Goldman Sachs Industrials and Materials Conference

May 9, 2023

Summary

Growth has been driven by fleet and operational modernization, acquisitions and specialty expansion. Management aims to close peer gaps over the next one to two years and expects margin resilience in downturns, supported by pricing discipline and cost levers.

Good morning, everyone. I'm Jerry Revich from Goldman Sachs, and I'm delighted to have with us from Herc, Larry Silber, CEO, Mark Humphrey, CFO. Gentlemen, thank you so much for joining us. Larry, to start the conversation, since you came to Herc in 2015, the financials are drastically different. Margins are 10 points higher, dollar utilization is 10 points higher. Talk to us about the journey so far over that time frame and your top priorities going forward. Yeah, great. Well, thanks for having us, Jerry, and we appreciate being here. Also in the audience is Leslie Hunziker, our Senior Vice President of Investor Relations. If anybody has any questions after, Leslie's available. But yeah, thanks. It's been a wild ride over the last eight years. Yes, we've had tremendous improvement in the business. Some of that has been helped, obviously, by the environment in which we're operating in. We went through some challenging times in COVID, but that spurred on even more activity. We went through just about everything in the business, from fleet modernization to systems and technology modernization, to sales force investment and training and education of our organization. Pruning. First pruning the facilities and then building back facilities in the right markets. We pruned the majority of our international operations. Obviously, we operate in five Canadian provinces and 39 states. When I got here in 2015, we had operations in China and Saudi Arabia and Qatar and Europe and Latin America. We've pruned all of that to where we're a North American-focused company only. As we improved our capital structure, rebuilt our business, focused on margin improvement, getting the fleet right, turning over the fleet, focusing and consolidating manufacturers to where we only have a few manufacturers per category, gave us purchasing leverage in those areas, and allowed us to really have the strength to grow. We started adding specialty businesses to our core business mix, which gave us even greater margin opportunity as you solutionize rather than just supply products. Solutionizing enables you to grow your margin and grow your value to those customers. About two years ago, a little over two years ago, we felt our capital structure was right to where we can enter the world of M&A, begin to acquire companies to improve our density in large urban markets, which is where we're focused, and add acquisition companies to our portfolio. We've done about 30 acquisitions, added nearly 70 locations over the last two years to the organizational structure. Also, again, focused on large urban markets, focused on areas where there's growth opportunity, where there's hot activity. We implemented a dividend over a year ago, which was a good return to shareholders, and we did opportunistic buybacks of our stock. So really been quite a journey. We still have more room to grow, to expand, continue to improve margins, and continue to improve the business. We view it as still a very vibrant industry, one which we can continue to grow and develop. Larry, I remember one of the first areas that you focused on was getting the right fleet in there. Right. As you've implemented your purchasing process, is there a natural uplift that we should be looking for in terms of dollar utilization as we continue to have the entire fleet purchased with your current run rate purchasing process? Yeah, I think that there's a recipe there, right? How we purchase fleet is an absolute huge component of that, right? I think at the end of the day, you have to look at it from one, pricing and in this environment, and as Larry was just speaking about, that has been a focus of ours since Larry came on board. So really, you're talking about pricing, and then you're talking about fleet efficiency, and then lastly, you're talking about just being able to lever. Significantly different company today, as Larry was talking about, from even 2020. We're up about 100 branches. So I think all of that plays in when you think about ultimately specialty mix inside of the strategy that Larry was speaking of as sort of the third component there of the overall lift in dollar utilization. Mm-hmm. Looking at your performance versus your two biggest public competitors, you've really narrowed the margin and dollar utilization gap, nearly closed it. There's still a bit of a gap. I know you folks are focused on closing it completely. Talk to us about the path to get there, if you don't mind. Yeah, no, look, I think we have made great progress on narrowing that gap, and we're within striking distance in the next year or two of equaling that. But it's really around continuing the focus on disciplined pricing. Adding to our fleet mix specialty products that drive that higher margin and drive that better capability from a solutionizing standpoint, and then maintaining that mix between national accounts and customers. We're at about a 50/50, and that might go 45/55, and then depending upon the seasonality, it could even go 60/40. But we'd like to try to maintain that mix to where you can get higher margins from the spot market and the local customers than you can from some of the national accounts. But plenty of opportunity there. Finally, scale. As we continue to scale up, and we add more fleet to the existing footprint, that revenue drops to the bottom line and helps you close that gap because you have a fixed cost structure, and you're putting more volume through that fixed cost structure. So that helps you close the gap. So plenty of opportunities to do that. Larry, based on your comment a moment ago, it sounds like you wouldn't have to ramp up headcount as you add more fleet. Is that right? You want it? Go ahead. Yeah. I think in context of 20%-30% fleet growth, which is sort of the last couple of years, right? I think, and Larry mentioned this, there will always be a focus on the sales force, and making sure that that ramps up along with the fleet, right? Generally speaking, that's compensation that we're not afraid of. I think as it relates to sort of the core base business, yeah, there's runway there to add significant fleet without adding significant headcount. Can we shift gears and talk about your ability to react and manage the cost structure to the economic environment? 2020 was really interesting, given the drawdown in utilization and your margin performance. Can you talk about whether that's representative of the type of performance we can expect the next time we see a meaningful slowdown in activity? Yeah. I think, and as I just stated, while there was, I don't know, 160 basis point uplift from 2019 to 2020 during the COVID downturn. Even from 2020 to now, we are a very different business. More mature, more diversified fleet. At the same time, the same levers that we utilized back in 2020 are at our disposal today, and we would utilize those levers to sort of maintain that margin profile that we've sort of continued to grow into. Can you talk about those levers? You pulled back on third-party deliveries and what are the other pieces? Yeah, look, I think a lot of levers to our disposal, which we employed during that COVID period. That sort of we woke up on a Monday, and we reacted by Friday and took it very seriously. The main lever is cutting off incoming fleet, right? We have 30-day commitments to all of our OEM vendors, to where we're only obligated to take what's in sort of the manufacturing channel 30 days out and scheduled for delivery within a 30-day period out. We could and would turn off incoming fleet, which would reduce CapEx. During COVID, we reduced $400 million worth of incoming fleet within a one-week period, and it didn't come in. That would happen. We would look at disposal channels on what age fleet do we want to dispose of because we'd have an issue in terms of utilization. So we'd dispose of fleet. Wouldn't necessarily be at distressed pricing. It would be at normalized market pricing, probably below what we're seeing today because we're at an all-time high in the used equipment market. But you're always able to dispose of fleet. You generate cash from doing that. As you said, we'd reduce third-party freight, we'd reduce overtime. We could freeze merit increases and annual increases in the business. There is a number of different. Obviously, we'd stop hiring, and we'd look at attrition. Not replace that attrition until it was needed. So a lot of levers that could quickly be employed that would allow us as a business to maintain that margin profile, even on a reduced volume level. So just to make sure I'm on the same page with you think you can maintain the run rate margins whenever we go into a downturn? You think you'll be able to maintain prior year levels? Yeah. I think, again, the margin expansion journey as we've talked about. It sort of resets as you sort of continue to mature inside the business. Yeah, I think that the margin expectation, obviously the nature and extent, breadth and depth of a downturn, notwithstanding, we would expect to maintain margin profile. Can you just help us understand the variable part of the cost structure better? How much do you cut third party transport? Just because not a lot of businesses have that type of profile where volume's down 5%, 10%, and they can maintain margins. Yeah. I think this is a very sort of recession resistant, nothing recession-proof, right? But the recession-resistant aspect of this business does allow us to Larry was talking about it, right? From a fleet side, we've discussed from a P&L side, all of those things, people, salary, et cetera, is about 30% of that P&L on an annualized basis. Those levers are there for us to pull, again, depending upon sort of the breadth and depth of what it is that we're facing. The other interesting thing about this business is during a downturn, we generate cash. Yes. When we are generating cash, then we are reducing our leverage, whereas, a number of companies have to go out and borrow to sustain their business until that business goes back. Not in our case. We generate cash, we pay down debt, leverage goes down. The business really functions maybe countercyclical to what many other manufacturing or normalized businesses do. Can we continue to pull down that string on what the next downturn might look like? When we saw pricing in industry over COVID down 1%, great financial crisis down 15%. What would you attribute the difference in performance for the industry to? Yeah, look. Hard to predict, right? What the next downturn is going to look like. It was hard to predict COVID, and certainly was hard to predict '08, '09 downturn. But the industry is much more disciplined today than it was at any time in the past. Certainly the top three and even the top five rental companies in North America all have professional management in place, all have great systems in place, all have pricing tools in place. Things that will help enable more discipline to the market so you do not see a runway down. Obviously, we would turn off the fleet purchases, as we have discussed. Generate a lot of cash. We would rotate the fleet where we needed to in a normal rotation. We would right-size the staff. It would really depend on how pronounced and prolonged that downturn would be in terms of what we would do to the base organization, right? As during COVID, we maintained our entire base organization throughout. We had very few furloughs at all in the business. So if it was much more prolonged, we probably would have had to take some greater action, but fortunately we did not. We would have to see how that went. But I am expecting the industry will be well-disciplined and well-managed through any downturn period. How much of an impact does data availability help Rouse in particular? Yeah, that was going to be my point, too. I think that is probably one of the biggest differences between then, 2015, to the one, right? You have sort of 50%-60% of North American rental companies reporting in to Rouse and we see that data weekly and then more rolled up monthly. That certainly goes to the discipline in the overall marketplace in the industry that Larry was speaking of. I think it's invaluable. In terms of the pricing landscape today, one interesting dynamic in the cycle is higher rates and the impact it has on operating costs, essentially, for your competitors. Are you finding pricing is surprisingly strong given that dynamic? I was pleasantly surprised by your pricing number for the second quarter in particular, given the tougher comps. First quarter. I was wondering. Yeah. Well, the outlook for what Mark said. Okay in the first half. Yeah, no. We were happy with that, and I think a little bit above our expectations as well, because I think we guided to mid-single digits, and it came in much stronger than that. We feel that the market is accepting the price increases that are being put forth because everybody knows what's going on around inflation and what those inflationary pressures are. It was a little bit higher than what our expectations are, but we were happy to see it. I think the market, one of our competitors came in much stronger than us in the pricing scene. That means maybe we left a little bit on the table. Who knows? H&E? Yeah. In terms of opportunity to continue to push pricing, can you talk about customer receptivity to pricing on a spot basis? Yeah. On a spot basis, quite frankly, it's much stronger than it is on a national or contractual basis. We saw low double digits in that area, and we were able to push that pretty well on a spot basis. On a national basis, obviously, those are annual contracts that roll over ratably, over a 12-month period. We've implemented over the last 18 months in what has been traditionally a very difficult environment to raise prices. We've been able to raise prices at the national contract level. Those have been accepted and received and understood by those customers, and we haven't had any real significant pushback at all. So we're seeing that to be pretty firm. Larry, you spoke to this earlier, you want to get the right mix of national account versus spot. Can you talk about where the margin differential stands between those two different account types? Yeah. I think you're probably looking at mid to high single digit differences in terms of margin and on a core basket of goods. But on a national account, what you have to think about is you might bid a core basket of goods that might have a margin differential, but then you have all of the other products that aren't priced that you can get book or near book, which gives that customer profile an overall very strong margin profile. So while we do believe the customer, the local or spot business does give us a higher margin, our specialty business in a national account gives us higher margin as well. So we're able to sort of generate very good margins across the entire portfolio of customers. Can we just continue down that thread, specialty M&A opportunities from here? Can you talk about what type of specialty businesses would fit your portfolio and what the pipeline looks like? I will let Mark talk to the pipeline, but I will talk to the specialty. We have been looking at businesses that are complementary to our overall businesses and gives us greater inroads and that are focused on solutionizing. As an example, we have recently acquired four businesses that are trench solutions, trench shoring businesses that allow you to provide a solution to a customer, to prevent injury or accident in the market. Then we help design and engineer or near engineer applications the way you are putting that, and it is not just a customer calling and saying, "Bring me a 185 CFM air compressor," or, "Bring me a skid steer loader," or, "Bring me a 19-foot scissor." They are saying, "Hey, I got a hole in the ground. It is this big. I need to make sure that not only is it safe and protected and I want to put in a trench shoring system. I also, when it rains, I got to pump out that water that is out of there on a dewatering basis, can you provide a pumping system to move that water somewhere else?" So trench shoring, pumping, development of our pumping business. We have had a small pumping business. We have invested in that, growing that, and certainly our power generation business, which is far beyond just expanding into providing a generator. It is really providing power for sites for an ongoing, sustained basis. Take a mega project that is being built out in the middle of the desert. There is no power, there is no grid out there yet, and it might be two years while they are building that factory where they will need power on a sustained basis. So we will not only have to provide the power, we will have to provide all the cabling, get that facility cabled up, and then help deliver the fuel to that generator for that period of time. So we have an ongoing daily relationship with that customer. Then finally, the next area would be HVAC, where we have moved in a big way into the HVAC market, providing air conditioning during the hot weather, heating during the cold weather. Some of it on a sustained basis as backup to a system that might be on a building like this while they are doing maintenance on a building like this. And some of it might be emergency response type activity. So we are very big in emergency response, responding, and equipment that responds to hurricanes, tornadoes, fires, floods, things like that. Very interesting. What sort of valuations are you seeing on a replacement cost basis in the specialty business? The reason why I ask is, your stock is trading at a 10% discount to replacement cost. Same level it traded in the last cycle when margins were a lot lower, specialty business was a lot lower. If we were to think about it on a sum of the parts basis, what's the EV to replacement cost that you're seeing on these specialty deals? Yeah, I think I would look at it more in terms of a basket, right? The 2022 deals, we sort of averaged a 5.5x multiple on those deals all in, and there was specialty, as Larry said, inside of that. I think when we think about it, right, you have 5.5x sort of overall multiple. Yes, we're trading more towards 4 at this point, but our goal is to take that 5.5 multiple and work it down to a 3.5 to 4.5 depending. Then, ultimately, those target metrics from a return perspective are accretive to our overall return on invested capital. Mark, is it possible to contextualize relative to replacement cost of assets that you're buying? Well, all of this is sort of publicly available, but last year's $500 million of M&A brought in somewhere in the order of magnitude of $370 million, $380 million of fleet. On specialty, I'm presuming you're closer to 2 to 1 probably, right? That's not far off. Yeah. Okay. In terms of the cadence of deliveries of gear this year, you took higher deliveries in the fourth quarter, higher deliveries in the first quarter. Is that utilization year-over-year? Is that a pressure across equipment categories, or are there any equipment categories that have same or higher utilization rates? Yeah. No, look, I think we ran very hot last year across all of our categories. We're still running hot on what I'll call our core categories. That's booms and scissors and material handling product are all running at or near high record levels, and we're still seeing supply constraints in those categories today. In some of the other categories where we brought in fleet that are either seasonal, we brought in air conditioning in the winter, we brought in heat in the summer. Those, you take them because of the supply constraints we've experienced, we took them when we could get them as opposed to when you actually need them. We're hoping to get back to a more normalized supply chain by the end of this year, so that in the fourth quarter, we're not taking, in the fourth and first quarter, we're not taking in as much fleet as we took in last year. We're hoping that the supply chain returns to a more normal cadence. We're hearing that from our vendors, except for some of those core categories that I mentioned. Some of the others say that they're returning to a more normal supply chain incoming balance, and we're hoping that that'll allow us, come Q4 and Q1 of next year, to have a more normalized supply chain similar to 2019. You're still running as hot on booms and scissors as you were a year ago? Yes, we are. Wow. Yeah. In terms of putting this gear to work, when we're talking about AC, are we going to see an abnormally large step-up in the second quarter or in the third quarter? It sounds like you might get a sharper snapback, just HVAC as an example. Well, I think what we're moving towards is a more normal seasonalized demand similar to 2019, which means, as we move into Q2 and Q3, those are the heavy construction seasons, and it'll be more of a similar curve to what we experienced pre-COVID. From a capital allocation standpoint, or CapEx allocation, I should say, can you talk about what proportion of CapEx this year is towards specialty lines of business? And how do you expect that mix to look on a multi-year basis? Yeah. I think what we've done this year is we're still investing heavily in our specialty business. So it's probably in the same percentages, as our fleet is, which is about 24%, 25% specialty. We said we want to continue to grow that specialty to 30% of our overall fleet. So we'll continue to do heavy investments in our specialty areas, particularly, with the acquisitions that we've done in those specialty areas like trench and power generation and HVAC areas. From a new equipment purchase, we'll keep it in that. I think as we went into last year, we sort of moved a little bit towards our core gear because we wanted to do some fleet rotation. I think we got that going, and we're well on the track. I would say it's going to be a normalized year going forward with about the same level going to specialty as going to core fleet. Are there any areas where you are spending more than a percentage of fleet? No. I think we are- Pretty balanced. Yeah, we are pretty balanced. Yeah. In terms of looking at your geographic footprint, can you talk about where you're allocating gear? Which parts of the footprint are seeing the most fleet delivered? Yeah, no, look, we have a strategy and have had a strategy since I got here of feed the hot hand, right? The markets that are hot, we feed the gear to. So if you look at area where some of these mega projects are and where we've done some acquisitions like Austin, like Dallas, like Phoenix, and then certain parts of the East Coast, we're feeding those markets that are demanding it. But all of our regions on balance are growing similarly, double-digit growth across all of our regions across North America. We're seeing a lot of activity with hotspots in the areas where some of these mega projects are that we're participating in. Larry, I meant to ask you when we were talking equipment categories. We are hearing that excavators and earthmoving generally are starting to shift into oversupply, both in terms of used inventories and new inventories. Where are utilization rates for those types of assets for you? Yeah, no, look, we're not seeing that as an area of oversupply. You look, we have one primary manufacturer on our big earth, and we have two primary manufacturers on what we call mid-size and small. Quite frankly, our large supplier on the large earth is, and has had a good supply chain since late last year. So we have not had challenges with our largest supplier of earthmoving. Our two, what I'll call mid-size to compact suppliers, are still somewhat challenged. We still can't get everything we want when we want it. So we're not really seeing that today in our business. We're still trying to bring that equipment in. Utilization is seasonally adjusted. Well, I'll say seasonally normal. As the wet weather in the winter ends and they start digging foundations and doing preparing ground and moving earth and things like that utilization is seasonally ticking back up the way we would expect it. We're still challenged on what I'll call medium and small compact earth to get the equipment when we want it and when we need it. Putting the pieces together, do you expect your time utilization to return to prior year levels in the third quarter, or we were just way too hot last year? Well, we were running way too hot last year. We hope that we don't return to those levels because we were losing business. We weren't able to supply customers with equipment last year when they wanted it. So we were losing some business. So we've planned so that we don't get back to that level. We're still running at that level in access and material handling product. We hope that that supply chain will loosen up a little. We did go to a third vendor, and we do have a third vendor in that category to help ease some of the challenges we had. But the rest of the categories, we think we're prepared from a fleet input standpoint to be at a more normalized utilization level where we don't lose customers, where we can supply customers and have them available. Any questions from the audience? Can we talk about your expectations for fleet inflation in 2024? I know some OEMs are taking orders. At the same time, a lot of OEMs and earthmoving, in particular, are posting really attractive margins this year. So how do you think about inflation, if any, for 2024? Yeah, look, I think it's a bit too early to talk about inflation. We haven't gotten to that point with any of our manufacturers. We are beginning to work on availability of manufacturing slots for next year. We're already doing fleet planning and working with our key vendors to secure those slots for next year's fleet purchases. But we really haven't gotten into any discussions about pricing at this point or inflation or what that might be, so a bit too early. Larry, your personal experience from the manufacturing side, having been through these cycles, is there a potential that pricing for some categories could actually be down year-over-year in 2024? Well, there's always that potential, but I'm of the opinion that once you get it, you don't give it back very easily. I would expect that there might be some vendors that their supply chain has eased up and they're not getting surcharges from their supply chain. There might be some opportunities for deflation across some categories. But I think, if I was still in my manufacturing shoes, I wouldn't necessarily give up what I got, because there's been other inflation that you're not going to give back, right? There's wage inflation in the factories. There's other things that you're still going to have to deal with in the world in which we live. So I think it'll be challenging. Certainly, the surcharges around transportation will go away. For instance, containers coming over from Asia used to cost $6,000 a container during the height of COVID. I think those have been reduced to sub-$2,000 a container. So that surcharge around that stuff will go away. But too soon to tell. Haven't had those discussions yet with any of those vendors. Hope to bump into one or two of them here at your conference and maybe strong-arm them into giving me a view of the world, but we'll see. In terms of to secure slots in 2024, if price is not on the table yet, what are those discussions around? Basically making sure that they're going to have the capacity to meet the demand that we expect to give them, as well as what our peers are giving them, and maybe more capacity than what we've gotten over the past couple of years. Because we've been constrained in some of those categories. So there's some categories that our vendors have constrained our growth, where the growth is available, that we'd like to have more capacity. So the discussions is, where are you going to be, what capacity you're adding, making sure that they don't over add more capacity than what the market really needs, because we want to have a disciplined market going forward. All of it's been pretty productive. Super. Please join me in thanking Larry, Mark, and Leslie for joining us. Thank you very much. Thank you. Thank you, everybody.