United Rentals: Dirt Cheap, But Cyclical And Risky

United Rentals (NYSE:URI) is one of the cheapest stocks out there right now. In fact, it ranks as the 29th cheapest mid or large cap stock (out of ~1,700) based on its forward P/E of 7. URI is also trading well below its average five-year valuation no matter which metric (P/E, EV/EBITDA, P/B, P/Cash flow, etc.) you want to look at. It looks like URI might be cheap enough to make it a good buy for adventurous investors, but the stock comes with some substantial risks.

The Good

Let's start off with what is attractive about URI before we get into some of the risks. URI is the biggest player in the equipment rental market with an estimated market share of 13%. The number two player, Ashtead Group (Sunbelt in the US/Canada) is only about half as large with a 7% market share.

This gives URI two major advantages. First, it has better purchasing power than competitors, especially smaller local competitors with just one or two locations. Second, URI can greatly increase the efficiency and utilization rates of equipment by sharing amongst branches.

However, we don't really see any of these advantages show up versus Ashtead Group. It's highly likely that there is too much of a difference in the types of equipment the two companies rent out to make the comparisons meaningful. URI rents out a significantly higher number of larger more expensive items like aerial platforms and forklifts compared to Sunbelt. Meanwhile, it looks as though Sunbelt has a substantial power-tool rental business (smaller cheaper, items).

FY2018

URI

Ashtead/Sunbelt

Equipment count

230,000

680,000

Original cost

$4,300,000,000

$8,930,000,000*

Cost/piece of equipment

$18,696

$13,132

*Converted from GBP using exchange rate of 1.36 at April 30, 2018, Sunbelt FY2018 year end.

(Source: Company filings, author's calculations)

We can see that Sunbelt has more items at a lower cost, while URI has less at a higher cost. Additionally, URI's dollar utilization rate is 44% compared to 55% for Ashtead/Sunbelt.

Instead, most of the advantages that come with being the largest rental equipment company are mostly against smaller, local or regional players.

The Bad

The equipment rental industry is commoditized and is highly fragmented and highly competitive. Companies are offering identical products (equipment produced by third party manufacturers) and mainly competing on price and availability (a well-maintained and serviced JLG lift is the same no matter where you rent it). As would be expected in a highly competitive industry, returns on invested capital for URI are below the average of the stock market as a whole.

The equipment market is also highly sensitive to the economic environment and very cyclical. URI details in their 10-K that their business is primarily linked to the non-residential construction market and the oil and gas industry.

Demand for our services and products is sensitive to the level of exploration, development and production activity of, and the corresponding capital spending by, oil and natural gas companies, including national oil companies, regional exploration and production providers, and related service providers. The level of exploration, development and production activity is directly affected by trends in oil and natural gas prices, which historically have been volatile and are likely to continue to be volatile.

Our general rental equipment and trench, power and fluid solutions equipment are used in connection with private non-residential construction and industrial activities, which are cyclical in nature.

This means that the business has high operational leverage. When times are good equipment, utilization rates are high. When times are bad, the company has a significant amount invested in PP&E that is not earning any return. Indeed, the company posted losses in FY2008 and FY2009 on a GAAP basis although the company was free cash flow positive those years (we net out buying and selling equipment when calculating capital expenditures since the company sells old equipment and the proceeds are accounted for as cash from investing activities).

URI also carries substantial debt, which is junk-rated at BB/Ba2 by S&P and Moody's, respectively. The company has pursued a roll-up strategy over the past decades and taken on significant debt to fund a regular series of acquisitions (275+ over 20 years in total). While a roll-up strategy in this industry seems to make sense, given economies of scale and efficiency benefits, the high debt load still means there is risk. A substantial portion (about 30% according to company filings) of the debt is variable rate, and interest expenses will rise if the Fed resumes raising rates.

The good thing is that compared to FY2011 (when company management said business stabilized after the recession), URI is relatively less indebted today.

(Source: Company filings, Yahoo Finance (historical stock price), author's calculations)

On just about every metric, the company is better able to service its debt load now versus in the past. So, despite substantial debt-funded acquisitions, the company appears to have reaped enough benefits to make them worthwhile.

Summary

URI is a very cheap stock that carries a substantial amount of risk. It's a heavily indebted company in a commodity business. However, for more adventurous investors, there are some things to like. The stock is dirt-cheap, returns on capital are okay but not great, and as the largest company in the sector, it enjoys a few benefits from scale especially versus smaller competitors.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source : https://seekingalpha.com/article/4241239-united-rentals-dirt-cheap-cyclical-risky

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