Investors seem ready to hear a familiar story from tool hire specialist Ashtead: a collapse in industrial demand, slashed rental rates and a rapid fall in earnings. But rehashing the narrative that unfolded after the 2008 financial crisis would be simplistic.
A rapid descent this year has left shares in the tool hire company priced at a meagre 12 times forward earnings. For context, that’s far behind a post-referendum average multiple of 17, and roughly at the same level as the weeks immediately after the first UK lockdown and Brexit referendum, when doomsday scenarios similarly took hold.
The risk of recession in the group’s core US market has trumped bullish guidance. Guidance for a stateside rise in rental revenue of between 13 and 16 per cent this year has been held in place, giving 12 to 14 per cent annual growth at a group level after accounting for the closure of Covid-19 mass testing sites. That is against a lofty comparator, too.
The return of live events and restart of construction projects has fuelled demand for heavy equipment. Disruptions in supply chains favour large fleets. If those constraints squeeze at the edges for smaller rivals, there is a chance that Ashtead could take more market share. The result for Ashtead has been higher rental rates, which compensated for Ashtead’s own inflationary challenges, such as increased wage and energy costs, even as discretionary spending was dialled back up last year. The pre-tax profit margin improved to 21 per cent, against 18.6 per cent a year earlier.
Brendan Horgan, chief executive, sees these figures as a green light. An ambitious capital expenditure target of $3.3 billion to $3.6 billion has been set for this year, an increase on the $2.4 billion spent last year. Opening new hire facilities is the priority for allocating that cash. That will sap free cashflow this year, expected to come in at about $300 million, down from $1.1 billion last year.
By gaining scale in the largest regional markets, Horgan reckons that Ashtead can benefit from both economies of scale and supplying more types of equipment, a convenience it can charge more for. Before the pandemic, rental rates for those clustered markets were about 2.3 per cent above areas more sparsely packed, revenue per customer was 15 per cent higher and margins 4.3 percentage points above.
But that was before the risk of an economic contraction had reared up into view. The fear is that an expanded fleet will sit gathering dust. But if a fall in demand materialises, Ashtead has room for manoeuvre. Admittedly, some outgoings can’t be stripped out, such as maintenance costs. Yet cutting the lofty capital expenditure budget would boost coffers, while halting expansion in the size of the fleet would avoid compounding the problem of falling utilisation of equipment and improve free cashflow. That measure came in at $1.1 billion for last year, even after a step up in capital expenditure.
Financially, the group is also more secure. Leverage is also at a near record low, with net debt at 1.5 times adjusted profit before tax and other charges, more conservative than a multiple of 1.8 in 2019 and 2.7 in 2007. Funds available under the debt facility stand at just over $2.5 billion.
Diversifying into specialty tool rentals and reducing reliance on the commercial construction sector might lessen the pain from a fall in new projects. Construction accounts for 45 per cent of revenue, versus almost 90 per cent in the two years after the 2008 financial crisis hit.
Greater caution is understandable, but there is more chance of the group surprising for the better than the worse at the group’s current market rating.
Advice Buy
Why The sell-off in the shares looks overdone, given a stronger balance sheet and potential for steady rental revenue growth
DiscoverIE
Rising inflation and its impact on growth mean investors are rightly more sceptical of corporate earnings prospects. But DiscoverIE, which designs, produces and supplies customised components for multinational manufacturing companies, should have more mettle than most to withstand a downturn.
The FTSE 250 constituent has honed its focus on four sectors it sees as long-term structural growth markets: renewable energy, medical, transportation and industrial, and connectivity. The idea is to produce components that become part of a client’s design specification, and then reap the benefit of repeatedly making that item over many years.
Organic revenue growth over the 12 months to March was 14 per cent ahead of the pre-pandemic level — and a target of 10 per cent — as demand recovered more sharply than expected. Supply chain angst and steady demand means global manufacturers are keen to stockpile, pushing the order book 62 per cent higher than this time last year. The benefits of pricing, keeping a rein on costs and making acquisitions with margins north of 20 per cent helped to push the margin closer to a 13.5 per cent target. Memory of the post-Covid recovery rush is fading across the stock market. Manufacturing activity in Britain and in the eurozone is still expanding but it slowed markedly last month, according to S&P Global/CIPS purchasing managers indices. The same goes for the US, in most part.
A sell-off in DiscoverIE’s shares in recent months means that there has been a de-rating in the exorbitant valuation of the company at the end of last year. A forward price/earnings ratio of just under 23 is hardly cheap, but it is much closer to the range recorded before the post-Covid rush. Investors have been willing to stump up for companies they hope can generate more stable earnings from defensive end markets. Making custom parts means about 80 per cent of revenue is generated by recurring orders over an average seven-year lifespan of a manufacturer’s production system. Yet a more pronounced slowdown in consumer demand, which could cause lower production, could hinder organic growth for DiscoverIE.
Advice Hold
Why Earnings growth could become more difficult as economic expansion falters
