United Rentals Inc. (URI, Financial) holds a prominent position as the top equipment rental company in the U.S. with a vast network of 1,521 branches. The company provides a wide selection of equipment, from general construction and industrial tools to specialized equipment tailored to various applications, and leases them to construction and industrial companies, utilities, municipalities and even homeowners. It is a good business.
Since 2016, I have monitored United Rentals and have been pleasantly surprised by its market outperformance. In early 2016, I thought the stock could hit $100 per share in three years. In 2018, United Rentals was closing in on $190 a share and in 2019 had fallen back to the $110 range. With the stock off 20% from its February high of $481, and with the earnings continuing to grow, the company's shares look like a bargain again.
Financials
With first-quarter numbers set to be released later this month, management anticipates 2023 revenue to come in between $13.7 billion to $14.2 billion, representing a 17% to 22% increase from the previous year's $11.64 billion. Profitability is projected to rise at a similarly brisk pace, with Ebitda potentially reaching $6.85 billion. Net cash is expected to be between $4.4 billion and $4.8 billion, while free cash flow excluding charges is forecasted to fall between $2.1 billion and $2.35 billion for the year. The company’s market capitalization is just shy of $26 billion.
CEO Matthew Flannery said 2023 is likely to be a year of robust growth for the company, irrespective of the macroeconomic environment. This is a very aggressive statement considering fears of economic slowdown, especially in commercial real estate.
Potential weakness in the housing sector could mean in a pullback in non-residential construction, which forms the backbone of United Rental’s leasing business. That said, the $1.2 trillion Infrastructure Investment and Jobs Act is going to funnel a lot of money toward transportation infrastructure, broadband expansion, clean energy initiatives, water infrastructure and more. For instance, it dedicates $110 billion to roads, bridges, and major projects, $66 billion to railways and $65 billion for broadband infrastructure. United Rentals will be there to provide the heavy equipment necessary, which is why analysts like ValueLine project earnings per share to reach $61.05 by 2028, representing an annual increase of at least 11% from 2022's $32.50 figure.
That outlook is based on several tailwinds for construction-related providers. Including increased infrastructure spending, the growing trend towards on-shoring critical industries and a broader shift toward equipment leasing are all huge factors that United Rentals will continue to extract value from.
Manageable debt
The industry the company operates in is highly fragmented and dominated by a few companies. United Rentals has performed very well using its main strategy of leveraged buyouts to grow via acquisitions. In the short term, it works, but, in the long term, it builds a substantial amount of debt that tends to burden a company’s growth.
The company only keeps about $100 million in cash on the books while adding another $2.5 billion in long-term debt since 2017. However, United Rentals has continued to use the debt to buy hard assets that produce returns north of 10% a year. The profit has continued to push retained earnings higher with every $1 retained, generating $2.50 in market value.
Dividends, finally
United Rentals has recently become a dividend-paying company, with the board of directors approving a quarterly distribution of $1.48 per share in January. The first payment was made on Feb. 22.
The company's leadership team indicated the decision reflects their confidence in the organization's future prospects. Further, dividends could bolster the share price by broadening the potential pool of investors to include those seeking income.
As long as United Rentals can maintain its 42% gross margins and 18% net profit margins, it should be able to continue growing despite paying dividends. This could also be a good way to keep current shareholders who have held on through the last three, five and 10 years and experienced exceptional capital gains.
Future value
With all the above factors, United Rentals is poised to maintain its position as a leading company in the equipment rental industry. Many of the equipment brands featured in its product catalog can also be found at other competing companies, such as Sunbelt Rentals (owned by Ashtead Group PLC (LSE:AHT, Financial)) and Herc Holdings Inc. (HRI, Financial), as well as numerous smaller rental businesses throughout North America. However, what separates it from the smaller competitors is selection and reliability that few, if any, can actually compete with. These factors create a durable competitive advantage in brand power, barrier to entry and scale that even Sunbelt (which is a little over half United Rentals’ size) has a hard time matching in most markets.
With that in mind, United Rentals still has plenty of room left to grow. Despite being the industry leader and successfully increasing its top and bottom lines at incredible rates, the price remains undervalued. While the sector median price-earnings ratio is around 16, the stock is trading at 12 times earnings. Regardless of what happens in terms of market fluctuations or profit expectations, United Rentals will be around in 20 years in the same line of business, providing a valuable service to customers at higher prices to meet inflationary demands. More importantly, it will likely be a much more valuable company as well.
