Bank of America Global Industrials Conference 2022

Mar 17, 2022

Summary

Growth plans combine $1 billion-plus annual fleet investment with targeted acquisitions focused on major North American markets. Strong demand, constrained supply and accelerating rental rates support a path toward high-40% EBITDA margins over the next couple of years.

Okay. Greetings, everyone. Welcome to the next virtual session of the BofA Global Industrials Conference with Herc Holdings. I'm Ross Gilardi. I'm the senior machinery analyst based in the U.S. We're delighted to have Herc join us at the conference again this year virtually. Very pleased to have President and CEO, Larry Silber, and CFO, Mark Irion. Gentlemen, thanks so much for being here today. I think we're just going to go right into Q&A. If anybody has any questions, feel free to just put them through the system and we'll definitely do our best to get to them. Larry, maybe just to kick it off, it's been an exciting time for Herc the last several years. You've really shifted much more into growth mode recently as you laid out at your Investor Day last year. You certainly become more acquisitive in the last 1-2 years, and I kind of wanted to sort of start there. I think you've done roughly a dozen acquisitions. You've allocated about a half a billion dollars to. Why pay a premium for fleet on OEC for M&A when you've clearly got ample organic growth opportunity? Talk about how you're balancing those two things, and then I'll ask you about Cloverdale as the next one. Yeah. Well, great, and thanks again for having us, and good morning or good afternoon, depending upon where everybody is in the world, and it certainly is exciting times for Herc. As you mentioned, in September, we had our Investor Day, and we laid out our strategy, which including both a combination of organic as well as M&A or inorganic growth, if you will. As you know, we get our best returns by investing in our fleet and building our fleet and running that through our existing locations. We closed with quite a bit of fleet last year, over $4.4 billion in fleet on hand, and really looking, that represented about 20% there and growing organically very fastly. But our capital allocation strategy also included some M&A opportunities to, as we look to develop and grow the top 50 urban markets in North America, which is where we're focused. We're in 40 states and five Canadian provinces, and we look at M&A as sort of a make versus buy decision, and opportunistically as to where do we need to fill in some gaps? Where might it be easier to do M&A as opposed to a greenfield? M&A gives you immediate access to real estate, which you know is very hard to come by. It also gives you fleet, which has been very hard to come by, and it gives you people, which as you know, mechanics and drivers is very hard to come by. So we look at that as one of the reasons why we want to invest in M&A. We look at particular markets where we think we have a need to continue to grow our business and where the opportunity might be faster and might present some very excellent businesses to grow with. We completed nearly $500 million worth of acquisitions through the end of 2021. We are off to a good start this year. We just 2 days ago announced Cloverdale, which is an upper Midwest, Great Lakes region company. Excellent company, excellent organization, been around for nearly 65 years, tremendous reputation, and gives us better position in some very key markets for us. That is interesting what you said in your opening comments there, Larry, about these equipment shortages being an incentivizer for M&A. Do you really look at it that way? Is that one of the things that is pushing you to do more deals? No, I don't think that is a driver, but I think that is just a benefit, right? Because when you acquire these companies, you pick up that gear. It is certainly not a driver for us. The driver is really more strategic from the standpoint of how do we get a better footprint? How do we get strategically located in these top 50 markets? How do we round out some of our capability, and how do we add to the capability, whether it be around people or locations or gear. The side benefit is, yeah, in a very tight supply market, we are picking up equipment and adding that to our already record level of fleet investment. Just on that, as you just laid out, you filled in the footprint quite a bit. You are 300 locations in 40 states. I know that number is dynamic, but I think that is roughly where you are. Anywhere would you like to be bigger? How do you think about footprint density versus just sort of being everywhere? You mentioned you have been filling in the holes. Do you see any holes from here, either geographically or by end market that you would like to address? Yeah. No, great question. Look, I think we're up to, with the announcement of Cloverdale, I think that'll bring us to about 324 or 325 physical locations. We only count physical locations as branches. I think some of our peers, if they have a business within a branch, they might count that as two branches. We don't. We count only physical locations. So I think we're up to about 324 or 325 once we close on the Cloverdale. Our focus, since I got here, has really been on the top 50 MSAs in North America. That's where we're focused. The areas that I think we'd like to fill in is where we just made this announcement relative to Cloverdale, that great Midwest part of North America, maybe some of the Rocky Mountain regions and some of the top MSAs provide some opportunities and maybe some of the larger cities in Western Canada, as you go outside of the oil fields into, whether it be in Edmonton or whether it be in Vancouver, and certainly continuing to develop and grow in Toronto. So, upper Midwest is opportunistic and an area of focus and really anywhere where there's a top 50 market where we don't have a really strong footprint, we'll be looking to add capability. Well, what have you actually seen? I'm curious, just given your focus on the top 50 MSAs. If you compared sort of your denser metropolitan markets to what you've seen more out in the kind of the rural markets, Rust Belt, even the Corn Belt, is there anything notable? The farmers are making a lot of money right now. I think some of the Midwestern rural states fiscally are in pretty good shape right now. Do you detect any sort of variation across the different markets and sort of demand trends and so forth that are worth mentioning? Yeah, look, while some of what I'll call the rural markets may have a strong appeal at the moment, they're not generally appealing to us, because we're really focused on metropolitan markets where there's a broad array of activity that happens regardless of any economic environment. There's a steady stream of business in those markets, and that's where we're focused on big infrastructure projects, big data centers, big warehousing and distribution centers, the building of EV plants. Those tend to go towards larger metropolitan markets as opposed to the rural markets. Certainly, we have some facilities in some rural markets, but those are more historical than they are in terms of where we're targeting. We think there's ample opportunities, though, in the major MSAs to focus and continue our growth over the next several years. Talk about that. What are some of the levers for share gain? Obviously, you laid a lot of this out at the Investor Day, but maybe you could remind everybody and what is in your multi-year plan in terms of market share in a lot of these markets. Yeah, look, certainly it's building the density in these markets and being able to have enough branches so that you can share equipment effectively and cover customers in these markets, so density is important. Fleet is important and putting a significant amount of capital investment into new fleet, and added fleet to each of our branches. That'll pour down and give us market share opportunities. Then we look at technology as being an enabler to us. Maybe Mark will talk about that in a bit around some of our technology advancements and enablements. Then the development of our organization and our people and the maturity and that we've gotten up the curve with our sales force, and really are at a point where our organization is capable and ready to continue to deploy the fleet that we're putting into these locations. Yeah, Mark, maybe we'll punt that one to you on the technology. How has Herc used technology to enhance its competitive position? Right. Yeah. As one of the big players in the market, we've got the ability to continually invest in our technology platform, and that's something that we will do and that we're committed to in the future. It's a transactional business, so there's a lot of opportunities in terms of customer-facing technology to continually invest. We're about to roll out a big enhancement to our ProControl platform, which integrates telematics and gives customers access through one sort of channel to access their telematics, their contracts, and just manage the equipment that they've got in a more efficient manner. As those tools continue to evolve, we'll continue to invest in them. There's logistics tools in terms of giving customers visibility on where the equipment is being delivered and how that's coming and being picked up. There is internal efficiency-type technology investments in terms of data analysis and providing information to our managers and operators to sort of manage their business more efficiently and effectively. So there is a continual investment. We have got the size and scale to make those investments, and we are committed to being a leader in terms of the industry, in terms of our technology solutions. If you step back and look at your markets just with try to sort of a fresh set of eyes. Obviously, you guys are positive on the outlook. But just thinking about interest rates, the economy, Russia. I know you do not have any Russian business. I know you are a domestic play. But there are indirect implications maybe to sort of think about on business confidence or what have you, commodity cycle. What are your latest thoughts on the longevity of the cycle, given all this volatility in the macro landscape as it pertains to your business? I think the end markets continue to be solid and strong, and the construction equipment economy that we are involved in is just about as good as it gets, right? So there is strong demand across all of our end markets in North America. As you mentioned, we do not have any real direct impact from the Ukrainian conflict, and it is terrible to watch on TV, but it does not really seem to be affecting our business directly. And it is almost as good as it gets out there. So we are in an environment where demand continues to be strong. Supply is still constrained. As a bigger player with a big pocketbook, we have got $1 billion plus of fleet scheduled to come in to an environment where utilization across the industry looks to be at record levels, and we have got an ability to put it out on rent very soon after it lands on the yard. Rates are as good as they have been. There is a strong industry focus on rate. All the leading rental players are focused on rate and starting to have a conversation with analysts and investors on rate, which is not typical. So it is as good as it gets and as good as I have seen, really, in my 25 years in the business out there. Latest thoughts on infrastructure? There's been, I think, some subtle developments in the last week or two, but are you getting any more visibility on when some of these projects might commence? Yeah, look, I think there certainly has been some smaller projects that have been identified, been developing. Planning is going around and particularly around roads and bridges and various levels of infrastructure within cities and within some surrounding areas around cities. So we're starting to get a little bit of visibility on that, but I can't tell you that we put any gear of any significance out to any projects at this point. I think it'll be later in the year, towards the end of 2022 and into 2023, that some of these will be more shovel-ready, be ready to go, and we'll participate accordingly. Whether or not we actually participate in a big way or not, the whole fact that they'll be there will put an additional strain on equipment availability and continue to afford us opportunities in markets, not only for deployment of gear but for pricing as well as equipment remains in somewhat short supply and limited. We're the bigger guys. We'll have the gear, and we'll have it available for those projects as they come up, but we'll also have it available for other projects and be able to continue to push rate. Just on that, last year, you guys were really proactive on CapEx, and you managed to hit this year with a lot of fleet on the ground and ready to go. In the process, I think we're able to circumvent some of the cost inflation that's been out there from your suppliers. Can you still do that now at this point, or how are you thinking more about how are you approaching your CapEx needs? Because you put some numbers out there for the next couple of years. Yeah, look, we have on order for this year and receiving daily significant amounts of gear pretty much in line with what our requirements were to our manufacturers. There are certainly some delays that are minor, 30, 45 days, but nothing significant that is going to impact our ability to deploy that fleet and hit the kind of growth forecast that we planned. We have over $1 billion of fleet on order for this year, which we expect to see come in, and we plan to do similar amounts over the course of the next two years. Yeah, we have previously been able to stave off the inflationary pressures around that through our outstanding fleet group and our ordering and our procurement methods. But we are going to see some inflation going forward. I think Mark can comment on the magnitude of that and what that might compound like over the next couple of years. Right. Yeah, no, you are right, Ross. We insulated ourselves with orders getting in early last year. But that is not something that we can continue. So it is looking like a mid-single-digit inflation in terms of the cost of the equipment in 2021 and 2022 over 2021. Then as we move in through some of the early orders that we got into 2022, as we roll into 2023, over 2022, that looks like another mid-single-digit cost inflation on the equipment side. But the model is quite resilient in terms of inflation. We have eight years to get that 5% back. So there is the opportunity to continue to improve our dollar utilization with the mid-single-digit rate cadence that will more than cover that up over the eight years. On the income statement side, the biggest cost line item is headcount and associated costs. That is maybe 30% of our revenue line. Getting mid-single-digit revenue growth in terms of rate, again, more than compensates for most of the inflation that we have on the income statement. So we have the opportunity to improve our margins in a modest inflationary environment. Mark, are you saying mid-single-digit rate is what we should be Are you talking rental rates? Is that what we should be assuming and what you're assuming for the next couple of years? Certainly, a drive over the next couple of quarters. There's clear momentum coming out of 2021 into 2022. As I mentioned, we're seeing real discipline in the big players and the small players in terms of rate. The industry is focused in a way that it really hasn't been, I think, top to bottom in the 20, 25 years that I've been involved. Yeah, we're pushing for mid-single digit rate. We're pushing for an increase in our year-over-year rate growth, which was 3%, 3.2% in Q4. So we're looking for that number to increase each quarter through 2022. Okay. The indicators are positive by and large, but if you look at the You guys cite the ABI. The ABI, I've struggled over the years to figure out if it's truly useful for your business or in rental or not. Sometimes I feel like it is, sometimes it isn't. But the ABI had softened up a little bit and certainly, there's plenty of commentary. We can all see it around labor shortages and cost overruns on these projects. Are you seeing any bigger projects that you were kitting out the customers for that are getting delayed at all? Or is any of that filtering into your business? Right. So ABI is a little bit confusing. Is it a guide for 12 to 18 months? So there's a lot of things that can change over 12 to 18 months from an indicator that we're seeing today. It's an index, so over 50 is positive, and it's cooling off from record levels back end of last year, but it's still over 50, which indicates strength going forward. We're seeing, Larry can touch on the big projects. We're not seeing any delays in the big projects that we're exposed to, and there's a steady stream of big projects breaking ground and being talked about. The amount of big projects that are out there is unusually strong, I would say, compared to what we've seen over the last couple of cycles. Yeah. Spot on. We have not seen a slowdown whatsoever. The number of new projects that are being announced every day, big projects, whether it's battery plants or EV plants or data centers or warehouses or just general construction activity that's going on, big redevelopment of major city areas, it's been as strong as I've ever seen it in my career. It's an ideal environment that we're in. As Mark said, we're not having any direct effects from the Ukraine conflict, at least at this point. Hopefully, we won't, and we'll continue to have a very positive environment for our business. You guys laid out the CapEx expectations for the next couple of years in your Investor Day. Does that level of CapEx just go as far as you anticipate at the time, just given the cost inflation out there? Or potentially, do you just need to spend more to just get the type of fleet growth that you envisioned? Well, look, we have a pretty good plan in place of $1 billion plus over each of the next three years. We'll continue to do that, of course, unless there's a change in the economy or economic environment, of which we can react, as we've shown in the previous downturn during COVID-19. We can react quickly and adjust that and make sure we're spending to the appropriate levels. We're talking 20% plus fleet growth, so mid-single digit inflation on that doesn't impact the growth capabilities at all. We're also not selling much gear at the moment. So the replacement needs in the short term are less significant. We're focusing on growth and maximizing the size of the fleet to be able to maximize our rental opportunities. I think Ashtead had noted some just short-term slowing at William F. White last quarter in their studio and entertainment business. That's an important vertical for you guys. Did you see that? They sounded like they thought it would pick up again. Yeah, look, certainly, everybody has a little blip whenever there's a pickup in the COVID-19 environment. But it wasn't long, didn't last long, and everything is back to all normal levels in our entertainment, and in fact, higher. Our entertainment business is outpacing 2021 and seems to be very strong. And content providers or content makers have an insatiable appetite to continue to produce these films, and we are participating in that quite heavily and have a really outstanding business that's back to full capacity and beyond. Okay. Interesting. Talk about the rest of your business and your broader specialty business, and what are you really excited about, Larry? And what do you think is really different about your portfolio more on the specialty side? Yeah. Well, maybe I'll let Mark talk to some of the statistics and things like that. But look, specialty has been, since I got to the business at the end of 2015 and began to redevelop Herc into what it is, it's. As you know, we said we wanted it to be somewhere between 25%-30% of our business. I think we've reached the low end of that range already with our specialty businesses, our ProSolutions business, which includes power, as well as, HVAC, heating, air conditioning, cooling, as well as our pumping business, and we continue to add to that capability in those spectrums. Our other specialty is obviously entertainment is a specialty business. Our ProContractor tool business is a specialty business. We've recently added, through acquisition, some trenching capability, which will continue to grow and mature over the next several years in our business. We continue to look for opportunities, both in terms of market and fleet, to grow in terms of specialty. I think we'll have a difference in our specialty versus what our competitors may have in terms of the total portfolio and markets that we serve. I think we're still on track to become 30% of our business. I think we're mid 20s right now and looking for that to be a growth area. Mark, you may want to talk about the benefits of specialty on our income statement and how it works. Right. Well, it is generally accretive to margin and asset utilization. I think the real benefits of being a big national player continue to play out, and the big national players are going to be able to continue to sort of grow share and dominate specialty offerings. They tend to be seasonal or opportunistic, I guess, in terms of where that demand comes from and when that demand comes. You've got to have a lot of capital available and be able to put the resources in to take care of that demand. Being a big diversified national player with the geographical footprint that covers all the opportunities that come up, those benefits are becoming more and more apparent, and I think we continue to lead the growth in that market. Mark, I just want to go back to make sure I understand what you were saying before about acceleration. I think in the fourth quarter, your consolidated rate was up 3.5. Is that right? Yeah, something like that. I think it was 3.2. Yeah. Sorry. Whatever was up in the fourth quarter. Yeah. Are you saying that in your outlook, you expect that 3.2, on a year-on-year basis, to be a steadily higher number on a year-on-year basis each quarter this year, even as you comp the higher number in the second half of 2022? Yes. Yeah. When we're talking about momentum, that goes from 3.2 to something more than 3.2 in Q1 and something more than that in Q2 and Q3 and Q4. Okay You mix them in there in the year-on-year growth. The initial wave in 2021 came from spot, and that was obviously our tools pick that up, and that moves quicker as those contracts turn around faster. The slower to move is the sort of 40%-50% of our business that's national accounts. But we've got that work going on, and that momentum is in place, and that's like a supertanker. Once that's turned, then as those contracts start getting renewed, then we get rate growth in those contracts as we go forward. But yes, moving from three up towards mid-single digits is absolutely our goal, through 2022. As I said, we've got significant leaders in the market that are talking about rate and rate growth at levels that I haven't heard them talking about. It is supportive from the leaders of the market as well as the smaller mom and pops. Is it that mid-single digit, is that the full year average? Does that look like up 3% to 4% in the first quarter and up 6% to 7% exiting the year? Is it that type of trajectory or? It needs to be balanced. I would prefer to get into a low mid-single digits cadence for a couple of years rather than just go all out into a tight environment and get a spike that we fall back from. Right. But certainly looking to move into the 3% to 4% and then into the 4% to 5%. Okay. All right. Got it. When you look at specialty versus gen rent, within the context of what you just said, any discernible differences or they both move at that similar cadence? Specialty being more seasonal comes in lumps. You've got a wave in the summer, when the heat comes in and the air conditioning goes out. Similarly, in the winter, when that heat season comes around. There is positive rate opportunity in both those segments. It just comes a bit lumpier with the seasonality in the specialty business. Okay. All right. We've got 5 more minutes. There's a couple things I want to cover. EBITDA margins, I know you guys have gone over this many times, but just remind us all, where'd you finish in 2021? Where do you want to be? How will you get there? How long is it going to take you? We saw in our Q4 results, we did 44.4% EBITDA margins in Q4. Year to date 2021, we did 43.2%. That was a 450 basis point increase year-over-year in 2021 over 2020. We've seen margin improvement every year, COVID or no COVID, for the last couple of years. We've got momentum as we move into the next phase of our growth. With 20% fleet growth driving over 20% revenue growth into 2022, we've got a lot of room for operating leverage to work and to continue expanding our margins. We see a pretty short runway into the high 40s, in terms of EBITDA margin over the next couple of years. Okay, got it. Just thoughts on leverage. You've really worked it down over the five years since being separated out. You've gotten more aggressive on M&A and fleet. How do you make sure you don't overextend yourself at some point in the event that demand doesn't turn out to be what you think? I mean, clearly, you've laid out a pretty strong case. From a contingency standpoint, if you had visibility on the peak, how high would you actually be willing to take your leverage at the peak of the cycle? Right. I think you saw through 2021, we're running low twos in terms of leverage, and that's worth almost $500 worth of M&A. So there's the ability for us to grow our fleet substantially, plus 20% zone, as well as do that sort of $500 million-ish range of M&A each year and maintain our low twos, which is the sort of lower end of our 2-3 band. So within normal M&A and pretty substantial fleet growth, we can sort of operate at the lower end of our leverage band. If a larger deal was to become available, there's not many of them out there, but we'd certainly look at it. I mean, that would be an opportunity where we would consider taking up leverage. But I think outside of that, we will run sort of in that 2-3 times leverage zone and return capital to shareholders and do M&A to sort of fill in that excess leverage which starts building up. Mark, just quickly address used equipment. Last quarter, you guys reported your revenue number was softer than the headline number, and it was, I think, purely because you sold less used equipment, which is a function of the fact that the market was much tighter than expected, and you held onto fleet, which is kind of an absurd reason on that particular day or whatever. That was the actual reason for people to view that negatively. What are you assuming on used equipment this year? Just given the environment, are you just feeling like more and more incentivized to sell less and less? Yeah, you're absolutely right. There's inflationary cost in terms of replacing that fleet. It's hard to find more gear to replace that fleet. We're strategically focused on just maximizing our fleet size to maximize our rental opportunity. Certainly through 2022, you'll probably see similar restricted sales volumes to what we saw in 2021. Maybe it opens up by Q4. That remains to be seen. But at the moment, we're maintaining the fleet to continue its rental life with us to the extent we can and only really selling fleet that doesn't have a rental opportunity or is at the end of its rental life. Okay. But would you agree that just generally disappointing on used, disappointing is the wrong word. Used equipment sales falling below expectations is a positive reflection of what's going on in the market, not a negative reflection. I don't want to. Yeah, no. Agenda. Absolutely. Yeah, absolutely. The used equipment market is very strong. There's not a lot of supply going into it, but strategically, the economic return we get from holding onto that fleet for another year and renting it is far superior to any sort of economic opportunity we create by selling that fleet. We're a rental business. We're in the business of renting, not the used equipment sales or end product of just managing the fleet. Okay. All right, guys. We are about out of time. Thanks so much for the update. It is great to see you guys and hear the latest at Herc. Thanks everybody to joining this session, and feel free to email me or reach out if I can do anything to help. Hope everybody enjoys the rest of the day, and see you soon. Thanks, Ross. All right, thanks. Absolutely. Thanks, Ross. Yep, bye-bye.