Bank of America Global Industrials Conference

Mar 16, 2021

Slides

Summary

Growth focus is shifting to 15–20 greenfields in 2021, selective M&A, and operating leverage. Management expected rental rates to improve during 2021 and guided to $400 million–$450 million of CapEx.

Great. All right. Welcome back, everybody. Hope everyone's having a productive day so far. I'm Ross Gilardi. I'm the Senior U.S. Machinery Analyst. Thanks for being here at the BofA Global Industrials Conference, obviously held virtual this year. We are really delighted to have Herc Rentals joining us today. From the company, we've got CEO Larry Silber and CFO Mark Irion as well. Guys, I really appreciate your support this year and you being here to speak with a lot of our clients. I think we were just going to go right into it. Larry, maybe a great place to start is just talking about the journey for Herc. The company's come a long way, obviously, over the last 5-6 years, and maybe you can just talk about Herc's turnaround progression. What inning do you think we're in, and what should we be excited about in the future? Yeah. Great question, and thanks for having us, Ross. We really appreciate being here. Look forward to answering as many questions as we can during this fireside chat. In terms of the innings, I generally, in the past, have referred to the innings more about the economy, but glad to refer to that more about our business today. I think we're in that seventh inning stretch in terms of closing the gap versus our larger peers and having this business operate on more of an equal stance to those folks. As we went into this business and separating it from Hertz 6 years ago, we were really focused on operational improvements in the business. We have most of those well in hand and under control and continue to look to drive that. Fortunately, we were, because when we were impacted by COVID, we were already focused on the cost side of our business and the operational structure to make sure that we were a very resilient business through the downturn. As we began to come out, we saw the benefits of that happening. Throughout the pandemic, we kept the focus on our people, on our branches, and our culture, and on safety. We kept investing in training and building the bench so that as we came out of this pandemic and moving into the current period of time, we're now at what I'll call focusing on growth. We'll continue the emphasis on operational improvements, continue to look for cost opportunities in the business, cost takeout opportunities, but now we're at a point where we're targeting top-line growth. Growing, adding branches to our business. We've targeted 15-20 greenfields. We completed our first acquisition at the end of December down in Houston, Texas, bringing our branch count in that market up to 12. We will continue to look for those opportunities as we grow our specialty business as well. It has been a tremendous business for us and a tremendous investment over the last couple of years, and we are starting to see the real rewards out of that. I think we are in the seventh inning. We are going to close the gap on margin. We are going to close the gap on the differences between the business, and now we are going to go into accelerating our top-line growth. In terms of just closing the remaining gap that is out there, what are the opportunities from here, and how do you do that, Mark? I think it is really operating leverage from here on out, Ross. Most of the work has been done on the margin improvement and getting the cost structure right. We definitely got learnings in 2020 from that. That is going to enable us to sort of manage that at a lower level going forward. But the real benefit from here on out is operating leverage, growth of rental revenues, focusing on capital investment on our existing locations, and then flowing through $0.60 to $0.70 on the dollar in terms of EBITDA improvements from that revenue growth. Talk about your specialty business a little bit more. It is one of the things we have tried to point out which we think has been underappreciated with Herc and all the different things you are doing. Just how do you think your portfolio in particular is different, and why was pricing for specialty rentals so much more, at least from the outside, seem to be so much more resilient than the gen rent business? Yeah. Look, when we got here in 2015, there really wasn't a specialty business to speak of at Herc. Shortly thereafter, we began a major investment and build-up not only in fleet but of people and technical resources for that business because it is a more technical business. We continue to drive that, invest in that, and add resources both in terms of branch locations and in terms of people that can demand that type of selling experience. As a result of the specialty nature of the business, that drives the type of margin that's in that. It's more of an engineered or a pre-engineered sell, solving the solution rather than someone coming in and requesting a portable air compressor or a backhoe or a skid steer. We're really being required to provide a solution to a customer and engineer that, sometimes set that up, and sometimes maintain that during the course of whatever is being done. So it commands a premium in terms of the type of rental rates that we get. What parts of that specialty rental business are you most excited about? If you could also just talk on the live events business and entertainment, because that's a really interesting niche that Herc's had a nice position over the years. I think much revenue last year. Remind us proportionately how large that business was pre-pandemic, and are you seeing that business start to come back yet? Yeah. Ross, the second part of that question. We have studio and entertainment. That's 5%-6% of our revenues in a normal year. The live events is the smallest portion of that. The studio makes up most of it, and we're really excited about that. We continued to invest in relationships during COVID. That was obviously very significantly impacted in Q2 and Q3, and started picking up in Q4. It's going to be a nice tailwind for us as that business comes back and grows over 2019 levels during 2021 and beyond. We continue to invest, we continue to develop those relationships, and it's going to be a real strength for us going forward. What else would you highlight in specialty that you guys are excited about? It's remediation and sort of a lot of the work that comes from these sort of natural events that put pressure on power systems or do damage to the infrastructure and require temporary power, dehumidification, drying. The recent sort of storms that went through Houston had a big impact there. That was in a location where a lot of our hurricane response is already located. So that fleet was there. We moved fleet in, and it was a similar sort of impact to our business. It's sort of like a large hurricane in terms of impact. It's going to have a net positive impact on Q1. That ability to respond to these natural disasters in various geographies, it's a big advantage for us on a big rental company. We can pick up a winter storm in Houston. We can pick up a winter storm impact in Toronto and New York. We can pick up summer hurricanes in Florida and elsewhere. That geographic ability to move our fleet to wherever the response is needed is a big advantage that we see as a large rental company, and we think we can continue to increase the secular shift of that gear towards rental and also pick up market share from other rental players that don't have the same geographic footprint that we do to be able to respond. In that entertainment-related business, do you have a sense as to what portion? You said it's 5%-6% of your business pre-pandemic. Any idea what it is for the overall industry? Where I'm going with that is, when you start to see that end market really start to pick up again, is that going to just soak up a lot of just whatever lingering excess capacity there is out in the market? Is this generally a lot of just typical gen rent equipment that goes into this end market that might have been diverted to other places? I'm just curious if there's a bigger industry story here as well as you see that end markets gradually come back to life over the next year or two. Yeah. Well, look, first of all, I don't think there's a lot of excess fleet out in the market. I think all of the rental companies, particularly the larger ones, have done a great job in managing that fleet through the pandemic and positioning ourselves and our other competitors in a good spot to where the fleet has been well managed. I don't think there is a lot of excess capacity or fleet out there. Entertainment, I think for everybody, is probably in that 4%-5%, 6% range. I don't think it's much bigger than that across the board. Like Mark said, we've remained focused on the studio side of the business. While we do participate somewhat in the live entertainment, it's not really significant for us. We will do concerts and live events, PGA events, and things like that. But for the most part, our focus is around the studio side. When and if all that comes back, our fleet is fungible. We can move fleet around. We can satisfy that. We certainly have enough advanced purchase orders in with our suppliers to be able to satiate that demand when and if it does come back this year. We're already, last weekend, if you watched THE PLAYERS Championship, they did have 10,000 spectators there. So there is some live events coming back, and we will see that. That'll just be sort of gravy for us, quite frankly. But we have ample fleet to be able to satiate that demand. Can you talk a little bit more about your strategy to target urban markets, which has been a critical part of Herc's strategy? What are activity levels like in, I don't know, some of the major cities around the country? If anything you could highlight. Obviously, the East Coast and the West Coast, the major cities, the impact has been a bit different than it has been in the Southeast and in the interior parts of the U.S. Yeah, I would say, in general, everything's pretty much back to, or at least normalizing and back to a normalized way of doing business. Everything's open. We don't see any major projects shut down as a result of COVID or any pandemic-related issues. Certainly, certain industries are ramping up, and we'll begin to see that through the seasonality. We're having what I would call a normal first quarter, seasonally adjusted, and we'll continue to see that volume on rent increase as we exit Q1 and go into Q2. So overall, we're pretty confident and pretty optimistic about what we see across North America. Obviously, some areas around Texas were impacted by the storm, but that created other opportunities. Some parts of the country are wet right now. As that dries out and we come into spring, we'll see normal activity. I'd say the only area that probably is a little more affected than others has been Canada. That's been operating at a little bit of a reduced level. We'll see that come back as well, and as you know, that's a smaller part of our business to begin with. As the vaccines become more prevalent across Canada and across the U.S., I think everything will begin to open up. We're already seeing it in most of our major markets. Our strategy around major markets is a focus on the top 25 to 30 MSAs. We think, and we believe, and we've demonstrated that building an infrastructure of multiple branches in an MSA gives us greater flexibility, greater ability to use our equipment, share our equipment, and get better utilization in those markets. That's where our focus is around that growth strategy in those areas. How about Texas? You touched on it before. The aftermath of these snowstorms and deep freeze and everything we're reading about with the water infrastructure, and it seems like there's a lot of issues that need to be resolved in that market over the next several years. There's been a ton of weather events in the last 3 to 5 years around the country. Does this one feel different, and does this feel like it could be a longer-lasting tailwind for your business? Matt, I think in terms of the event, we framed it up, it's a large hurricane. There's short-term needs for temporary power. There's remediation work that's required in terms of drying out businesses with broken pipes and that type of stuff. That's a short-term fix up and clean up, similar to what you'd see in a summer storm. The second portion is long term, there's an infrastructure need in this country. I think it's pretty well established, and a lot of the major metro markets need that investment over time, and we're here to participate with that. But that's more of, I think, a gentle rising tide as opposed to a big wave of activity that's going to continue in the short and medium term. Can you guys talk about what's happening in the used equipment market? It seems like things have tightened up pretty quickly. Yeah. Would you agree with that statement? Yeah, we would agree with that. Look, we went through into the beginning of 2020, where for all practical purposes, it shut down with auctions, live auctions, just stopping. As we rolled into Q3 and Q4 of 2020, things started to come back. Certainly, we've seen some very strong activity in terms of pricing here early in the year in that market, and I think that's a function of supply and demand in terms of the large rental companies tightening their fleets up as they went through 2020. Yeah. The availability of gear, good gear to go into the used equipment market is probably a little tighter, which drives the prices up. That'll have a positive impact on rates as we go into the year. As supply is tighter obviously we're going to focus on moving our rates up and taking advantage of a tight supply line or supply chain in the marketplace. Is it a realistic expectation to see rental rates positive year-on-year in the second quarter, Mark? During the course of 2021, for sure. Second quarter is a bit of a strange comp, right? It should be a realistic expectation there. It was a tough comp or an easy comp from last year. But we've done a great job in terms of managing rate as a company, and we'll continue to focus on it. We don't have much of a hole to dig our way out of. We were actually positive for the year. We certainly are focused on getting positive in rate for 2021, and that's a very reasonable expectation. How do you think the smaller industry players fared this downturn? We're all familiar with yourselves and United and Ashtead, obviously. But a big portion of this industry, a significant portion is still smaller, independent rental. Do you think that portion of the market, maybe not fared as well, maybe that's an unfair way to put it, but sort of behaved in a similar way as the majors? Did you see that supply discipline from a lot of your more local competitors as well, and does it feel like there's reasonable financial health in that part of the market? Yeah. Look, I think the whole industry fared pretty well, quite frankly, through this downturn as a result of having better tools, better management information, better capability to respond quickly. I think this was not what I would call a normal downturn that would happen over a 12 or an 18-month period. I think everybody sort of felt this coming quickly, reacted quickly, and took the appropriate steps that needed. We think there's a fair amount of discipline, not only in the larger players, but certainly at the small local regional mom-and-pop players. And there's a fair amount of health. We're not seeing a lot of distress out there. That said, I would say that there's probably a few of the mom-and-pops that would hope that this might be the last downturn they have to live through and may look to exit at some point over the next couple of years. But look, I think the industry did very well through the downturn. Very good. Where will you guys be on fleet age by the end of 2021, assuming that your CapEx output comes to fruition. Do you think you are going to need a couple of years of elevated CapEx to bring that down? I am just trying to think about what the trajectory of more on the gross capital spending side, like what it maybe looks like over the next few years. Right. Yeah. So we closed something like 46 months, I think, in 2020, and that drifts out a couple of months during 2021 based on our sort of guided CapEx plans. It is within our sweet spot, if you like, of 40 to 50 months. There is no deferred maintenance CapEx built up. We sold off the fleet in Q4 2020 that we needed to, and we have got the fleet that we need to sort of manage our way through. So additional CapEx will be guided growth, as we sort of expand the fleet and start moving into growth mode sort of towards the back end of this year and into 2022. There is not a huge amount of deferred maintenance CapEx. It is a normal maintenance CapEx cycle that we are on. This slowdown was so short and sharp that it did not really create the sort of fleet age issues that tend to build up over a longer down cycle. Right. Right. Mark, remind us how you guided capital spending this year and how you are thinking about it. Are you at the point of the year yet? We are still mid-March and people are getting vaccinated and the weather is starting to warm up, at least up here, although it took a step backwards the last couple of days. Do you feel like you have the necessary visibility yet to make a bigger call on CapEx this year? We guided $400 million-$450 million of CapEx for the year, and that's on a sort of $730 million-$760 million guide for EBITDA. We've got it committed, so we're going to put that out there. We feel pretty good. Q1's starting off the way that Q1 does in a good environment or a normal environment. We're not seeing any signs of distress in non-res or any other end markets, really. We feel pretty good about the year. Also, the fleet supply from the manufacturers is getting kind of tight. Lead times are starting to build up. They've got issues with their supply chain. They're ramping up their production from a dramatic slowdown last year also, and it's a little bit more complicated for them. That is good. We've got the commitments in there. We're going to be able to get what we need. We're also getting into that before any sort of price increases start creeping in with some of the commodity price pressures that some of the suppliers are coming into. We're in really good shape for 2021. I don't know that we could get more CapEx in to land in '21 given those sort of supply bottlenecks are sort of building up. We're in good shape. It's good shape for the industry. I think that's showing up in your used equipment prices. Fleet could be getting tight overall during the course of '21, and that's usually a really good setup for rental where we've got $3.6 billion worth of fleet ready to go, and we can be the supplier, just to sort of fill that constriction of supply if that's building up. What do you make of all the non-res data out there? You would never know, just looking at the data, the way you guys sound and the way the rest of the industry sounds. What is particular to your business that just the non-res data doesn't capture? Because it tells a much different story, and I think a lot of investors, including myself at times, really have a hard time getting their heads around that. Yeah, look, I think what we're experiencing, obviously coming into this year with non-res sort of reacting in a more normal type of environment, you saw some project delays or things that were shut down by COVID. You saw some maintenance in non-res get pushed out because of COVID. That stuff is all starting to come back Right and is resuming a more normal type activity. At the same time, you're still seeing new project lets come up, albeit, not at the same rate that it was, but I think it'll take a time for that to ramp up. But in the meantime, we're seeing that delayed or pushed out activity sort of roll into Q1, Q2, and that'll continue, and activity will pick up. So I think it's going to take, from my perspective, this year for non-res data to sort of normalize, and we'll get a better picture at the end of the year. But I don't think non-res activity is going to have a negative impact. I think it's going to be quite normal for us as we go through 2021. Got it. What are you seeing in energy? Anything picking up yet with oil prices going up so sharply? Well, not yet. Energy is a small part of our business. As you know, we reduced our exposure to O&G quite a bit. We do participate heavily in alternative energy, like solar farms and wind farms, and activity which is pretty strong for us and pretty good. But in terms of O&G, both upstream, midstream, downstream, we've reduced our exposure and we haven't seen an uptick there. I think we will see in terms of downstream or midstream, some of those delayed turnarounds come back on, and that'll happen. But we're prepared to respond. It's not specialized gear. Again, our gear is fungible. If we see an opportunity, we'll go address that appropriately and at the right levels. Can you paint a mental picture for us with a wind farm or a solar farm? What role you play in that, and is that just in the initial construction of the farm, or is it on an ongoing basis? Well, for the most part, it's in the initial construction. Whether it's forklifts, or scissor lifts, or booms, or carts that bring the gear out. So that's where most of the activity. There is some ongoing maintenance, but that's at a reduced level going forward once the farm is built. Can you discuss the demand and the needs to carry more zero-emission fleet right now? Does that become a bigger issue over the next year or two that could become a cash flow headwind or anything like that? Are you getting asked from your customers in any major way for more electrified gear? Clearly the aerial suppliers are coming out with some interesting new products, but love to hear your take on it. Yeah. Look, does it become a headwind or some kind of major issue for us in the next couple of years? No, I don't think so. That said, we've always been focused on trying to have the most emission-free gear. As of right now, about 90% of all of our diesel-operated products are Tier 4 compliant. We've done that change over the time period since we arrived here in 2015, focused on upgrading that fleet. We always have had a major fleet, as you mentioned, from the aerial work platform people, the boom and scissor people, the light plant people. We focused on electrified product there, and we'll continue to build that fleet as we go forward. Being one of the major players, we are always at the forefront of our suppliers' thought process when it comes, and we're first in line, if you will. As they develop product, we'll add that to our fleet. I don't think we're seeing any major requests today outside of a few customers here and there that want to have as green of an environment as possible. But we're ready, willing, and able, as that fleet becomes available from our suppliers, to add that into our fleet and put it to work. But from a standpoint of what we've been able to do, I think we are as compliant as could be, and as willing to be more compliant as we can be going forward. We're big supporters of that, and we believe that at some day will become a major portion of this industry. But let's remember, a big portion is diesel engine today, and we're going to be as good as diesel engines can be. Mark, are we at the point where Herc can say that it's very comfortable being free cash generative through the cycle now? There was a day where that wasn't really true. The last two years, obviously last year, gross capital spending just got gutted to deal with the situation. But companies generated a lot of cash the last two years, and even with CapEx normalizing now, do you feel like you've turned the corner where you've got steady free cash generation through the cycle? Any way to think about an appropriate conversion rate from EBITDA or earnings or anything like that? Yeah, I think so. There could be some cyclical, if there's a big growth focus early on in the cycle, I think that would make sense to invest some of the capital that we banked last year and put that to work. So outside of a blip that's supporting a big growth year, then yeah, we should be generating free cash flow positive results in a normalized year. I think that 10%-15% zone feels good looking at the competition out there and looking at our capabilities. Free cash flow yield in the teens is a decent through cycle yield. You're talking about the yield on the share price as opposed to some type of conversion rate on your earnings metric. Is that correct? Yeah. You guys are the third largest player out there, but do you feel like you have the scale right now to really compete as effectively as you can with URI and Ashtead? Should we expect Herc to become a more acquisitive company? I want to give you an opportunity to talk about Champion really quickly, but that was not a huge acquisition, but it also seemed like an important milestone for Herc. Yeah, absolutely. Look, I don't believe, and we don't believe that scale is an issue. We think that we can operate as effectively as our larger peers in the marketplace. We have ample scale and capability to compete on any project anywhere in North America. So scale isn't an issue for us whatsoever. As far as we are now, as I mentioned early on, in that growth mode. We did complete our first acquisition in December with Champion Rentals in Houston, and that added four branches to our footprint there. Gave us now a 12-branch footprint in that major metropolitan market. We're going to continue to look for M&A opportunities. I always view that as a make-buy decision, Ross. Can we effectively open a greenfield or is there an opportunity for us to buy a business that's easy to integrate, synergistic with our business, provides a good fleet and a good customer base and revenue for us to integrate, versus opening a greenfield, putting in our own culture and our own people right from the get-go? We are focused this year. We'll have 15 to 20 greenfield locations added, and we'll continue to look for incremental M&A opportunities that make sense in our top major metropolitan markets, top 25 or 30 MSAs in North America. Got it. Very good. What kind of technology are you offering to your customers to help them be more productive and drive better returns out of their fleet? Talk to that. Yeah. The fleet now is all coming in with telematics that are pretty comprehensive in terms of your ability to manage each unit. We've got a tool that gives access to that telematics information for our customers, and they can use that to manage uptime, downtime, engine hour usage, or hours of operation for maintenance individuals, maintenance intervals and stuff like that. So we've got the ability to punch through into the actual units and just check out where they are, how they're operating, and how often they're operating to manage the fleet like that. Got you. Okay. Thoughts on infrastructure spending? You think it's going to happen? Finally. We've talked about this- I know. I'm not holding my breath, but what do you think? I'm not holding my breath either, but look, there is a fair amount of infrastructure spending that is happening at the local level that was certainly out of this Yeah this new bill, this $1.9 trillion. There was several hundred billion dollars that's going to flow down to the states and then flow down to the local communities, that we'll see spending in and participating in. Will there be a large, something like TEA-21 or T10, that happened many years ago? Your guess is as good as mine. Certainly, the rhetoric and the discussions coming out of the administration now is that we're all going to see some corporate and personal tax increases that'll go to fund an infrastructure spend bill. God knows we need it in North America, right? The infrastructure in North America is aging and needs to be upgraded, so certainly we're all hopeful. We have not built anything into our plans around infrastructure spending. Whatever we have is our normalized coming out of local governments and local communities. Any major federal plan is not built into our forecasts. If that happens, it'll be gravy. We'd certainly love to see it happen, but like you, I'm not holding my breath. Very good. All right. Well, guys, I think we covered a lot of ground. Why don't we just wrap it up right there? I know everybody's got a busy day and a lot of meetings to get to, but enjoyed seeing you both and hearing the latest on Herc. Thanks for being with us today, and we'll see you soon, everybody. Thanks for joining this session and have a great rest of the day. All right. You too. Thanks, Rob. Thank you. Thanks everybody. Bye-bye. Thanks everybody.