2018 Citi Industrials Conference

Feb 22, 2018

Okay. Good morning, everyone. We're going to jump right into it. Our first presentation of the day is, we have the team from United Rentals here, which we're really happy about. To my direct right is Bill Plummer, the CFO. To his right, Matt Flannery, who is the COO. Everyone here knows Ted Grace from IR to his right. So all-star lineup here this morning. Bill, maybe we'll just, and Matt, just open it up here. We'll go into Q&A, obviously, and then as the presentation goes along, if anyone has a question, just get my attention, we'll go over to you. So maybe just from a high level, just update us in terms of discussions with customers as they look into 2018 and beyond. Obviously, you had the ARA Conference here earlier this week, and my takeaway was from suppliers and from some of your peers, was just recurring theme of the strength we saw building in 2017 in terms of project activity and just underlying activity levels continuing to strengthen. So just curious from your perspective, again, update us in terms of some of the trends and what you're seeing. Sure. I think everybody sees the macro data that comes out, all very supportive of a strong demand environment. Can you folks hear me? I don't know if this Okay. As well as our customer backlogs, and you've seen our customer confidence survey that we put out every quarter, all according to a continuation of the strong demand that we've seen in 2017 throughout 2018. Personally, we feel pretty good about 2019 as well. Our visibility out beyond that, we wouldn't put too much weight on, but we do see legs in the cycle and more importantly, strong demand from our customers. Good. Maybe just breaking that down a little bit further across the key markets in terms of commercial construction, infrastructure, and industrial. I think it's fair to say we see strength across a broad range of verticals. Commercial construction has very nice momentum across a bunch of different subcategories within that category. Infrastructure, our belief is that even without a federal infrastructure program, there is building momentum at the state and local level to invest in infrastructure around the country. We've seen that in a number of different projects, and we can talk about those if you like. On top of the building momentum in the market generally, our strategy has focused more on infrastructure, certainly supported by the Neff acquisition, but we were focused there even before. We believe that there is a real opportunity for sustained growth for us in infrastructure. As you look across other project types, it just feels like there's inherent demand, and/or we have an opportunity to execute more deeply in those categories. It's across the board. Maybe just on industrial being an important category for you, maybe just highlight some of the highlights there. Yeah. 2017 was probably more on the flat side in downstream, and we see an uptick forecasted both internally and externally for downstream. We actually see robust activity coming in 2018 for the chemical vertical as well. Even in both of those areas, when you think about capital projects versus what we would call run and maintain MRO type projects where we're very balanced in our onsite activity, which is mostly dealing in the petrochem market in MRO. The capital projects are just icing on top of the cake, so to speak. We feel very good about our industrial prospects for 2018. Interesting. You think about, boy, this is loud. There was in this room yesterday, an automation company, and one of the things that they highlighted was, speaking to the outlook for just underlying CapEx in North America is, and if you think about the prospects there and the tailwinds, partly in response to tax reform, but their comment was, "Hey, we're actually starting to see some very early discussions from some of our customers in terms of" Again, they're not making these changes overnight, but early dialogue in terms of maybe shifting some of that manufacturing base back to North America. Curious if that's consistent or you hear something along those lines. It's consistent from an anecdotal perspective. I would see that as more of tailwinds for future 2019, similar to the infrastructure bill, right? We see that as 2018 is solid without those anecdotes and without an infrastructure bill. That's why we feel good about 2019, because all the stuff that you're hearing and talking about and that customers are relaying to us feels like it could be for future growth in 2019. Good. Okay. So pretty clear in terms of the demand outlook. Maybe shift focus a little bit to the supply side. Obviously, critically important in this industry. I was listening to a call from one of your competitors last week, and one of the things that they said was, "Hey, this time it feels like," on the part, at least the OEMs are, they remember 2008, 2009, and they're being a little bit more disciplined in terms of not to throttle up the adding another shift and kind of getting too far ahead of themselves. Maybe curious if you could weigh in on that. I guess as part of that, we're also hearing of more, we had a dirt OEM here, one of your large suppliers here yesterday, and they were highlighting just availability and just supply chain issues, which is kind of acting as a governor on their ability to ramp up. There's a lot there, but maybe just kind of focus on the overall industry supply response. Well, I think it is fair to say that the OEMs seem to have a more cautious approach to the upcycle here. Would agree that they are remembering the downturn, and they are being more cautious. Some of that is because they are consciously being more cautious. Some of it is because the difficulties of actually ramping up capacity, they are still working through. I think broadly we would say yes, we believe that they are being somewhat of a governor, but it is not just the OEM side of the picture. I think the rental industry has also recognized the value of not killing the goose that lays the golden egg, not over-fleeting for the level of demand that they are there. I can only say that anecdotally, just talking from people around in the industry, but it feels like there is an awareness, a consciousness that, "Let's fleet up, but let's make sure that we are being more prudent than the past." Will that continue? Especially will it continue if the OEMs all of a sudden add on more capacity? Time will tell. But it feels like the industry overall, both suppliers and participants, are being more cautious in the run-up here. We are late enough in this cycle that if there were going to be a big party, an over-fleeting event, you would think we would start to see signs of it by now. It is not showing itself just yet. Yeah, I would say most of that view was fortified in the ARA show that we attended earlier this week from both the OEMs and the rental companies that were there that we spoke with. I think Bill covered the view very well. Speaking of ARA, that is typically a show that attracts a lot of the independents, and which if you think about who potentially is impacted more heavily by tax reform, and some of the benefits of tax reform would be those small to mid-size operators. Maybe just speak to, I think because the negative angle of that is, hey, things get so good for them that they see this big reduction in their tax rate, and they go out and ultimately start to fleet up and compete away some of that tax benefit. As you think about how they are typically managed, they are probably running to not generate income and focusing on minimizing cash taxes. Can you maybe speak to the rental industry overall in terms of the impact from tax reform and what that means or does not mean in terms of your kind of marginal player? Maybe I'll start. It's hard for us sitting here to say what the rental industry overall will do in response to tax reform, not knowing their tax position before tax reform. Certainly, a decent share of the smaller players probably operated at pre-tax incomes that are pretty close to zero. It wouldn't be a major impact. I made the point the other day that even United Rentals, we weren't a federal cash taxpayer until last year. We were operating on NOLs, using up NOLs that we built up during the downturn. I think that there's that dynamic playing through the industry, at least initially, that might minimize the impulse of people to say, "Hey, look, tax reform just put a bunch of money in my pocket. Let me go spend it on fleet." Again, to my earlier point, I think there's anecdotal evidence that the industry is more aware of the need to generate returns than they've been in the past. Therefore, that impulse to go out and spend every dollar on fleet is less than it used to be in the past. So cross your fingers, but certainly it feels like there's a little bit more thoughtfulness to how we're going to use the incremental cash flow this time around. I would agree. If you get back to the root of why we talk about the OEMs and the discussions and the vibe that we've got from ARA, that's the source. I think we're looking at about 10% volume increase is what they're projecting to. There's a large portion of that that's replacement, but more importantly, if you just take the aerial players, which are the ones that we have most visibility to, if you look at that 10% year-over-year growth for them, that adds a little less than 1% total capacity to the installed base in the industry. So even that 10% growth number is not a large number from a more capacity perspective. Just given the underlying depletion then it's- Yeah. Okay. So all right. So supply and demand presumably starting to come further into balance. What interrupts the rate trajectory, and how is this not conducive in terms of a continued increase in improvement in rates for the industry and URI specifically? Yeah. We talked about this a little bit the other day as well. It's not obvious to me what might interrupt the trends that we've established here in the recent past. Whether it's rate or overall demand in the market, whatever. There's positive momentum in a number of different ways, and I'm not seeing the negatives that could be significant enough to make a major difference. Obviously, I'm holding aside major external factors. I mean, war with North Korea will put a little hiccup in our plans. But holding that aside, holding really surprise moves anywhere in the macro environment, it's not easy to point to things that are going to get in the way of us continuing to exist in a market that's good. So you think from a rate perspective, Matt Flannery, you typically will, the industry, just given the seasonality, obviously, you dig a hole in one Q, or at least January, February, and then as we turn into March, you start to get the benefit. Do you think the industry overall, given this backdrop, do you think we're in a position where Ask differently, what is URI doing to avoid trying to dig too deep of a hole here in the early part of 2018? It's a major focus for us. To be fair, it has been in years that we've dug a hole. Sometimes we are more successful in our efforts than others. But if you get to flat in a Q1, that's a victory. You look at our history, we've maybe had one or two in the past 10 years where we had a flat Q1, but it was coming off of lower comps. I think that the industry overall, the largest levers, everybody's balancing that time rate, right, to optimize their dollar utilization and their returns. If you look at any data that we look at, it looks like throughout the back half of last year, the whole industry enjoyed strong metrics and time utilization. If you take the combination of the demand that we spoke about earlier and strong time utilization in the industry, that should bolster rates to continue the trend that we saw throughout 2017. Where do we sit here at almost a year post-NES? Where are we in terms of repricing that book overall? Well, at this point on the NES customer base, we're largely done. There was, if you recall, when we talked about the deal, there was a larger gap there than we usually see in acquisitions. We managed through that problem pretty aggressively in the first 3-6 months. At this point, we're managing our rate by customer vertical, by customer type, and by market. We're not looking at the source of where that customer originated from at this point in 2018. So that in itself would tell you we're largely done. Speaking of acquisitions, we're fortunate the Neff acquisition, from a rate perspective, was very similar profile to us when you looked at categories. There might be a percentage point higher or lower on a certain category, but overall, they were a strong service organization that understood the value of service and how it turns into rate and very comparable to what we achieved with rate. So that was a much easier pricing integration. Sticking with those two acquisitions, where are we in terms of, I think Neff, you noted that you had integrated onto your IT platform within a week. Just kind of looking back, overall integration, not just from a rate perspective, but overall in terms of how those deals have been integrated into URI. Yeah, I think they've gone very well. The Neff integration, they looked a little bit more like us in terms of how we operated the systems that they had. So it was more straightforward, and I think it's gone very well so far. We talked at the earnings call about the synergy realization being very nicely on track. I'd call it ahead of what we would expect. But the actual operational integration of making decisions about people, facilities, and customer integration, I think is also going very well as well. So encouraged there. The NES integration, again, I'd use the phrase Matt used. That's essentially done, right? There's really not much discussion about, okay, what do we need to do in order to complete this NES integration? And so we feel very good about that one. Good. Maybe switch focus to the specialty business. That's one that coming off 20%-plus organic growth in 2017, and obviously, a continued area of focus for URI. Maybe just highlight some of the factors at play there that are contributing to that organic growth, whether it's cross-selling, it's share gains, just maybe highlight a couple of the points. Certainly Particularly in specialty. As you pointed out, Tim, across all three of our major specialty businesses of trench, pump, and power, we have seen strong double-digit growth in two of the three into the high 20s. Part of that is the organic growth in the year two of the cold starts that we have been focusing on and will continue to focus on. As a matter of fact, we have another 17-plus cold starts in specialty slated for 2018. As you see the maturity of the cold starts over the past two years, you continue to get growth on that. We did have the Cummins acquisition, which helped the power team. Even on a same store basis, our power business was in the high 20s growth, so very, very strong growth. When you think about the two acquisitions we did this year of Neff and NES, you could say, "Well, that is a departure from your specialty focus." It actually gives us a broader customer base to cross-sell our specialty products into. So it bolsters the specialty business' opportunity, and that is a focus for all of our strategic sales team. Part of their compensation is actually cross-selling. We think that there is continued strong growth opportunity for specialty, and we expect them to continue to get more than their share of the overall business of our growth capital. Pump was one that obviously got off to a little bit of a hiccup there, just given the timing and when that coincided with the decline in the upstream markets. Talk to what you have done there in terms of diversified some of that into municipal markets and how that has helped to cushion the downturn. Then obviously, we are starting to see the upstream market continue to grow. Just where are we overall in terms of the exposure within pump? Well, I think I would say that we have made a very significant effort and had very good success in making that transition. I think the pump team, the rebound in performance certainly has been helped by upstream oil and gas coming back a little bit, but there is a very significant component of whether it is sewer bypass or mining support or dewatering in construction sites, of that team identifying those opportunities, right? It has benefited tremendously from the cross-sell effort that we have made just across our business overall. We have made very nice progress. We recognize, though, that there is still a very significant opportunity to continue to drive that kind of diversification. Truthfully, if upstream oil and gas continues to be robust, the challenge might be keeping the focus on those other types of demand. But it's something that we're going to be very keen to do and make sure that we don't let ourselves get back to the point where upstream oil and gas is calling the shots, because we think that the broader opportunity is much more attractive if we can execute on it. Absolutely. If you recall, part of our original deal thesis was to broaden the footprint and to penetrate different verticals when we bought the pump acquisition. We certainly did not expect or model that we would have the problems in upstream immediately after purchasing them. But necessity was the mother of invention there. We probably accelerated our cold start model to start to utilize the product that we had because of the upstream downturn, and it really worked out well. As a matter of fact, the pump region and that business unit had the strongest numbers they've ever had this past year in 2017, and were actually awarded at our annual meeting as top region. So they've done a great job of battling through that, where 50% of their business got cut in half. So we're very happy with the progression. Interesting. Obviously, cold starts have been an important driver there, and you've probably done over 100, I think, at this point. What has Paul and his team learned along the way in terms of you do more and more of these, presumably the metrics improve, but you're also balancing that, I presume, against the fact that the market's becoming more saturated than it was when you did the first cold start. So anything you can share in terms of underlying profitability or revenue metrics for those cold starts today in year one to two versus maybe a few years ago? So we've provided a high-level look at the progression of cold starts in the investor material. I can't remember, Ted, is it specialty overall or in one of the specific businesses? It was two specific businesses. Okay. Trench safety and power HVAC. So trench safety and power. You can see in our investment material explicitly how that maturity curve plays out. I would say that broadly, and that's where most of the cold starts are with a few in pump broadly that data would be indicative of how cold starts mature. Meanwhile, the organic business, the same stores, continues to grow very robustly as well. We've seen 20%, 25%, 30%-plus growth for a sustained period in our specialty results, and the bulk of that growth is coming out of same store growth. So we've got both engines going in terms of driving that growth and specialty, and we certainly are looking at every opportunity to continue that. Interesting. Any questions from the audience? Just staying on specialty, I guess from a competitive standpoint, what's preventing your large competitors from building out similar specialty businesses? Is there a risk of that becoming more commoditized similar to the overall general line business impact? Well, first off, we're not seeing that in our results, but it's a fair question. We think one of the differentiators that we've created in our business and our value prop to our customers is the bundling. The cross-sell has been a very aggressive effort, and we've put resources, both in people and product towards that resource. There's two different areas that we'll compete against in the specialty business. There'll be standalone specialty providers. They certainly don't have the opportunity to give the full broad soup to nut service, so to speak. But then even some of the national players add specialty product. We think it's a huge differentiator that we decide to carve out these businesses within our broader portfolio and focus on them. We think that focus and that investment of, you could argue, redundancy maybe in management or facilities, if you were looking just from a cost perspective, has really paid off in growth and returns. That is how we view our success, and we think it is a differentiator for years to come. Bill, maybe we can shift to capital allocation. You are talking about over $2.5 billion of operating cash flow in 2018. What are your priorities and what are you going to do with it? We have sang this song for quite some time. You all probably know the verses. For us, the first question is always how do we support our strategy with organic investment, CapEx being the main avenue for organic investment, and is there an opportunity to invest more than what we planned? We have guided to somewhere around 1,875 just to use that number of CapEx this year. We are always asking ourselves, is there an opportunity to invest more than that where it makes sense? Assuming we got the number right for 2018 CapEx, though, the next question is, hey, are there acquisition opportunities that, again, help support the strategy and extend the strategy? We are always looking for those. You saw that in 2017 with the deals that we did. We will continue to look for those opportunities as we go forward in 2018. Truthfully, deals come when they come. If you are a disciplined buyer, if you do not go at the market saying, "I am going to make acquisitions happen." You go at the market saying, "Where are the acquisitions that make sense for us, and let us see if we can get them at the right value." That is how we are approaching that. If those deals line up, then we will use some of that cash flow for acquisitions like we did in 2018. If those deals do not show, then we are left with the question of, do we return some of the cash to shareholders, or do we leave it to reduce our leverage ratio even further? Our view right now is that our leverage is well-served. We have always talked about 2.5-3.5x as the range of leverage net debt to EBITDA that we are comfortable with. Being at the lower end of that range when we're at or near the peak in the cycle. While we don't believe we're at the peak in the cycle, if we hit our guidance this year, we're going to be 2.2 times, so materially below the 2.5 bottom of that range. It's a legitimate question as to whether we allow that to happen or whether we return some of that cash flow to shareholders in the form of repurchases. By the way, that 2.2 times assumes that we fully execute the remainder of our current repurchase program. It only assumes that we do $350 million or so of repurchase in 2018. It's a discussion point that we will have with the board over the next several months. Exactly how far do we want to go in allowing leverage to reduce? Or do we want to do more share repurchase than the existing program that's authorized? I'd say stay tuned, and we'll let you know as we engage that debate and discussion with the board. Maybe on the M&A point, is there a, not a preference, but maybe highlight the pluses and minuses of gen rent versus specialty? We always are interested in any acquisition that makes economic sense. I think we've demonstrated that with doing both specialty and gen rent acquisitions when they've come to us. But there is very much an explicit focus on driving growth in specialty that we believe acquisition can and will play a significant role in delivering. We're always looking very intently at specialty opportunities wherever they may come up. Gen rent, again, those deals will happen when they're meant to happen, right? NES and Neff, if you had asked us going into 2017 whether we would do two large-scale gen rent acquisitions, I think we would have bet no, we wouldn't see conditions that would allow us to do that. Lo and behold, we ended up with both. We'll do those gen rent deals when they make sense, when they support a strategy, such as Neff enhancing our infrastructure position, and when they are at valuations that allow us attractive returns. Sorry. Just following up on that. You think about, and it's going back to your point about the leverage and relative to where you think you are in the cycle. If you look at URI's history, there's a period where you exhibited a lot of countercyclical cash generation. So generating a lot of cash in the downturn, then you gave it all back in the upturn. And here we are in a year where you're growing organically by $500 million, and you're going to generate, whatever the number is, $1.4 billion in free cash flow. Does that at all impact or come back into, as you think about that leverage target through the cycle of 2.5 to 3.5 times, just given what appears to be a more stable and better cash-generating entity than it maybe would have been in the past? So ask you that question again, Tim. What- Just basically the underlying cash generation of the company. Where does that, if we go into a downturn, what leverage do you have, and would you see that same pattern exist, in a downturn, the cash flow generation of the company should be higher than it is today? Yeah, I think the industry has demonstrated that indeed, the cash flow can be higher in a downturn, at least initially. As we model downturn scenarios, certainly, we model a very conscious reduction in CapEx, and if you're spending close on to $1.9 billion in CapEx, and a downturn shows up, you've got a lot of room to dial back. That certainly will support free cash flow going up above what you might otherwise experience. That CapEx reduction can offset at least, again, in the early part of a downturn, can offset a pretty significant reduction in operating cash flow. We would expect that that would play out in the next downturn as well. But our view is that you can't sustain a rental company not spending capital for an extended period of time. As the downturn continues, at some point, we would hope to start making investments to grow the fleet, making investments to replace fleet that's aging out during the course of the downturn. Those investments will start to absorb some of the cash flow as you trough and start to climb out on the other side. You would expect to see, if you have a normal curve of cash flow generation during the up part of the cycle, during the initial part of the downturn, your cash flow go up, and then as you go past the trough, it'll come down again as you start to reinvest in your business. We believe that is a very sensible way to manage a rental company, and so that's what you can expect to see as we go through the next downturn. Matt, maybe one for you, just in terms of how the branches are managing and utilizing the fleet. Just talk about time utilization, and we're bumping up on, if not at historical high levels, and on the one hand, you've got the negative from the standpoint of growing more in the specialty business and putting more CapEx there, which will drag that time unit, but there's also more use of telematics and other things that presumably helps you in terms of being able to manage the fleet better. Just overall, what's the ceiling and as the footprint sits today in terms of time unit? Sure, Tim. As we've said in the past, we don't pretend to know where the ceiling is, but we continue to believe we can do better. When we were at 67 and a half, we pushed towards 70. Now that we're getting closer to 70, I think there could be a couple of more points there. Our operational excellence team continues to look at opportunities to change processes and tools to help the team enable that higher time utilization. I think one of the benefits of our continued growth and density is we can do some things from a time utilization perspective, from a fleet sharing perspective that are unique to us. That's one of the reasons why scale and acquisitions in gen rent businesses where some could view as redundant. We think we're a better owner of that additional capacity in the market because of what we can do with that density. That drives a lot of our thinking, and as you pointed out, there is a drag in time unit and specialty, but we'll take that trade-off of the time unit drag and the return uplift every day of the week. We feel we can continue to grow our time utilization throughout the long term, I'm not saying immediately in 2018. With the continued focus on our operations, even with the drag in specialty or maybe a local customer vertical could come in at a little bit lower time unit. We think the balance of improving our base business will offset any of those headwinds. Maybe just to focus on cost of rent. You've been able to hold that in check here, and now we've got clear the other day in talking to some of your peers, just driver availability, mechanic availability becoming more and more of a challenge. Just what some of the things that URI is doing internally in terms of what levers you have to pull to be able to manage that overall cost of rent. I would say, first and foremost, I always say that we close the back door. Our very low turnover, we think is a strength for us. We don't have to turn as much of that hourly labor force as the industry average. We're in the single digits of turnover, voluntary turnover in that audience and overall as a company. That's the number one strength. Number two is training and retaining and then growing. The whole industry has a challenge with bringing youth into the trades, the whole construction industry, not just United Rentals. We're very aggressive in recruitment. You've heard a lot about our military recruitment. That's a great avenue to continue to add folks into that arena. Our acquisitions about capacity. One of the values of buying Neff and NES is that capacity in the shops that we buy and the technical capacity of the hourly labor force, and we work very hard at making sure we retain 100% of that. Those are the ways that we attack it, and we feel good about our approach. Maybe just one on the used equipment market. There's the view that given we've seen lead times continue to push out, that presumably that accrues to the benefit of the used market. Just maybe update us in terms of what you guys are seeing through, and I guess part B of that is how high can you go in terms of your own disposals through the retail channel? How has that changed as you layer in NES and Neff? The used market, it continues to be very robust, and our expectation is that will continue. Our experience in fourth quarter, for example, used pricing was that our pricing in our retail channel was up 5%, and that's a like-for-like unit comparison. That's an environment that I think does support the ability for us as a rental company to manage our fleet very actively in the used equipment market. The volume that we can sell into that market is also quite robust, so you've got a combination of good pricing and strong demand for the equipment. From our perspective, it doesn't get much better than that. The retail channel for us is north of two-thirds of what we sell, and our view is that it certainly is something that we want to continue to drive focus on. It is another way that we distinguish ourselves as a rental company, relative to others who have to use auctions more readily or brokers more readily. We want to continue to drive that retail channel. Where can it go? It's like utilization, right? Not quite sure how high a share it can represent. All I would say is it can be higher than it is today, and let's go out and strive to make it higher every day, and we'll figure out where it can go by getting there. Maybe the last one just on digital and what it means for URI overall. I saw Michael the other day, and that was one of the things that he highlighted in terms of things that he's more positive on. Just in a sentence or two, what digital means or what can it mean for URI? Well, as you know, we've invested quite a bit of the past few years building a digital platform where a customer can seamlessly place an order with our organization. We were first in our industry to do that. Candidly, I think that's going to be the price of entry at some point, and although we're seeing growth in that space, the digital usage, if you just capture it as a percentage of revenue, is not the needle mover right now. But it's the capacity that we're building to grow off that, just not to touch new customers and broaden our customer base, but I do believe that many more of our existing customers are going to convert as time goes on. I really do think it's a core competency you need to build if you're going to stay in this industry, and we like to be ahead of the curve on that. There are other ways, whether it's using and introducing telematics. There's many ways that we use it internally for ourselves, for our techs, where we have apps where they can show up on a job site and click on the app, and they can see exactly where the asset is they have to work on, and if there's any other assets in there that need preventative maintenance, for example. So we think it's an opportunity to leverage it not just externally for our customers, but internally to drive productivity. So digital has many legs to it. Right now, the customer-facing platform is something unique to us that we're going to continue to build on. Great stuff. I think we'll end it there. Thanks, guys, for coming. Thank you. Thank you. Have a great conference.