Goldman Sachs Industrials and Materials Conference 2021

May 12, 2021

Slides

Summary

Priorities are shifting from structural improvements to top-line growth, with $0.60-$0.70 EBITDA flow-through targeted per revenue dollar. Fleet investment is expected to accelerate into 2022 as utilization and pricing recover.

Thank you. Good morning, everyone. Welcome to the Fireside Chat with Herc Holdings. I'm Jerry Revich from Goldman Sachs, and I'm pleased to have with me Larry Silber, President and CEO, Mark Irion, CFO, and Elizabeth Higashi, Head of Investor Relations and Sustainability. Larry, Mark, and Elizabeth, thank you very much for joining us. There we go. Maybe. Sitting waiting for some now. Can you hear us? Perfect. All right. Very good. We are back in business. It has been nice to see you, and nice to hear you now as well. Thank you very much for joining us, Larry, Mark, Elizabeth. We appreciate it. Well, thank you, and good morning, everyone. Can we start the conversation just to frame the journey that you folks have been on? When you folks took over as management team 5 years ago, dollar utilization was in the low 30s. Now you are nearing the mid-40s and the margin improvement has been a similar order of magnitude as well. Can you talk about what the strategic priorities look like for you from here? Are you done on the structural improvement journey, or how much more room do you have to continue to improve dollar utilization margins beyond the cycle as you see it? Yeah. Let me begin, and maybe Mark can chime in after, talk about some of the improvement opportunities more numerically. I think it is almost 6 years ago now, Jerry, that I arrived. It was May of 2015 that I came on-site, and we are actually coming up to our fifth anniversary of being independent and doing our IPO on July 1st. You are right. Actually, we spent the last 5 and a half years or so focused on the operational side of our business, getting our fleet right, getting our organization set up, working on technology. Doing all the things that were sort of the basic blocking and tackling in this business to make sure that we could perform at the levels that we have demonstrated that we can and have been performing at recently. From an operating standpoint, I think we still have some things that we could work on and get incremental improvements. Maybe Mark can talk to those. I think our strategy now is focused on top-line growth, and let us have that growth, and let us let that volume rain down on our organization and provide that incremental margin opportunity. So that is sort of what the future looks like. We will continue to work on operational improvements. There are always things that we can get better at, but by and large, the big chunks are behind us and now the opportunity is lever the top line growth. Mark, anything? Yeah. No, I think that is it, Larry. This initial phase has just been getting the fleet right and getting the operations lined up and starting to do some of the Getting the cost base set right. From here on in, it is operating leverage, so we can drop down $0.60 to $0.70 of every dollar of revenue growth into EBITDA, and that is the focus for the next couple of years. Just to frame where we have come so far in the journey, the roughly 9 points of improvement in dollar utilization, can you talk about how much of that has come from price, how much of that has come from fleet productivity? You folks obviously spent on cost to get the service levels up early on in the process, so presumably we should be looking at good operating leverage from here as well. Right. I think on the dollar utilization side, the initial phase of the journey was really just getting the fleet right. Getting the mix, stepping up the specialty business, getting focused on core suppliers that were ready to provide product support and to streamline the maintenance and the repair side of the business. That's been in place pretty much for the last five years, I think, in terms of buying right, in terms of making these investments in the specialty fleet. The last phase, probably over the last two years, was improving price, and improving the fleet efficiency in terms of just the utilization and sharing and getting the fleet into the right places. That's starting to take place. You're seeing that in the results of the first quarter. And going on from here, I think, we continue to make strides, and the goal is 45% dollar utilization over the next couple years. Yeah. We might get there sooner than that, I think. Considering the long-lived nature of the asset base, is there a natural uplift to dollar utilization that we should be thinking about heading into next year? Essentially, you've got eight-year-lived assets on average and you're six years into the journey. Presumably, there's a benefit from buying right that's going to be increasingly flowing in from here, I would imagine, as some of those assets that were purchased right before you folks came in roll off. Is that a fair way to think about it in indicators? Yeah, look, I think we've already achieved most of that benefit by this point. Yeah, there's still some fleet that was acquired prior to us being here that will naturally roll off, but I don't think that what's left will have a big impact in dollar utilization. I think we've achieved that, and we'll see that. I think future lift is going to come from continuing to focus on price. Which as you know, we've been the leaders in the industry on moving price. We'll continue to focus on moving price. Last quarter, we were the only one of the majors that had positive price. And we'll continue on that trend. Obviously, mix as we continue to add to our specialty gear, that'll help us from a dollar utilization average standpoint. And we're going to continue to grow our specialty business. And then obviously fleet efficiency, logistics, and being able to improve our time utilization. We have a little bit of room to go there. That will help us as well. But from an acquisition standpoint, I think most of that is already built in. Okay. In terms of Mark, the comment that you made a couple moments ago on getting the absorption going forward. So you folks have essentially spent money to get service levels up, and now you are harvesting that spending, I suppose. How should we think about how much more fleet on rent your business can achieve before you have to ramp up headcount and layer on, make additional cost investments? I think within the flow through guidance that we are targeting 60%-70%, there is always room in there for incremental variable costs, right? And that picks up fuel and delivery costs. That picks up incremental drivers. That even gets incremental sales reps. So there is room for that leverage to continue really into the future without pause. I think the real benefit in our fixed cost structure is 280 purpose-built rental locations that can take billions of dollars more fleet without having to really change that fixed cost structure dramatically. So the real benefit to this organization and that fixed cost absorption is just putting more fleet on these existing locations, and there is room for incremental headcount, and still flow through $0.60-$0.70 in the model. In terms of how much runway do you have on that 60%-70% flow through? Is it literally as simple as what you just laid out? If we ever get to the point where we have billions of dollars more of OEC, then we will drop down in flow through? Or is there anything that could drive a normalization in that flow through rate sooner, Mark? I don't see any. Well, I think the next couple of years it's pretty clear, and we've got a great track record on it. There seems to be a stop somewhere around the 50s. I don't think you push that up to a 60% or 70% margin, which it would end up if that model just kept on getting plugged forever. So it looks like it stops in the 50s, and that's where we're guiding to get there. But we've got a pretty clear runway to the 50s, and that's where we're heading over the short term. One of the other levers that you've spoken about in the past has been customer mix and profitability needing to improve for some of the customer base in the past. Where do you stand on those initiatives today? Is everyone essentially on the right pricing schedule, relative to what's optimal for the business? Yeah, look, from a customer mix standpoint, we continue to sort of move. We want to grow the overall, rising tide raises all ship, grow the overall customer mix bucket, but we want to move to more of a local customer base and less of a national account base. That doesn't mean we want to lose any national accounts or go away from it. We just want to grow the local customer base at a faster level than we are our national account base. We've been making good strides there, continues to improve, and as that mix shifts, that continues to help us. That said, we've made great improvements on our national accounts and on the ability to raise price and to improve what we've been operating on there. As we gain new customers, we continue to focus on a broader basket of goods to those national accounts and putting in our specialty gear into those customers that allow us to prove the margins as well in the national account. So yeah, we've been doing pretty well. Always room to continue to improve and we're focused on that on a daily basis. One of the benefits of the margin improvement journey that you've been on is how much lower leverage is now compared to 5, 6 years ago. You folks, I think, made your first acquisition or multi-branch acquisition recently. Are we at a point where M&A is attractive for you folks? Can you talk about how the pipeline looks and how we should be thinking about the financial profile of any potential additions to the portfolio? Yeah, look, I think we have a three-pronged approach to growth, and that's really where we're focused on, is growth on the top line for the foreseeable future. We've made three acquisitions. We closed on the Champion acquisition in December, which was a four-branch location in the Houston, Texas market, and then we closed on two single-branch operations in the San Francisco Bay Area during the month of April. So we are focused on M&A. Our first priority is going to be about what we just talked about, putting more fleet onto our existing locations and leveraging that activity out at a fixed cost structure and reign down the kind of margins we just talked about. Secondarily, we continue to focus on greenfield operations, and we said we're going to do somewhere between 10 and 20, and that depends on the availability of real estate and what we can do to get those operations opened and functioning. Thirdly, M&A certainly is an opportunity for us now, and we'll focus on opportunistic M&A, and we'll look at make versus buy decisions. Do we put in a greenfield or is there an M&A opportunity in a particular large market, a large metropolitan area that we're focused on building our footprint and having greater density of branches where we can have better fleet productivity share that type of gear. Yeah, we are looking at it, but I wouldn't say it's our primary driver. Okay. From a capital deployment standpoint, if we don't have a big opportunity to deploy capital via M&A, how should we be thinking about where we're going to deploy the free cash flow that you're going to be generating over the next couple of years? The float is obviously not super high for the business, so I would presume buybacks aren't terribly attractive. Mark, maybe you could just flesh that out for us. If we don't have big M&A opportunities, what's going to be the target for the free cash? I think the initial and the primary focus will be on growing the business. So growing the fleet and strategic M&A where it makes sense. As you mentioned, buying back stock doesn't help our float. So we're a little bit constrained there. The other lever available is a dividend, which is something that we could consider once we're comfortable with our free cash flow. In terms of where we are seeing M&A, can you just talk about the financial parameters? What are multiples like on an EV to replacement cost standpoint, EV to EBITDA, compared to where your business trades? Right. So these smaller deals each have sort of nuances to them. It's negotiated. So some of the pointier metrics in terms of EV multiples or multiples of OEC get, I guess, obfuscated a little bit. In general terms, you're looking in the mid fives in terms of leverage to the mid sixes, with the smaller companies being lower on that leverage scale. If you get a bigger platform or a specialty platform, then you start moving up that scale in terms of leverage. Got it. The margin profile compared to your business, generally, what should we be thinking about? There's generally an option, there's generally a synergy in terms of improving the margins on these businesses. Similar to the journey that Herc's been on over the last five or six years, a lot of these smaller companies aren't necessarily being run at optimal margins. There's a synergy for us to take over those assets and run them a little bit more efficiently. Got it. Okay. Can we just shift gears and talk about industry supply, demand? The benefit in this cycle versus five, six years ago is there's much greater prevalence of industry data. Can you talk about what you're seeing for industry capacity utilization and can you talk about how having that data heading into this recovery is impacting decisions that you folks are making? I presume he's talking about Rouse data. Yeah. Yeah. That Rouse tool is great, and they've continued to develop it over this last cycle, so there's a lot more information available. Just heading through last year, you can sort of see our trends and the industry trends in terms of volume and capacity. That helps us frame up our decisions in terms of what we're doing in terms of fleet size. You can see that the industry is reacting rationally and taking out fleet through last year. That kind of gave us a little bit of comfort in terms of our ability to price and our ability to manage our fleet. Similarly, on the way through, you can sort of see, now as it's trending up, obviously fleet's tightening up, the capacity utilization, that gap in utilization is getting taken down. You can sort of see modest fleet growth moving back in. That again gives us comfort in terms of the decisions that we've made and our ability to fleet up and to sort of manage pricing conversations with the customers and stuff like that. We continue to run our business as we see fit. The Rouse data sort of helps us see guiderails, I think, in terms of just general trends and gives us specific information if we want to drill down and is certainly a big advantage in terms of just having additional data points out there to manage the business. When we look at operating hours put out by Komatsu, it does look like we're recovered in March back towards five-year average utilization levels, but not above where we were in 2019. I'm wondering, is that consistent for other class of equipment? Obviously, you folks rent much more than just earthmoving. I'm wondering, can you comment on what the trends look like for your broader equipment categories? Yeah. We're tracking 2019. Obviously, the 2020 metrics get pretty skewed as we head into sort of April. It looks like the industry, in general, is getting back towards 2019 utilization levels. For you folks, you've been on a continual journey in terms of increasing your fleet availability. I think you folks are on track to hit 70% time utilization for the full year, but please correct me if my math is wrong. If that's the case, is there room to take the utilization number higher, or are we at the end of that time utilization improvement journey for your business? Well, look, your model might be a little bit high from where we are and what we're tracking to. But look, we right-sized our fleet in the back half of last year. Certainly after COVID hit, we got right-sized, and we're looking to continue to improve that utilization. But we're adding a significant amount of fleet coming in as we speak during the month of May and June. All of our 2021 fleet acquisitions will hit the ground, and that'll certainly impact our utilization. But look, we'd like to drive towards that upper range, and you always have the opportunity to do that. Part of it deals with fleet logistics and picking up gear, getting gear checked back in, doing the maintenance, doing the rental-ready inspection, and then getting it back on a rental-ready line for rent. A lot of the utilization opportunity is about tightening that logistics, not necessarily having the demand for it. Can you talk about what you folks have learned over the course of the pandemic that might help you accelerate that tightening of the logistics timeframe, Larry? Can you just expand on, given the performance, what you folks feel like is applicable on a go-forward basis? Yeah. Look, I think the pandemic allowed us to figure out how to better utilize our own delivery fleet and our own logistics capability and improve there. We've actually added resources and capability around logistics as a learning through the pandemic. I think that'll enable us to improve some of those dwell days, some of those buckets where we might be able to pick up a day or two, and that'll have a pretty good impact on our utilization rate going forward. From a CapEx standpoint, considering where lead times are for the industry, presumably you folks have to get your 2022 orders with your supply base sooner this year than in the past. Can you talk about the range of fleet growth scenarios that you folks are thinking about as you put in your commitments to the supply base? Yeah, no, we're going to have to get our orders in early in 2022 this year. That's clear. I think our 2021 guidance points to strong growth in 2021, and we'd want to get aggressive early in the cycle to sort of maintain that growth going into 2022. As you move through the cycle, the drivers, your revenue drivers sort of move from the utilization take up that you've been referring to price, and it starts becoming heavily weighted towards volume growth driven by fleet growth. So you would look to see accelerating fleet growth from us going into 2022. Mark, in terms of order of magnitude, investing aggressively early in the cycle could mean that free cash flow is essentially negative in a year like 2022 because of the opportunity to put the capital in early. Is that a reasonable way to think about it, just so we're well-calibrated? Yes, I think so. The fleet's around for eight years, so getting that in, making those investments early and getting as much utilization on that asset for the full cycle makes sense rather than putting it in later on in the cycle. Companies like ours with a big balance sheet and ability to commit big chunks of capital, we can get in and grab market share, I think, from the smaller players and make opportunistic investments early in the cycle with commitment. Could you talk about any interesting environmentally friendly products that you folks are adding to the fleet? We were speaking with the team at Terex earlier. They are talking about a similar pricing point for their electric scissor lifts as diesel. Is that a growing part of your fleet? What do the economics look like for those types of products for you folks? Yeah. No, great question. Look, we have, since we got here, have been focused on anything that is environmentally friendly. We went through the complete changeover of getting all of our diesel stuff to most current levels of Tier 4 specifications, focused on improvement relative to that. Look, a great part of our fleet for many years to come is still going to be diesel engine driven until manufacturers like Volvo and Bobcat and Kubota and Deere and those introduce electric versions of those machines. They are only at the very early stages. But the other fleet, like scissors and booms and forklifts and things like that, where there is an abundance of electrically operated material, we have been buying that aggressively. We have been adding that to our fleet, and we will continue to focus on the opportunities to be environmentally friendly there. But a large part, as I said, of our fleet, is dependent upon manufacturer availability of that type of gear. We are only at the very early stages with some of those manufacturers and having electrically operated, whether it is backhoes or whether it is skid-steer loaders or things of that nature. Are you able to price higher because the customer is getting all of the fuel cost savings? Are you able to get a higher day rate? Well, not yet on any of what I'll call the earth-moving gear because there isn't just enough of it in the fleet or enough demand for it at this point. But I think electric scissor lifts and booms have been around for a long time, and I think that's already priced into the market, so I don't think we're getting a premium for that. I think it is what it is, and it has been that way for many, many years. Mm-hmm. Got it. If we go back to the point that you made around pricing market in terms of your ability to get pricing in the first quarter. Can you say more about what enabled that? Is it just having some longer-term contracts rolling over for you folks, or were there other factors at play? Because to your point, pricing for the market was resilient, but it was not up. Yeah. I think we've been leading the industry on pricing for the last three years now, so it's something that we're kind of focused on, I think more as a management team, probably than some other management teams, and focus leads to success. We certainly utilize the tools that we've got, and we'll continue to lead, I think, the industry on pricing as we go through here. So Q1 was a kind of specialty driven quarter. So a lot of that came from the specialty fleet and the return of the entertainment fleet, which does have a premium price. But there's a constant renegotiation of major contracts on the national account side and on a daily basis in the spot market through the tool. We're focused on price on a daily basis, and we'll certainly try and leverage the equipment shortage this year to generate positive pricing results. Mark, to your point on that front, used equipment inventories have just been absolutely decimated. Fleet availability is really low. How do you folks allocate fleet in that environment, right? Because you have to decide if you're going to rent it out on a spot basis or give it to an existing customer at a lower rate. Can you just talk about how you make that decision in an environment where during the summer months, you're going to be all full out, I would presume? It's really what we do. Every summer this happens in certain markets and in certain branches. The model is designed to be fully utilized for a couple of months in the summer, just to sort of make up for the lower utilization that you get in the weaker quarters. We're still moving out of Q1 into the summer, so we're not at peak utilization. The industry continues to absorb the excess capacity that it had sort of rolling out of 2020. We're just in the natural ramp-up. It looks like it's going to be a little bit crazier this summer than what it has been in sort of 2019 and 2018, and we'll see how that plays out. But this is the national decisions that get made. It's a matter of balancing reservations, it's moving fleet. This is what our operators do on an hour-by-hour basis every day. It's the same sort of thing. It just gets a little bit more intense, I guess, once you get to your full capacity. Crazy is good in this case. Absolutely. On the conference call, Mark, you spoke about, "Hey, look, we need to make sure that the competition's doing the right thing over the course of this year before we get too positive on pricing." Since then, I think the market has tightened considerably in terms of used equipment availability and we've seen further price increase announcements on new gear. How have the data points been from your standpoint since the conference call? It does feel like the pieces are falling into place for a pretty good normal seasonal pricing lift for the industry. But I'm curious what you're seeing and tracking as well. We're not really that far away from that conference call, I don't think, in terms of data points. We do continue. You can see the continued absorption of fleet. It's our normal seasonal move, so things continue to get better. The new fleet's rolling in. So that comes in and that tends to sort of move out on rent pretty quickly. We're involved in the sort of Q2 ramp-up, which is the move from Q1 of soft utilization into Q3, which is peak utilization. All along the way, that comes with improved pricing, typically. So we're seeing the same normal seasonal behavior that you'd expect in a good year. It's been a really strange cycle because of how abruptly work stopped last year. As a result, we saw the industry stay really disciplined on price. How do you think about the cyclical upside for pricing for the industry as a whole? If you think about it on an inflation-adjusted level to prior cycle peak, how much headroom do you see for pricing over the course of the cycle for the market? I'm not sure. We should definitely be able to stay out in front of inflation. I suspect with last year's pricing decreases being quite modest for a down cycle, that you're not going to see the real acceleration coming out of that that you saw in the previous cycle. We expect at Herc to be able to outpace inflation by one or two times, I think, through the cycle pretty comfortably. Yeah. That's nice to hear. Well, that's all the time we have today. Larry, Mark, Elizabeth, thank you very much for joining us, and thank you everyone for tuning in. Thank you. Thank you. Appreciate you setting this up, Jerry, and we'll talk to you again soon. Sounds great.