Introduction

Ashtead is UK-listed, operates in the USA, UK and Canada, and generates over 90% of earnings in the USA.  It rents out an array of plant and equipment.  The major categories include aerial work platforms, forklifts, earth moving equipment, pumps, power generators and scaffolding. These are typically hired by the construction and industrial sectors, albeit this is broadening into other areas such as facilities maintenance and datacentres. In the year ending April 2021, Ashtead generated revenue of £5bn, and Operating Profit of £1.2bn.  Its customer-facing brand is Sunbelt Rentals.

Economic Model

The economic model that is easy to understand and can be modelled and extrapolated.  A simple illustrative example of the unit economics is as follows.  Ashtead acquires new equipment for $100 and reports a ‘physical utilisation’ of 75% and ‘dollar utilisation’ of 50%.  This means equipment is rented out 75% of the time and generates $50 per year of rent.  The EBITDA % is approximately 45% after annual non-depreciation costs of $27.50 and depreciation costs of c.$9 (c.9% of Original Equipment Cost) leaving an operating profit of $13.50, or c.27% of revenue.  This translates into a pre-tax return on tangible capital of 20%, calculated as $13.50 of profits on a net book value of the equipment of $67. (Note: the fleet is on average depreciated to net book value of 2/3 of OEC based because it has an average age of 3-4 years). The equipment is typically divested after 7 years for 35-40% of its Original Equipment Cost (OEC) i.e. $35-40. The economic model has become more attractive over time as the moat has widened.

Moat

Ashtead has several moats protecting its business and allowing it to make consistently high returns. First, it benefits from procurement scale with OEMs allowing it access to equipment at a 15-20% discount compared to even the largest end-use customers or independent equipment rental businesses.  Second, as it has grown it has become more cost efficient.  This comes from improved operational practices, improved logistics, and investing in technology to drive efficiency in sales and operations. Third, there is a modest network effect whereby a customer trusts the Sunbelt brand and knows that they will get timely access to quality equipment wherever they are, serviced by Sunbelt’s 850+ branches in 49 US States, and easily ordered from a user-friendly app linked to a corporate payment account.

Sunbelt is one of two market leaders in the US, the other being United Rentals (hereafter ‘UR’). The top two players have opened a gap with the rest of the market in the last 10-15 years in scale, economics and customer offering.  The combined market share of these two in 2010 was 9%, this had risen to 25% by 2021.  UR is slightly larger with 14% vs Sunbelt’s 11% share. The #3 player, Herc Rentals, is much smaller with only 3% market share, the same level it had in 2010. No other players have gained significant market share in this time.

It is probable that that opportunity to join the top two may have elapsed as scale begets scale and re-enforces their advantages.  Ashtead’s management have suggested that they will ultimately achieve over 20% market share and the top 2 players will account for over 50% of the market.  We see no reason why this should not be true.  We view both UR and Ashtead as being investable at the right price.  Ashtead has typically traded at a premium to UR, which may be unexpected given its UK-listing vs UR’s US-listing.  The two businesses have a different approach to acquisitions.  Ashtead rolls up a lot of small players, often retirement sales of owner-operated family businesses.  UR has made a smaller number of larger ($1bn+) acquisitions of top 5-20 players.  The latter route can be a speedier approach to gaining market share and explains UR’s greater market share today.  However, Ashtead’s approach is lower risk and results in moderately higher returns on capital, as smaller acquisitions are typically less costly.  Ashtead has also benefitted from organic growth opportunities from some of the fall-out of UR’s acquisitions where subsequent branch rationalisation results in Ashtead being able to open new branches when UR closes them, thereby picking up some of UR’s customers.

Growth

The long-term growth drivers include increasing rental penetration and market share capture.  The American Rental Association estimates US rental penetration is 56%, up from 40% 15 years ago.  This is behind markets like the UK where rental penetration is over 75% and suggests significant scope for further growth.  Moreover, Ashtead has been moving into new market areas, referred to as ‘Specialty Rental’, often forming a rental proposition where previously there was no alternative to owning.  Examples of this include floor cleaning solutions, power solutions, and even studio filming equipment.  Specialty currently comprises 29% of Ashtead’s US rental revenue and is growing faster than the rest of the business and with superior economics.

ESG tailwinds

Increasingly, Ashtead is seen by its clients as a compelling solution to meet their environmental goals and reduce wastage.  The Company provides the example of a 2.5 Ton Mini Excavator which has a physical utilisation when part of Ashtead’s fleet of 57% and replaces the need for 10 owned assets which would be used far less intensively - largely sitting idle in 10 different companies’ equipment lots.  Renting thereby saves the equivalent of 32,500 KG of CO2, reducing scope 3 emissions by up to 90%.  This message is becoming an increasingly important part of their sales pitch with Ashtead’s CEO, spending a lot of his time with their largest more ESG sensitive customers, extolling the environmental virtues of rental vs ownership

Why the mispricing opportunity?

We believe Ashtead was materially under-priced when we invested in 2020 and remains somewhat under-priced today. We can think of 3 mains reasons for this:

First, equipment rental has historically been quite cyclical.  In the Global Financial Crisis (‘GFC’), the industry suffered from suppressed industrial and construction activity.  Customers sought to conserve cash and perhaps extend the life of owned assets rather than renting a newer one.  Rental providers reduced prices by c.20% and saw margins and profits deteriorate.  From FY2008 to FY2010, Ashtead’s EBITA declined from $376m to $111m.

The market has since become less fragmented with the larger providers having increased their market shares.  Relatively new to the scene has been the widespread subscription by market participants to local price benchmarking data.  We believed that improved local information about the pricing environment was leading to more a disciplined approach to pricing behaviour than during the GFC.  Moreover, rental penetration is now much higher than it was in the GFC, meaning that customers are more reliant on, and operationally entwined with, rental providers than previously.  As such, rental providers have been in a more stable and defensive position this time. Since the pandemic the downturn has been very mild and effectively “this time was different”.  In the year ending April 2021, Ashtead’s revenue increased 3% over the prior year, they held their nerve with robust pricing, and operating profit declined just 3%.

Second, the market has not always fully appreciated the attractive growth opportunity in Specialty Rental.  In the year to April 2020 Speciality comprised 24% of US Rental Revenue.  It had been increasing in share and growing by at least mid-teens percentages annually for a few years.  The economics of Specialty were even more attractive than General Rental with fewer competing providers.  For some categories dollar utilisation (rental revenue as % OEC) was as high as 70-80% vs the 50% typical of the rest of the business.  One of the catalysts for the strong share price performance in the last year was an excellent Capital Markets Day held by the Company in April 2021 where they provided detail around the Specialty market opportunity, and their ambitions within this.  They believe that their US Speciality business will eventually be as big as their whole US business is today. Today’s share price partly reflects an improved understanding of this opportunity by the market.

Third, an overhang on Ashtead’s valuation for some time had been a lack of Free Cash Flow generation.  IFRS accounting profits had grown steadily over time.  In addition, cash from Operations had grown steadily but this was almost entirely consumed by reinvestment in the business in the form of capital expenditure and acquisitions. Ashtead had been investing in growing its fleet and acquiring competitors well in excess of what it needs to do to maintain a steady state asset base and competitive position.  This dynamic was better reflected in reported IFRS profits than hard calculations of free cash flow.  Ashtead has a long runway for deploying capital in buying its fleet, setting up new branches and bolt-on acquisitions.  It reliably enjoys good returns on reinvested capital of c.20% pre tax, unleveraged. Given this, the optimal strategy is to not generate free cash flow but to allocate spare cash within the business. The uncertainty created by the Pandemic induced the company to lower capital expenditure and hold back on acquisitions for a while.  As a result, free cash flow started to be generated very significantly, with the Company reporting free cash flow to equity holders of £1.24bn in the y/e April 2021, similar to the level of operating profits.  In prior years this had often been negative.