AGB 2024.2 - Ashtead Group (AHT.L)

Methodical Share Gains

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Ashtead

Ashtead is the 2^nd largest equipment rental company in North America. The company supports 800k+ customers and has a fleet of 1M+ rental units, which are offered at 1,181 locations in the U.S., 136 in Canada and 191 in the U.K. Ashtead is headquartered in the U.K. but most of the business in the U.S. under the Sunbelt Rentals brand. The company acquired Sunbelt for $2.5M in 1990, which was based in North Carolina. Since then, Ashtead has expanded through a series of bolt-on acquisitions and greenfield location openings. In the U.K. the company has been the leading equipment rental company since 2015.

Customers of Ashtead rent general tools and specialty equipment from the company on demand. Construction end-markets represents 40% of Ashtead’s revenues, of which 90% is non-residential construction. The other 60% is non-construction, of which a large portion is MRO and other specialty equipment. Specialty equipment include power & HVAC, pump solutions, climate control, scaffolding, trench shoring, flooring, etc. and account for ~25% of revenues.

The equipment rental business model is fairly simple. Ashtead purchases general tools and specialty equipment from suppliers and rents it to different customers for a period of time. The company owns assets on average for about 7 years, and then disposes of it in the used equipment market. The annual rental revenues as a % of the initial purchase price is the dollar utilization of the asset. The hypothetical example that the company likes to give is $100 to purchase the asset, $60 in annual rental revenues (implying 60% dollar utilization) and a salvage value of $35. This generates a total of $455 in cash inflows over a 7 year period vs. the $100 initial cash outflow. This doesn’t take into account any costs of maintenance and repairs on the equipment during ownership and the costs to run the service, which would include employee salaries, facility costs, transportation costs, technology costs, etc.

Customers rent from Ashtead and other equipment rental companies because of three main reasons. First, there is flexibility in renting vs. owning. Customers can take on only the cost of renting when there is a need vs. having to own a piece of equipment even when it’s not being utilized. Second, the upfront purchase price is usually large (and going higher with recent inflation) and there aren’t any additional costs involved with renting like repairs and maintenance, storage, asset management, etc. And third is immediate access to the required rental equipment. Customers who buy new equipment typically need to wait 12-18 months to get their orders delivered. Many customers of Ashtead end up selling their owned equipment at the end of its useful life and renting the newer version of it going forward.

Renting has to make sense from a total cost of ownership perspective. Given the high dollar utilization for many pieces of equipment, owning does make financial sense if utilization is moderate to high. That’s why many of Ashtead’s customers both own and rent equipment. Rental penetration is one metric that Ashtead looks at when considering the rental opportunity of a new or existing market. Rental penetration is the percentage of a specific asset available for rent vs. total (owned + available for rent) in a certain market.

For general tools, rental penetration is 55% in the U.S. market. This has increased over the years from 10% in 1990 to 25% in 2000 to 45% in 2011 to today. Drivers of this increase include cost inflation for replacement equipment, more stringent health and safety requirements and better availability of equipment as the rental market has consolidated among larger rental equipment companies. While the rental penetration rate has increased materially over the years, it’s still lower than in the U.K. at 75%. The company has stated that the U.S. rental market could reach well over 60%.

For specialty equipment, the rental penetration rate is much lower at 10% and the company sees an opportunity to close the gap with general tools. While this is a broad average, the rental penetration rates for the different categories of specialty equipment that Ashtead offers is a wide range. Power & HVAC equipment, climate control and flooring are relatively low in 2%-6% range while lighting, ground protection and pump solutions are relatively higher in a 25%-35% range. Ashtead expects that the lower penetrated categories can increase to 15%-20% and the higher penetrated categories can increase to 35%-45% over time.

Growth in specialty has outpaced general tools in recent years. Ashtead’s specialty revenues has grown at double the rate of general tools and reached $2.5B in revenues in fiscal 2023. Just three years prior, in fiscal 2020 specialty revenues were half of that. Some of the outpaced growth in specialty can be attributed to acquisitions. Looking at Ashtead’s largest competitor, United Rentals, we can see similar pattern with specialty outpacing general tools. Specialty revenues for United Rentals accounts for 27% of total revenues, similar to Ashtead’s 25%.

Ashtead’s strategy for growth in specialty is based on clustering many smaller locations (most of which are specialty) around a few large locations in a region. The core idea behind clustering is having a wider assortment of equipment available for customers that need a combination of general tools and specialty equipment to complete a project. This allows Ahtead to be a one stop shop for its customers’ needs in that region.

In 2021, Ashtead introduced its growth plan called Sunbelt 3.0. This initiative had 5 strategic priorities, which were (1) Grow General Tool and Advance Our Clusters, (2) Amplify Specialty, (3) Advance Technology, (4) Lead with ESG, (5) Dynamic Capital Allocation. Most importantly, the goal for Sunbelt 3.0 was to add almost 300 locations in North America, and optimize its operations in the U.K. As the company gets closer to reaching many of its goals for Sunbelt 3.0, the company has telegraphed that it will launch the Sunbelt 4.0 initiative at its Capital Markets day in 2024.

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Why is it a good business?

As the second largest equipment rental company, Ashtead benefits from scale advantages. The company is able to get more favorable pricing when sourcing equipment due to the larger volume of purchases and also benefits from better availability when supply is constrained. And even with this advantage, lead times for new equipment have lengthened with certain suppliers. Since this also applies to Ashtead’s customers and competitors, rental penetration has increased in recent years.

Scale also allows Ashtead to service bigger clients, especially those that require different types of equipment for large projects. Ashtead accomplishes this through its clustering strategy, since many of the smaller locations in a cluster offer specialty equipment for rent. While Ashtead doesn’t disclose the % of revenues contributed from large accounts (United Rentals calls them National Accounts, which contributes to 43% of their equipment rental revenues), the company did mention some statistics about large accounts at its 2021 Capital Markets day. Of its large customers, 39% of rental revenue comes from those that rent at a general tools location and three or more specialty locations. And for every $100 spent at a general tool location, another $47 is spent at specialty locations.

Specialty growth benefits Ashtead in a couple of ways. First, it allows Ashtead to achieve better ROIs because specialty equipment has higher dollar utilization than general tools due to higher rates. This implies that increasing utilization of specialty equipment should improve ROIs even further. Second, it allows the company to diversify away from construction end-market exposure. Even though the company is mostly exposed to non-residential construction, it seems like Ashtead puts an emphasis on moving away from this cyclical end-market.

Clustering has resulted in better financial results vs. non-clustered markets. Clustered markets generally have 30% of revenues coming from specialty vs. 20% for non-clustered markets. The number of active customers is 120% higher, revenue per customer is 15% higher, time utilization and rates are 2.2% higher and EBITDA margins are 1.6% higher.

And even with Ashtead’s focus on increasing specialty equipment availability, the company has remained disciplined with the number of SKUs offered. Generally, Ashtead carries equipment only from one or two suppliers within a product range. This is because the more the company can standardize the fleet of equipment, the lower the costs of maintenance and repairs. Standardization also helps with fleet availability, making the clustering strategy even more effective across its markets.

Scale also allows Ashtead to invest in streamlining the customer experience, which is mainly in the form of technology improvements. Mobile and online applications can help customers track the equipment that they have on rent, place new orders, extend contracts and request service or pickup. This helps to improve operational efficiency and increase time utilization of its fleet. And while this is now table stakes for the large rental equipment companies, many of the smaller competitors and especially those with only a handful of locations don’t have the resources to invest in this area.

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Returns on incremental capital?

Over the past 10 years, Ashtead has spent 77% of its capital on capex and 23% on acquisitions. Capex is mainly related to purchases of new equipment and opening greenfield locations. For fiscal 2024, 84% of capex ($3.45B out of $4.1B at the midpoint of the range) is slated for new rental equipment.

However, not all of that is incremental additions to the fleet of equipment. In fiscal 2023, half of the company’s equipment rental capex was for incremental additions to the fleet and the other half was replacement equipment that was getting disposed. For fiscal 2024, the company is planning to dispose of $1.3B-$1.4B of equipment, which implies that 40% of 2024 capex is slated for replacement of the fleet and 60% is for incremental additions.

The remaining capex will mostly be for greenfield store openings and remodeling of bolt-on acquisitions. In general, the company does more greenfields in areas where they have higher market share and more bolt-ons where markets are more competitive. Store level maturity differs between the two types of new stores. Greenfields stores take on average about 3 years to reach maturity. Bolt-ons have differing maturity curves, depending on whether they offer specialty or general tools and their proximity to a regional cluster.

Integration also impacts the timeline. Ashtead has an integration team that meets with each employee prior to deal close. After a deal is completed, the company quickly shifts the processes of the acquired company onto their technology platform and makes sure that the team is up to speed on their new roles. Many of the selling owners of these smaller deals have stayed on to become managers and executives at Ashtead over the years.

Bolt-on acquisitions are available for Ashtead to acquire because the market is still fragmented even with the recent consolidation in the market. In 2009, the top three rental companies commanded just 15% of the market. That increased to 22% by 2014, 26% by 2019 and 34% by 2023. Even with 19% of the market moving to the top 3 players, there are still many smaller bolt-on acquisitions available.

Historically, the company has averaged half of its store growth from greenfield and the other half from bolt-ons. From 2016 to 2021, the company added 243 greenfield locations and 185 bolt-on acquisitions, so a 56%/44% split. The difference is mainly in specialty, where there were 2x more greenfields vs. bolt-ons (139 vs 67). This makes sense as the company has focused more on clustering for Sunbelt 3.0.

Within M&A, most of the company’s recent acquisitions have been bolt-on acquisitions vs. large transformational deals. An example that the company gives is the acquisition of Pride Equipment for $279M in 2017, which allowed the company to expand into aerial work platforms in the New York City area. Over the next two years, the company increased revenues by 45%.

In the 10 years from 2012-2021, the company acquired 103 companies. Breaking down the acquisitions by deal size, there were only 7 deals above $100M. The multiples paid for these companies averaged 2.1x revenues and 5.5x EBITDA, implying returns on capital of 18%. The smaller deals averaged a multiple of 5.2x EBITDA, while the larger ones averaged 6.1x EBITDA, a difference of 0.9x EBITDA. While we don’t have updated deal metrics up to 2023, these statistics will likely be updated at the upcoming Capital Markets day in 2024.

We estimate that Ashtead generated returns on incremental capital between 10%-20% over the past 5 years. Similar to United Rentals, returns in fiscal 2021 were impacted due to the Covid related slowdown in construction projects and industrial production. The company also cut capex and acquisition spend during that period to manage the company for cash flows. However, Ashtead more than made up for that in the subsequent years with record capex and acquisition spend expected through 2024.

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Reinvestment potential?

The North American equipment rental market for general construction and industrial projects is estimated to be $60B-$65B. With Asthead’s $7.5B in U.S. rental revenue and $0.5B in Canada rental revenue for fiscal 2023, this implies a 13% market share across North America. Within the U.S., Ashtead estimates that it has 13% share, behind United Rentals at 17% share.

Since 2021, the company’s internal target for market share in the U.S. has been 20%. The reasoning behind this is that the company has many markets (25 of 210 DMAs in 2021) in which they already command over 20% share and many more that are over 15% (additional 46 DMAs). Within Canada specifically, the company currently commands 9% share and aims to have a similar market share to that of the U.S. over time, since market conditions are very similar.

For the U.K., the market size is smaller than North America by a factor of 10x, which implies a market size of ~$5B-$6B. Ashtead leads the market here with 13% share in fiscal 2023. As mentioned earlier, the U.K. market has a higher rental penetration rate at 75% vs. 55% for the U.S. Historically, the company had over 20 brands in the region many of which focused on different specialty rental types. Over 65% of revenues come from specialty in the U.K., much higher than 25% in the U.S.

In 2020, Ashtead combined all the different brands under the Sunbelt umbrella to allow for better operational efficiency and to promote cross selling among the different locations. Prior to the rebranding, while Ashtead did command the highest overall market share in the region, but the benefits to scale were minimal due to the disparate nature of the operations there. The fleet was generally underutilized (again because of poor cross selling and an oversized fleet) and margins were muted because the benefits to scale weren’t being realized. To fix this, the company optimized its network by combining many locations, centralizing logistics teams and rightsizing the rental fleet.

Ashtead measures the return on investment for each region and as you’d expect, the U.S. market leads with 27% ROI. Canada has seen improving ROIs since fiscal 2018 (the first year it was broken out) from low teens to 18% by 2023. The U.K. is still a mixed bag with ROIs in the low teens %. It goes to show that improvements in the U.K. are still underway.

There are a few legislative acts in the U.S. that should provide tailwinds for the equipment rental market. The Infrastructure Investment and Jobs Act that was signed in 2021 added an incremental $550M net additional funding for construction related infrastructure projects. The Chips and Science Act signed in 2022 added $250B for U.S semiconductor R&D and manufacturing. And the Inflation Reduction Act signed in 2022 added over $350B in funding and tax credits for energy production and manufacturing projects.

Many of these projects are over $400M in size. Ashtead calls these mega projects, which include data centers, healthcare facilities, airports, power plants, and other large construction projects. When Asthead gets contracted for these mega projects, the company oftentimes sets up on-site solutions to service them. Ashtead sets up maintenance and repair services on-site and there is usually a dedicated storage and working space.

In fiscal 2023, there were 175 mega projects started valued at $300B and these projects made up 27% of construction starts values, almost double than what’s been the historical average. In fiscal 2024, that number jumped to 256 mega projects started valued at $344B, accounting for 29% of starts. Mega projects tend to take longer to ramp up as well, resulting in lower utilization for the first 4 quarters. Asthead recently gave an example of a mega project that took 4 months to get to 50% utilization and reached 85%-90% by 4-5 quarters. This high utilization level lasted for 2 more years.

With a reinvestment rate between 60%-80% and a return on incremental capital between 10%-20%, we estimate that Ashtead has increased its intrinsic value between 8%-12% over the past 5 years. The company should continue to have ample runway to make bolt-on acquisitions and establish greenfield locations, given the company’s goals for market share. Along with United Rentals, market share should consolidate at the top.

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What else is important?

Cyclicality

Equipment rental companies are cyclical by nature but we should recognize that they have become less cyclical over the years due to the increases in size, healthier financial positions and balance sheets, more exposure to specialty, and less exposure to construction and in particular residential construction.

Size and stronger balance sheets help during downturns (especially for the top two) because there is more flexibility in how these companies can manage the businesses for cash flow. We saw during the Covid slowdown period that these companies reduced capex and raised cash by disposing of their fleet. This made sense as utilization was projected to decline from the initial cancellations for many construction projects. Both United Rentals and Ashtead likely overcorrected to protect their businesses, but were able to quickly reverse course by spending more on capex and M&A than prior to Covid.

Specifically for Ashtead, the company’s exposure to non-residential construction allows the company to get decent visibility to the trends in those markets, since non-residential construction tends to be more late cycle. Other construction data points are usually weak prior to reach their end markets, which gives the company time to adjust their business accordingly.

Optionality

While this is unlikely to happen due to the company’s methodical approach to growth and expansion, a large acquisition could help the company establish a meaningful presence in certain geographies very quickly. This could have an outsized impact in Canada, where Ashtead’s 9% market share is much lower than United Rental’s 22%. Larger acquisitions would be dilutive to returns, however, since the purchase price and EBITDA multiple would be much higher than the average bolt-on. And Ashtead may need to take on debt or even issue stock to fund such a large purchase.

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