Deutsche Bank 8th Annual Global Industrials and Materials Summit

Jun 8, 2017

Slides

Summary

A five-year transformation aims to diversify the fleet and customer base, lift margins from the mid-30s to mid-40s, and grow through existing locations. Robust markets, improving pricing and higher rental penetration support the outlook.

There were no consolidators. We were actually in the top 10 rental companies at some point in the United States, a very fragmented business. In 1996, what was called the British Invasion came, and we were acquired by the Ashtead Group, or what you know as in the U.S. as Sunbelt. I went to work for Sunbelt at that time. The combined business had 24 locations in the United States. In 1998, I became the President and CEO of Sunbelt. Ran that business from 1997 through the end of 2003, growing it to over 200 locations. Left the industry completely into a completely different industry, defense contracting. Came back end of 2013, decided I want to come back into the rental industry. It's my real passion. Went to work for a couple different private equity groups, and then one day I was fortunate that Larry Silber, who I had met through Ingersoll Rand in my days at Sunbelt when he ran Ingersoll Rand, gave me a call while I was at Costco and said, "Hey, I just got the job to run Hertz Equipment Rental and spin it into its own publicly traded company." It was the opportunity of a lifetime, and two weeks later, I was working for the company. I've been here now 24 months. Just to tell you a little bit about Herc, formerly Hertz Equipment Rental. It started in 1965. It was the innovator. It was the first company to have a national footprint throughout North America. It was the innovator and beginner of all national accounts. It was the gold standard at one point, the largest business for a very long period of time in our industry. It lost its way, and it was under-led for a period of time. Everyone knows that we underperformed financially on almost every metric. But we have this amazing footprint that was purpose-built for this industry, and an amazing portfolio of customers and team members. Me and Larry saw this as an opportunity to come really bring this business back to its glory days and back to the gold standard. We're excited about the opportunity. Okay, that's a really good segue into what I wanted to talk about first, which is the business transformation that you guys are going through right now. I think that you have a strategy to diversify your revenues, and you're shifting your fleet to kind of a wider swath of end markets. Maybe you can elaborate a bit on that strategy. Yeah, absolutely. Hertz historically had a very limited portfolio of product and customer. They were very highly concentrated in national account business, which is something great that was given to us, but we knew we needed to grow our revenue in our existing footprint. To do that, we needed to expand the customer base we had, expand the product mix that we offer to these customers so that we could drive better return, better financial returns, and deliver a higher level of service to our customer. Ultimately, that will end up driving revenue, driving the top-line growth. We've made good progress in the last 24 months in doing that, and we'll continue to expand that. Okay. Maybe let's put this in baseball terms. What inning are you in that process? Well, we said this was a five-year plan. We're a year into that. I think we're making good progress. We have a $3.5 billion, $3.6 billion fleet at original equipment cost. It's going to take us some time to get that fleet completely transformed. But we've added a broad range of product, and we stated in the first quarter that our new account signings are growing at a greater pace than we've seen. Even though that doesn't kind of predict what revenue will be in the future, I think it's a good thing to have more new customers because ultimately, that will drive revenue. When we came 24 months ago, we had 450 salespeople. We now have 625. We stated in the first quarter that we grew the sales force by 75 in the last 12 months. We're out there. We're touching more customers. We're diversifying the fleet and driving that top-line growth. Okay, and I guess maybe just getting into a bit more of the detail, which fleet categories are the biggest focuses for growth? Is it more specialty sort of equipment? Well, it is a blend, right? There is a broad footprint or broad range of products that we need to diversify in, but we also stated that in the ProContractor tool and in what we call our ProSolutions business, which would be the specialty business, that we want to grow that to somewhere between 25%-30% of our fleet overall during that period. Okay, got it. Does that imply that if we think about more of like the general rental sort of pieces of equipment, are you paring back replacement demand of that sort of equipment, or are you still focused on keeping that fleet refreshed? No, we are definitely focused on keeping it refreshed, but there are certain categories of equipment that we will reduce. We said Hertz was historically in heavy earth-moving equipment, so we are reducing the amount of overall heavy earth-moving equipment we have while we invest in other types of products and grow that. What we are really focused on is driving and growing the fleet that drives a higher yield or a higher dollar utilization. To kind of go back to this national account business, we had a very limited range of product we rented to them, but it was a very sticky customer, right? On average, those customers had been dealing with Hertz for over 23 years. Now we go into that customer. We offer them a broader range. Maybe that's HVAC equipment, pumping, power generation, just different types of products that then drive the yield from that customer so we get a better return from that existing customer that was very sticky already. Okay, that makes sense. Aside from shifting the fleet, are there any other major initiatives that Herc is focused on to transform the company, or is that kind of the crux of what you are doing? Well, I talked about the sales force already. Yeah. This expanding the range of products that we deliver and the customers that we touch. Then we have also said that our growth, we do not need to go out and open 20, 30 new locations a year to capture that above-market growth that we have said we will achieve over this five-year plan. We have this amazing 270-plus Base of infrastructure that we need to now drive more revenue through our fixed costs. So all of these things add up to us growing our revenue above market, growing our fleet less than we have grown our revenue, which will ultimately grow our EBITDA faster than we are growing our revenue. That is how we climb that ladder from a mid-30s EBITDA margin to a mid-40s EBITDA margin over this five-year plan, equal to our peers. So we're not stating that we need to be better returns than our peers, we just need to get to where our peers are today. Okay, got it. So I think maybe we'll move on from the business transformation. It seems like we've kind of covered that topic. Maybe talk a little bit about what's been going on in the business. So from a trend perspective, what level of activity are you seeing within your end markets? So thinking about things like non-resi construction, any recovery in O&G, manufacturing, and if it's any different than what we've seen for the past couple of quarters. Let's start on just the kind of key metrics that we look at the industry. So whether it be the ABI construction put in place, all of those things look robust, and they look to continue that for the foreseeable future. So feel it's a pretty strong market for the foreseeable future. To talk about O&G, we stated in the first quarter that in the U.S., we feel it's kind of flattened. To some degree, there's probably opportunity out there that we're not really chasing. So we're constraining the capital to that because we see opportunity in other urban markets. That is our core strategy to grow in these large urban cities that we're in. Okay. We see better opportunity to put our capital to work. In Canada, we stated 15% of our revenue in the first quarter was from upstream O&G. 50% of that came from Western Canada. We see that as still choppy, but starting to see some stabilization, but it's a little bit hard to predict still because there's some pricing pressure. But in the U.S. overall, we would feel that we probably bottomed on the O&G side. Okay. Got it. Is it fair to say that in Canada, you think that we have bottomed too? I think we are saying that it is still a little choppy. I do not know if I would want to predict that just yet. Okay, fair enough. I think you noted on your first quarter call that rental revenue accelerated in your key markets throughout the quarter. March was especially strong. Is there any chance you could give us a sense of whether that strength has continued into April and May? We do not really give guidance on that, but I would say there is nothing that would lead me to believe that it has not. Okay, got it. That's helpful. Maybe used equipment pricing trends. You saw new account signing reactivations at a record level in March, as well. Has that strength continued into the second quarter? Yeah, like I spoke earlier, we're seeing record level of new accounts. It doesn't predict revenue in the future, but you would think it would. It's all science. You can back into how many new accounts you've opened. You'll know by the average what percentage of those are going to do business with you. You can even get it down to within how many days from the time they sign up, and then you can predict out how much revenue they'll do with you in the first 12 months. So the whole key to this is to fill the funnel with new accounts. You know that you're losing a certain amount of business every year. So you have to replace that, and to get above growth, you'll have to fill the funnel with that many more new accounts, and we're hitting record levels right now, so we're feeling good about that. The used equipment pricing, we stated in the first quarter that the channel mix has kind of normalized for us, and so we're feeling good about that, and we feel pretty good about the pricing has kind of flattened. So yeah, the used equipment market is, I think, I wouldn't call it robust right now, but it's stabilized. Okay. Going back to that new account signing strength that you're seeing, is it the investment in the sales force that's driving that? I would say absolutely. You think about a sales force. We grew from the 450, like I said, to 625 now, 75 of those in the last 12 months. A salesperson gets efficient at 18 to 24 months. They pay for themselves from four to six months. As we bring those on and they get more efficient, you should continue to see that trend. Also, I've stated that we're pretty much optimized in our sales force. I have this branch network of 270 plus. Total optimization, the work we did takes it to about 720 salespeople. But with the fleet size I have now, I only need about 625 sales professionals out there, but I'm not going to have to come back here in a year and say, "I just layered on another 100 salespeople." The next year to two is all about professionalizing that sales force and getting full efficiency out of them. We have something we call capacity, bringing them to capacity. Then I can continue to optimize that territory out. Okay, got it. How does their time split between trying to generate national versus more local accounts? It's a completely different sales force. Okay. We have a national account team that handles, they are kind of out there farming. Then you have a hunting team that is in territory-based sales territories that are out hunting in the 625 sales territories throughout North America. Okay, got it. Pricing is a really, really important issue to investors right now. It is probably what I get the most questions about in the industry. I think you guys had pricing in your key markets up 1.7% for the quarter. You probably like talking about us because we have done so well over the last five quarters. It has been amazing compared to the certain company that I cover. Your competitors continue to see negative pricing trends. Maybe you could try to explain the outperformance that you have seen versus peers. Yeah. I think it is a mixture. I think some would say that we had some low-hanging fruit, so we were probably underpriced in the market. There is probably some truth to that. Larry would tell you if he was here, prior to us coming, we had a bit of the Komatsu syndrome, right? You always sell less because Caterpillar sells at a premium. We immediately kind of reinvigorated the organization and brought confidence back to the sales force. I think there is some there where we are not afraid to ask for price now. I would say the biggest part of it is, I believe there is a lot of science to pricing, and that you have to align people with the right compensation to drive the right behaviors, and we did that starting January 2016. We redid all the compensation plans from branch manager through sales force to national account team, to drive the right behavior. We implemented our Optimus pricing software. Now a salesperson on his phone, at the job, he is laddered up, I call it. You have an expert price, you have a target price, and you have a floor price. There is all kinds of science that goes into that, whether what is your utilization on that product, what are other customers in the same category of that customer pay, and what has that customer paid in the past. It ladders that salesperson up, and it rewards him for doing that. He gets better commission if he brings that price up. To get a 1.7% price lift, 1.1 overall, if you take out the upstream O&G, or when you add back in the upstream O&G, you do not really have to increase price that much. You think about our business, it is an ad hoc kind of short-term rental. The average rental term is 1-4 months, whatever that may be, depending on who our peers are. That equipment is constantly turning, so you get that opportunity to ladder the person up, and I think we have been successful at that. Okay. I guess in thinking about how sustainable that is, maybe the right way to frame the question is, how much more of that low-hanging fruit is there to go? I think there's a mixture of both, right? There's a little mixture of low-hanging fruit left. We have a large base of national account and key customers. There's also, it's a pretty robust market. I think there's still some, I wouldn't call it low-hanging fruit, but there's still execution left within our pricing model and the science behind on how we do it. Okay. I'm thinking about the competitive landscape. Have you seen any changes in the competitive intensity of national and the independent rental companies? Has anything changed? Yeah. I don't like to speak to any one company or the competitiveness of the market. This is a $50 billion plus market that's growing at, whatever you want to believe, 2%-5% a year. Right. The conversion from ownership to rental continues to happen. I have 4% market share. There's so much opportunity. Whether there is some competitiveness in any one market from any one player doesn't really affect my strategy and what I'm doing on a daily basis to drive the top-line growth of this business. Okay, got it. I'm going to open up to the audience for questions in a second, but maybe just looking at the ProSolutions and ProContractor initiative first. I think you guys have said that 25%-30% of the fleet over time should be ProSolutions and ProContractor, and that's like a five-year plan. Could you give us a sense of how much value that could drive, whether via increased pricing or utilization over time? Maybe for the benefit of the audience, explain what ProSolutions and what ProContractor is. Yeah. For us, ProContractor is all the smaller kind of transactional tools that drive a much higher dollar utilization. You think about dollar utilization, hopefully everybody understands what that is. We're at 33%, 34%. Our peers are at 44% and 50%. We have a long way to ladder that up. It's a fleet mix, it's pricing, it's all these things we've talked about. ProContractor tool, they can range in the 50%-60%-70% dollar utilization. Then we've stated that the ProSolution business can be in that 40%-50% dollar utilization. The more I can add that as a percentage of my overall revenue, the more I can drive my dollar utilization up overall. We call it ProSolutions. Could be specialty business. It's any kind of business that you're literally offering a solution to the customer. The HVAC goes out in this building, they don't know what to ask for. They don't call and say, "I need X amount of tons of AC, and I need this, and this." They call you and ask you, "What do you have? How can you solve my problem?" Whenever you do that in any kind of service business, you always can get better rates because the customer doesn't need to understand what you're delivering in. They need to have confidence that you will solve their problem for them. So you move away from a commodity base, kind of, I'm going to get three prices on this product, to a, this person can solve my solution. So we want to grow those types of businesses, and there's lots of opportunity to do that. We talk a lot about what me and Larry have termed square footage under roof. So you take a market like Chicago, huge amount of opportunity for those types of rentals and solutions other than just where you look probably where someone's digging a hole or building a tower crane. There's a much broader range of customers and products to rent that historically, Hertz didn't do. It's not like we're inventing something new. Right. We're just doing something that this business never did that adds to the financial performance of the company. Okay, and I guess, is there any way to frame the dollar utilization gap between the ProSolutions, ProContractor fleet, and more of like the core fleet? I would tell you it's higher. Right. It will drive our dollar. The greater that is as a percentage over my overall business, even if I am underperforming in it compared to my peers, is still accretive to my current dollar utilization. Okay. Fair enough. Do we want to open up to questions? There is one here. Thanks. Me too. I wonder if you could comment on IT within the company, and is that something that had to or has to be upgraded? One other one too. Okay, so there are two parts to that. We are still connected to our former parent through IT, and that was some of our additional costs that we talked about in our first quarter. As we unravel that and become completely disconnected from that on our back office and front office, we are still operating on their servers and their systems. That is one thing. We are working 24/7 to get that done. The other side, I think technology plays a big role in the success of our business and the industry overall, and it is changing rapidly to a mobile device. Larry would tell me, "I want to run this business on my phone." Not quite sure it will get to that, but I think that technology is going to play a big role in, we rolled out what we call ProControl. Slipped my mind, I apologize, which is a telematics program. The customers are demanding, right, that they want to know where their equipment is at any time. Is it running? Is it not running? How efficient is it? As the large players will all have these technologies, but I think that is going to be, in the future, the real differentiator from maybe some of the smaller players and the fragmented players in the marketplace. Great, thanks. You already talked about your pricing and why it's better, but if we forget about you guys and just talk about the industry as we've gone through the spring, would you characterize pricing as seasonal at this point, or how would you characterize it? I don't want to comment on any one player in the market. I would tell you the market is, we're finding it to be fairly robust and there's plenty of opportunity, and you're seeing that in our pricing, in our, what I would call above market growth. So I would tell you that I'm not seeing pricing pressure within the marketplace. You may see it in some individual market or some very well-known project that everyone wants to be on. But overall, I think it's a pretty robust and strong market. Thank you. I think there's one in the back right there. Good morning. Just to follow up to that last question. You're still connected to Hertz Global Holdings through your systems and IT. You're expecting to separate from them. What is the cost of implementing a new ERP system? How long do you expect that to take? Well, we're not really having to implement a new ERP system. We're just separating the existing system and getting on our own. For example, front office, point of sale, we're on RentalMan, the Wynne system that both you or I and some others, I believe, are still on, and we are. We just need to get on our own servers and away from the Hertz IT system. Then on our back office, Oracle, we just need to get our own instance of Oracle and move off of sharing with Hertz. It seems fairly simple, but it's a little bit more difficult than we had anticipated. We will be off of it. It has proven to be, I think as you've seen in the numbers, a little bit more costly than we had envisioned. We're working very hard at it, and we'll be off of it within the time period that we set out. Are there any contingent liabilities between Herc and Hertz Global Holdings? I think you can read any of that in the 10-K. Okay, thanks. Any others? Okay. So maybe going back to what you brought up with ProControl, that was actually the next piece that I wanted to talk about. What is the current penetration and what's the customer interest in the telematics service? Yeah, I think there's a certain group of customers, very large kind of national accounts, that now it's expected. You have to have it. The top three or four players have it that are dealing with those customers. Okay. Then it's really an educational process for the customer, where you go out and you educate the customer on that as a solution, and then that customer becomes that much more sticky. We just landed a very big deal. There were ProSolutions we built into the bid for the customer on a large quantity of light towers, where the actual light towers will have to start and stop on their own, and they didn't want to send labor to do it. You can do that now through the ProControl system. So hundreds of these all start every night at the exact same time and shut down every morning at dawn. That's a huge benefit to the customer in labor savings because they would've historically had to send people out to do that. So they not only save in labor, they save in fuel. There's all kinds of applications like that. Or for the customer knowing that it's being delivered, so he knows the truck's pulling up to the building, so he knows to go down and meet them. Or calling it off rent on his phone so he doesn't have to actually. Nobody wants to use the phone anymore, right? They don't want to call anyone. They want to do it all through the app. Those things, as you educate the customer on it, they then learn about it, and they become sticky, and they like using it. Then they're going to, I believe, they will demand that in the future. So 24 months from now, 36 months from now, the average customer, that will be an expectation. You don't have that? They'll say to you, right? I think that's where the separation comes, and it gives you a real advantage. So you need to be able to afford to invest in those technologies. Okay. Then maybe just from a very high level, where do you think we are in the North American equipment rental cycle? I guess maybe the way to think about it is, what does growth look like over the medium term for this industry over the next three to five years? Well, the ARA says that it's growing, what is it? 3%-5% per year over the next four to five years. Larry stated, and I stated, when we put our five-year plan together, that people would always ask, "What inning are you in? What part of the cycle?" We said, "We believe we're in the middle innings of a good game here, and we've got the room to execute on our plan." The other question always comes, well, how is the Trump effect going to impact that? Who really knows if it's going to happen? If it does, it'd be great for the industry. I think many people have stated this is a huge shortage of specialized trade labor right now. That's kind of extending the cycle to some degree. Even if there was these billions of dollars in infrastructure spend that came in the next 24 months to 36 months, I don't know if all those projects would ramp immediately, just because there's not enough labor to do the work. I think it would extend the cycle, and I think that's a good thing, but we can't predict, and we didn't build that into our five-year plan. That would all be good for all of us in the industry, if that happened. Right. We can all hope. Right. How does increasing rental penetration fit into the medium-term outlook? Is that still a factor? Oh, I think it's absolutely happening on a daily basis. There's a new OSHA silica requirement that's coming out in September. You have to control all the dust from any piece of equipment, and it's the responsibility of the owner or the general contractor to make sure all the subs too. That's just one more thing. When you think of penetration of rental, so it's happened already in aerial work platforms and things like that, where 80-plus percent goes into rental fleets, where 20 years ago, it was 70% was retailed, and 30% was rented. Or in some of the smaller equipment, handheld equipment, things that grind and break concrete and all, there's probably 5% rental penetration and 95% ownership, but it's still a great rental product that we all rent. Well, with this new silica OSHA requirement, even from the manufacturers, we're hearing that that's going to drive. This rental penetration because the contractor's not going to want to deal with all that. He's going to want a solution to solve all of his problems. He's just going to decide to rent other than own, to try to keep up with all these new regulations. I believe across the board, rental penetration will continue. Will it get to where it is in Europe and some of these other places? Who knows? But if it just increased by another 10%, it would be an amazing story. Yeah, definitely. We can all speculate on whether or not an infrastructure bill will actually happen in the U.S., but let's say that it does, how quickly would the rental business benefit from that? I have no idea how much would be put to work immediately. I can't imagine much, especially on any kind of projects that our industry would benefit from. We're not going to benefit heavily from re-asphalting of roads and things like this, where usually that money goes to first. But tunnels, bridges, airports, any kind of mass transit, these things would all be great for the industry. Look, whether we personally benefit our company and our shareholders from any one project, we will benefit overall because it will tighten up equipment. It will generate more activity in the industry overall. Okay, got it. I want to hit a little bit on capital allocation. As you guys go through executing this business transformation plan, you're scrapping some equipment, you're purchasing new. How do you think about capital allocation on a longer-term basis? Yeah. Well, first, I like to think of it not as scrapping, but selling very nice, close-to-new equipment back into the market and getting the most value I can for it after its useful life. Look, we've got a good balance sheet. We're a little highly leveraged. We've stated that our leverage needs to be in the 2.5x-3.5x. We're going to do that by growing our EBITDA, not paying down debt. We feel that we have enough capital to fund the plan that we came out with, and we feel comfortable with our capital plan. Okay, got it. I guess, over the long term, again, would you be interested in being a consolidator in the industry, or are you more focused on just internal growth via CapEx? Yeah. Look, our five-year plan was based on not opening a lot of branches. I'll open two or three or four a year. I may close two or three. So you're going to see the branch count not change much over the next two to three years. We're not an acquirer. We're not going to be super acquisitive. We feel the best return for our shareholders and for top-line growth in our business is to push more revenue to our existing base. Having said that, if the right acquisition came along, we may do that. But that is not in our growth strategy, and we did not build that into our plan. Okay. I do, though, think there will be continued consolidation in the industry. Right. I think it is a good thing for the industry overall. Mm-hmm. Of course. Now, thinking about some of the equipment that you guy. I have to ask this question selfishly since we are almost out of time anyway. JCB recently announced that it is entering into the U.S. aerial work platform market. I guess, what are your initial thoughts on the product, and do you expect to allocate some of your aerial spend to JCB in the future? Right. We don't comment on any one manufacturer. I would say, I think JCB is a well-built world product. And we have no plans currently, but you never know what's going to happen. Okay. Got it. Fair enough. You have to leave your options open. Any other questions from the audience? I can finish up, but just want to make sure we're not. Oh, yep, we got two now. Hi. You said you're in roughly the second. Your five-year plan. Obviously, we've been in the midst of a construction recovery now for five to six years. I think we've seen estimates going out to 2020, but five years from now, we're going to be at roughly 2022, 2023. What gives you the confidence that you'll be able to continue to grow EBITDA and deleverage your EBITDA growth as the market could be turning on you? Well, what gives me the most confidence is I understand this business, and I know what's possible, and I know that we have 4% share in a $50 billion market, and we're in the right urban markets for growth, and we have the right infrastructure in place, and I know the opportunity to transform this business. Could you maybe just talk about your fleet a little bit in terms of what you have, the average age, and how you think about that going forward? I think we stated in the first quarter, average age is 48 to 49 months. We also stated that the $130 million worth of OEC that we sold out was an average age of about 84 months. Okay. Are you happy with that going forward? Are you happy with where you are? Do you want to bring that down going forward? I'd like to see that tick down a hair. Okay. Yeah. Do you have a timeframe over which and how you get to a particular? You'll see that happen over the next 2 to 3 years. Okay. I don't think it's too aged. I would tell you that I'm a big believer in making the asset sweat until its complete useful life. I'm not a big believer in balancing this where you get the most money when you sell the piece of equipment in its first 60 months for optimal retail out because I believe in how much cash do I bring in that piece of equipment, so that piece of equipment from the day it drops in my yard to the day I move it off the yard. If I can stretch the useful life of that asset another 12 or 18 months, and the customer's satisfied with that, and my R&M, repair and maintenance, isn't affected, then I'm going to rent that piece of equipment for another 12 to 18 months and generate cash with that product, and then sell it out. Because once you get to a certain age, the difference between another year and when you sell that piece of equipment is marginal. It's 2%, 3%, 4%, 5% in value because it's already lost. It's the old, I bought the car, and it dropped 20% in value the day I drove it off the yard. Okay, great. Well, we're almost out of time, so why don't we go ahead and wrap it up there. Thanks so much, Bruce. Thank you very much.