Double down on this 'Isa millionaire' stock

The group’s voyage across the Atlantic has been an undisputed success. According to AJ Bell, Ashtead is the UK’s top ‘Isa millionaire’ stock. Had you invested your full individual savings account (Isa) allowance in Ashtead since the tax wrapper was introduced in 1999, and reinvested the dividends, you would now be sitting on £17.1mn. It is well ahead of silver medal holder Games Workshop (GAW), which would have made you less than £9mn.

After years of earnings upgrades and share price gains, however, Ashtead has stumbled. Its shares are down 14 per cent year on year and investors are nervous about the demand outlook. While Ashtead originally expected to achieve rental revenue growth of 13 to 16 per cent in the year to April 2024, it is now targeting the “low end” of 11 to 13 per cent. 

Some are worried that momentum is waning. Instead, now might be an attractive opportunity to buy in.

Deconstructing demand

Ashtead’s difficulties emerged last November, when it said a “significantly quieter hurricane season” and a lack of wildfires had dented demand for its tools. Strikes in Hollywood also impacted its small Canadian business, which provides on-set equipment for the entertainment industry. 

These sound like one-off glitches. Natural disasters are unpredictable, but climate change is driving more extreme weather events, and the Hollywood row has now been resolved. The general backdrop in the US isn’t straightforwardly positive, however. Higher interest rates are dampening business confidence and the Dodge Momentum Index – a leading indicator of construction spending on non-residential projects – points to a moderation in spending. 

Legislative drivers such as the Inflation Reduction Act and the Infrastructure Investment and Jobs Act remain firmly in place, though. Moreover, Ashtead is getting increasingly involved in ‘mega-projects’, such as the $1.6bn (£1.25bn) LG Energy Battery Plant in Arizona. As well as driving sales, these multi-year schemes provide some helpful visibility.

Underpinning all this is the fact that renting equipment is still less popular in the US than it is in other developed countries. According to Panmure Gordon, just 55 per cent of construction equipment used in the region is rented, compared with 75 per cent in the UK. As the dial turns, Ashtead is in prime position to benefit, and periods of economic disruption such as the financial crisis and the pandemic have tended to accelerate the shift. 

Tough business model 

Ultimately, the strength of demand will always be subject to change and shocks. The reason Ashtead is such an attractive investment, though, is because of its uncanny ability to generate returns throughout the economic cycle. 

Over the past 10 years, it has pumped money into its North American business, expanding its network organically and making hundreds of bolt-on acquisitions. Since 2014, its US store network has more than doubled; its market share in the region has swelled from 7 per cent to 13 per cent; and its revenues have more than quadrupled. 

Yet, throughout the entire process, adjusted operating margins have barely wobbled, only dipping below 24 per cent at the height of the pandemic. And despite capital expenditure constantly ratcheting up, return on investment (excluding goodwill and intangibles) has never fallen below 20 per cent in the US, or under 15 per cent across the group.

This is a clear indicator of a tightly run company that both knows what it is doing, and which is valued by its customers. Indeed, one of Ashtead’s most cited characteristics relates to the quality of its customer service and excellent availability and breadth of its stock. 

Ashtead has also made various attempts to strengthen its business model. It is significantly more diversified than it used to be, for example. A decade ago, most US revenues were generated in the eastern half of the country, but it has now successfully expanded into California. The business is also less reliant on building projects: nearly 60 per cent of revenue comes from non-construction activity and the group has successfully grown its ‘specialty’ arm, which provides the niche equipment that smaller peers don’t typically offer.

Flight risk

Despite Ashtead’s origins, it is easy to overlook the UK side of the business. When you do focus in, however, some cracks start to appear. Margins in the UK are significantly lower than in the US and return on invested capital has proved underwhelming – particularly in recent years. Meanwhile, store growth seems to have plateaued, if not actively kicked into reverse. 

A big part of the problem relates to the fact that the equipment rental market is more crowded in the UK, with the likes of Speedy Hire (SDY) and VP (VP.) competing for work. As such, pricing is more aggressive. General economic growth has also been lacklustre. 

It is dangerous to write off underperforming parts of a business as insignificant – even if they are small. Currys (CUR) shareholders learnt this the hard way last year when poor trading in the Nordics prompted management to cut the dividend. Ashtead’s difficulties in the UK could also be a sign of troubles to come in the US.

For now, however, Ashtead has a long road ahead of it before the US market gets too crowded, and analysts expect UK operations to keep shrinking as a proportion of the whole group. Indeed, there is a very real chance that Ashtead will abandon its London listing altogether and head to the New York Stock Exchange in search of a higher valuation.

As such, now might be a good time to think about buying in. Ashtead looks pricey next to its UK peers: its price/book ratio sits at 4.1 times compared with VP’s 1.2 times. Given the make-up of the business, however, it makes more sense to compare it with a US rival – namely United Rentals (US:URI), the world’s biggest equipment company.

Ashtead has historically traded at a premium to United Rentals, partly because its growth trajectory has been steeper and partly because of the latter’s reliance on big acquisitions. At the start of this year, however, valuations of the two stocks converged and United Rentals is pricier than its London counterpart for the first time in over five years. This could spell opportunity.

Equipment rental companies are never without risk. The sector is vulnerable to accounting scandals and will always be somewhat cyclical. If the construction sector crashes, demand will inevitably slump. Ashtead’s impressive track record and proven strategy is extremely appealing, however – and its current valuation looks very reasonable, even if growth does moderate as expected.

In fact, if growth does step down a gear, Ashtead will have far more cash to play with. Management is planning to reduce gross capex from $4.2bn this year to about $3.15bn in FY2025, and broker Peel Hunt expects the group’s free cash flow yield to climb to 10 per cent by next April. 

Generous dividends or share buybacks could beckon, which would only complement Ashtead’s ongoing American road trip.