A Rental Stock That’s Fit to Own

Normally, I love the concept of renting things. Ideally, a company buys something, then turns around and rents it out to others who cannot afford to buy it outright. In most circumstances, the buyer probably will need to borrow money to buy the item, but then finance the rental itself at a higher rate and profit off the arbitrage.

There are two fabulously successful models for this. One is the timeshare industry, where a hotel or condo can be built and its units each sold 52 times. Most public timeshare companies got gobbled up by hotel companies, but some, like Bluegreen (NYSE:BXG), remain public. Another model is handled by companies like Rent-a-Center (NASDAQ:RCII), which rents out appliances to those who can’t afford to buy them.

You’d think that renting out construction equipment might therefore make for a great business, but things have been tough for this arena.

United Rentals (NYSE:URI) has been a big player in this space for awhile, and recently merged with RSC Equipment Rental, creating a network of 837 locations.

Consolidation can sometimes be a sign of tough times, though this consolidation will prove fruitful for the combined entity, with some $610 million of EBITDA impact expected through 2014. Management also is trying to focus on very specific types of accounts so they can operate more efficiently — for example, companies renting for longer periods, which will reduce transaction costs.

Costs are the bugaboo of this industry. To begin with, a lot of debt is required to purchase all those backhoes and forklifts. United has $2.65 billion in debt prior to the merger, and now has $6.7 billion. That debt does not come cheap, costing some $516 million in interest payments annually. When a company’s operating income is $591 million, that doesn’t leave a whole lot for the bottom line.

But one also must imagine all the labor necessary to move, store and ship these large pieces of equipment. It takes a lot of people, a lot of organization, a lot of safety compliance and tremendous attention to logistics for everything to be done right. Old equipment has to be sold and new equipment purchased.

The good news is that this is a high-margin business, which gets back to the whole idea of renting stuff like this in the first place. In addition, United has a great reputation and customers know the company has the equipment they need. Despite a tough economy, HIS Global Insight forecasts the rental industry will growth at about 8% this year, 1% next year and 15% the year after, before falling back to 6% in 2016.

United feels a bit bloated right now, and I think the key to the company’s success is going to be streamlining operations as much as possible. This is the kind of thing where little changes will add up. For instance, you’d think UPS (NYSE:UPS) trucks plotting out routes so they make as many right turns as possible isn’t a big deal … but it saves the company tons of money in gas.

Investors also should keep an eye on rate increases. The company increased rates 6.9% last year. If pricing power remains intact, that’s a great thing. Time utilization of the fleet is important, too — in the case of that number, you want to see it go up rather than down.

Overall, analysts expect 20% annualized growth over each of the next five years. The company trades at only 11 times earnings at the moment. It has been free cash flow negative for the past two years, although Q4 was positive at $42 million.

I think the market has priced in a lot of bad news here. United is worth a good, long look.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc., which  brokers financing, strategic investments, and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at pdlcapital66@gmail.com and follow his tweets @ichabodscranium.

Article printed from InvestorPlace Media, https://investorplace.com/2013/02/a-rental-stock-thats-fit-to-own/.

©2021 InvestorPlace Media, LLC