results have been encouraging as progress is delivered on improving efficiency (despite the UK and Spanish fleet still contracting). The shares currently trade at a discount to net assets (which appear prudently stated) yet the business continues to deliver improvements in returns on capital.
Andrew Nussey is support services analyst with broker Peel Hunt
“This article does not constitute a personal recommendation and the investments referred to may not be suitable for the specific investment objectives, financial situation or individual needs of readers and should not be relied upon in substitution for the exercise of independent judgement.”
