The “Brit discount” does not apply to construction and industrial equipment rental giant Ashtead. The FTSE 100 group is valued more highly than its American rivals, so it is understandable that Brendan Horgan, the group’s boss, does not feel the need to reach for a US listing despite generating about 85 per cent of its revenue in the States.
That confidence is well founded. Guidance for rental revenue growth this year has been raised for a third time, to between 21 per cent and 23 per cent, on the back of a 25 per cent boost over the first nine months of the financial year. That’s not all higher rates, either. Of the 19 per cent organic increase in rental revenue, 11 percentage points came from sales volumes, not price inflation.
Ashtead is a marker of the broader US economy, which means revenues fluctuate heavily through the cycle. Double-digit inflation and the prospect of recession has tempered the prospect of the shares being rewarded with an even higher rating by the market. The growth pushed out by the group over the first nine months sits towards the top end of the rates managed by Ashtead since 2010, but a forward price/earnings ratio of just under 17 leaves the shares more closely aligned with their long-running average.
The number of construction projects being started in the US has continued to rise. Diversifying into speciality tool rentals and reducing reliance on commercial construction might lessen the pain from any 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. About 30 per cent of revenue comes from speciality lines, up from 13 per cent at the time of the last crash.
Rising infrastructure spending in the US should provide another fillip. In 2009, 13 per cent of projects in the non-residential construction market were worth $400 million. This has risen to 30 per cent. The US Inflation Reduction Act, a $369 billion package to fund green energy projects, takes this further still.
Since 2010, Ashtead has quadrupled its share of the US rentals market to 12 per cent, making it the third largest supplier. Ashtead plans to rack up more spending on expanding its fleet and buying up more small businesses next year, with capex of between $4 billion and $4.4 billion slated.
Most of the cash will be spent on growth rather than replacing existing kit. The fear is that an expanded fleet sits gathering dust in the event of a downturn. However, utilisation has not been a problem thus far: Ashtead is recouping its outlay on equipment faster, banking just over 60 per cent of the money spent in the US market within 12 months compared with 54 per cent in 2021. Pushing up rental rates and utilising more of its fleet means the group is recovering more of its own cost base, which helped increase the margin over the first nine months.
Even after the step up in spending, there should be cash to spare — along with a leverage position that sits well within the target range of between 1.5 and 2. The balance sheet is in a firmer position than it was during the last downturn, with net debt 1.6 times adjusted profits at the end of January; in 2010 it was 3.2.
Ashtead has room for manoeuvre if demand falls. Cutting the lofty capital expenditure budget would boost its coffers, while halting expansion in the fleet would avoid compounding the problem of falling utilisation of equipment and improve free cashflow. That is set to amount to about $300 million this year even after the outlay on capex, maintenance and dividends.
Ashtead could justify an even higher price from the market.
ADVICE Buy
WHY An increase in US infrastructure spending and the chance of more revenue upgrades could push the shares higher
Elementis
The speciality chemicals group Elementis is no stranger to takeover approaches, with two US rivals taking a tilt in the space of less than 12 months during the pandemic. Right now, the FTSE 250 group might prove a harder sell.
The shares have more than halved in value over the past five years, but that does not exactly make them a bargain. A forward price/earnings ratio of almost 15 is a premium to the average over that timeframe, which could be a touch optimistic.
The pre-tax loss recorded last year widened to $55 million from $7.5 million in 2021. The culprit? The talc business, which makes chemicals used in the production of car and truck bodies and generates about 80 per cent of its revenue in Europe. Customers here were worst affected by soaring energy bills, which meant a collapse in sales volumes and failure to recoup the group’s own inflated cost base. The result? A whacking $103 million non-cash impairment against the value of the talc operations.
The remaining two divisions have made a better show of recovering higher operating costs by putting through price increases. But Elementis is still some way below targets set out in 2019 to improve performance. The plan of action? Redirect more of the budget towards research and development rather than aping rivals in the hope of generating 17 per cent of sales from new products by 2025, up from roughly 13 per cent at present.
The operating margin target has also been set at 17 per cent — an increase on the 13.6 per cent recorded last year. A goal that Paul Waterman, the chief executive, hopes to achieve in the next 12 to 18 months.
But that is while cutting leverage, which sits at a ratio of 1.9 but had originally been targeted at below 1.5, and eventually restoring the dividend, which could be on the cards later this year.
Free cash generated by the business after interest payments, capex and a list of other outlays left $34 million to pay down the debt to $367 million last year. That does not leave bags of cash for Elementis to play with at a time when its end markets face macroeconomic pressures.
ADVICE Avoid
WHY The shares’ valuation does not look compelling
