Jefferies 13th Annual Industrials Conference

Aug 8, 2017

Good morning, everyone. I am Justin Jordan from Jefferies. I am delighted to introduce from United Rentals, Bill Plummer, CFO, and Michael Kneeland, Group CEO. I guess, July 19th, you guys had Q2 earnings. I just want to kind of recap a little bit on that, and then we will obviously get into Q&A later, if that is okay. I guess just to start with, Mike, just on time utilization, you have had a phenomenal improvement in the first six months, year-over-year, record time utilization in Q1 and Q2. What has gone well here? How have you achieved this? Is this United? Is this the market? Is this a combination of factors? I think it is a combination of factors. To your point, we saw it ramp up in Q1. We talked about that with our results for Q2. Clearly, it continued along that path. In fact, to your point, it was a record for us for our second quarter within our history. In fact, every month within the quarter was a record. So part of it is obviously largely due to demand that we are seeing in the marketplace, coupled with the fact of driving further efficiencies inside our organization. Combination of both, but the market and demand has been strong. Okay, thank you. Just moving on with rental rates. Obviously, 2017 has seen a very clear trend of improving rental rates from negative 1.4 in Q1 to negative 40 basis points pro forma in Q2. I guess, you talked about in June, I think it was five of your 13 regions were in positive rental rates. Again, what has driven that? What are you doing? Is that a combination of end markets? Is that a URI specific initiatives? Again, I think it is a combination. Having the market backdrop be positive is certainly helpful in being able to drive rates. There is also a focus that we put on making sure that we are realizing rate as effectively as we can in that market that I think played throughout the first half of the year, let us say, but certainly in the second quarter. You can see it in the trends of rate over that time. So making sure that we are all conscious of the opportunity in front of us, making sure that people remember that there are ongoing pressures, operating cost pressure, procurement cost pressure, that we have got to recover, and rates is an important part of that. We do our good work in driving productivity and really executing the business well. But at some point, the market has to hand us rate opportunity in order to cover those costs. As long as we stay focused on that, I think we will be able to deliver some improvement in rates. We went a long stretch without, right? A couple of years roughly without significant rate improvement, actually some rate deterioration. We have some work to do in order to continue to move rates in the right direction. That's what we're focused on, and that focus along with the market backdrop, I think, were the key factors. Yeah. The only thing I would add to that, Justin, is the fact that everything that Bill said is absolutely true. The market overall, just about every company that's reported has shown rate improvement. So it shows the demand and the market conditions that are out there. Okay. Justin, you talked about five of 13 regions being positive rate territory in June. Where were we, for example, in July? Are you now back in positive rental rate territory? Yeah. We're not going to offer specifics on July or the quarter to date, right? That's the approach that we've been taking. But I would say that the momentum was nicely established in the second quarter, right? You could see it in the overall sequential path during the second quarter, each month in the second quarter. So momentum when it's going your way is a good thing. When it's going against you, it's a bad thing. But when it's going your way, it's a good thing, and our job is to make sure that we continue to move rates in a direction that we think they need to move in order to get decent returns out of the business. Okay, thank you. Just following on, I guess, dollar utilization or ROIC, I guess simplistically, I think about it as first you improve your time. You are clearly doing that. Secondly, you improve the rates, and hopefully we are getting that in terms of year-on-year positive rates very shortly, if not right now. Then thirdly, you get to improving or stabilizing ROIC and improving that. Is that sort of how you think about it in those sort of three steps, as it were? Yeah. That is a good, simple model. It is not quite that linear. Okay. Certainly the concepts I think flow that way. What I would say is that is exactly the mindset that forces us to focus and emphasize getting rates to be at the very worst flat, but hopefully positive on an ongoing basis, right? If we have got a flat to slightly positive rate environment, if you told me, Bill, you are going to have that for the rest of your working life, that is not the end of the world, and we can do something with that kind of a rate environment, right? We have established that we can continue to drive improved productivity, right? That is going to flow through to improvement in returns in just about any measure that you look at. So I would say that if we could find something in that flat to slightly positive rate environment, then the ROIC will follow. The ROIC improvement will follow. We are working toward that end, if not more. To say flat to slightly positive rate is our goal? No. We would like to move it higher because we believe that the industry requires higher rates than being basically flat in order to overcome cost pressures. But if you told me that that's all we could get, I'd say, "Okay, I can come up with ways to drive return improvement in that kind of environment. Can you just talk us through, you talked about cost inflation, and I suppose there's offsetting measures you can take to try and address some of that, like XL and lean, I suppose. But what do you think you need in terms of positive rental rates to stand still in terms of, let's say, ROIC or EBITDA margins, given the cost pressures? Yeah. As I said, I think we can find productivity enhancements to offset those cost pressures if the top-line rate environment is in the flat to slightly positive environment. So, I'd stay with that. And we have a set of productivity enhancements that we're working on today. The good news from our perspective is, there are other opportunities that we just don't have the bandwidth to access right now that we can go to to extend our ability to drive improved productivity and return. Okay. One of the features of Q2 was you increased CapEx guidance by $100 million bucks. I guess, can you just talk us through the thinking behind that and is that particular regions of the country that you're factoring better end market conditions or particular cat classes that you're seeing particular strength in, or what was the backdrop to that? It was pretty broad-based, both geographically and across customer type and project type and across cat classes. That was really the encouragement that gave us the confidence to say, "Let's add that CapEx." You look and whether it is the Northeast, the Mid-Atlantic, the Southeast, all along the Pacific West Coast, geographically, there was real strong demand. Eastern Canada was really strong in demand. We had some pockets in the South Central part of the country that was strong in demand. That gave us encouragement. When you look at different customer types. Big customers, medium-sized customers in a variety of different segments of construction activity, we saw good demand. Again, across cat classes. Our specialty businesses were growing very robustly. That is good. But gen rent was also growing nicely as well. It really is very broad, and when you see that kind of breadth, it gives you confidence that the demand is real, and we have got an opportunity to invest some more. We did. The only other thing I would add to that, Justin, is the fact that we are very disciplined in our capital allocation. We do not take it lightly. We spend a lot of time and effort looking at that. Bill talked about the demand that we are seeing and making sure that we are covering our customers, because our customer surveys are coming back very positive. But we think about it not just in today. We think about it going into next year and beyond. We spend a lot of time, as an organization, as a senior management team, analyzing our capital spend every two weeks. It is with a lot of discipline. Okay. Just follow up on that, on the discipline. I guess, can you give us some sense of where you think we are in the cycle? You are seeing some peers, one of which reported this morning, seeing increasing volume of the rent. Where is your view of where we are in the cycle? Well, each cycle is different, and this one is probably one of the most unique for a lot of different reasons coming off of a very bad recession. The recovery has been spotty at best. Last year, I think for most of the companies that we are reporting here, I would probably tell you that last year, with the strength of the dollar, the oil impact, and the European and Asian markets being somewhat slow, impacted them, and we have even heard that some of the industrial sector was technically in a recession. But it is coming back out of it. We saw that build up in our fourth quarter. We saw that continue in the third quarter. We do not know the length of how this will last. We can only tell you over the next several years, and including the ARA, which you have in front of you there, as projecting the next several years of continuous growth, single-digit growth within our industry. Again, going back to our customers, the data points that we see all point to a positive trend going forward. Okay. Justin, I guess one of the features, of course, of URI in 2017, as well as accelerating organic growth has been NES. I guess, can we spend just a few minutes on M&A and just how you think about M&A and, I guess, what were the specific attractions of NES to URI? We have said this numerous times, that acquisitions, each one, again, I use the word discipline. It is a three-legged stool. Strategically, how does it fit in? When you look at NES, it gives us additional markets. It gives us the ability to grow. Some of our markets where we have a lot of OEC, our regional equipment at a location, the ability to expand in that market becomes constrained. So the fact that we were able to expand some of our markets and enter new markets was attractive. The fact that we can get new customers that we can cross-sell, which has become a core competency, again, strategically became very attractive. With regards to the numbers, the numbers speak for themselves. When you take a look at the multiple we paid, take a look at the synergies and the tax effect, where it dropped in as far as the overall EBITDA that we were paying for. Very attractive. The math works. The culture, again, focused on safety. Very common to United Rentals, focused on the customer. NES, being privately owned, clearly didn't have all the capital that they probably could have used. From a cultural standpoint, they were able to lock onto their customers, they were able to do safety, and they have a lot of commonality with regards to United Rentals. Same operating system. Different operating system, but the same principles of applying how they go to market. The equipment was the same equipment that we have, so there was really no change there. From a cultural, economic, and strategic, it fit all three of those boxes, and that's why we chose to go with NES, and we're very pleased with that transaction. Mm-hmm. Okay. I guess when you look at any business and due diligence externally, and then when you get into actually owning it, as you did from April 3rd, what are the things that you found were different to what your external due diligence had told you, positive or negative or? No, I think there's always some things that move around a little bit. But the team, this isn't our first rodeo. We have over 275 acquisitions that we've marshaled through. As a result of that, we made mistakes, and you try to learn from them. But we have a team that knows how to look at things. We're very good at integration. I would tell you it's probably a core competency of United Rentals that's very unique. Whether it was RSC, whether it was the pump business, or whether it was NES, and we've had some bolt-ons along the way. It's how we approach it. It's how we come together as a team, both parties, and figure it out, and go forward. So I don't know that there was any significant surprise that alerted me. Bill? No, I think that's fair. It was a business that we strongly believed that we could drive operational improvement. I think that's coming to pass. Strongly believe we could get cost synergies out. I think that's coming to pass. Strongly believe that we could enhance and increase the amount of investment that goes into the business. That's coming to pass, so I can't think of a real negative surprise. Yeah. I just want to make everything clear. This isn't about size, right? Sure. This is about we look at acquisitions on its own merit, and we ask ourselves, "Why would we be good owners? We think of, again, capital allocation for us is extremely important. When we go forward, it's with that discipline and approach that we go forward with. Okay. Just thinking more generally about the rental industry, 2017 has seen an uptick in M&A across the whole industry. I do not know, I guess simplistically, as an outsider looking in, I sort of think getting more and more percentage of the industry into public company ownership is probably good or rational for rate discipline and return discipline. Do you have a particular view as to why you have seen an uptick in industry M&A this year? Well, I think just for various reasons. I think everyone has got their own strategic values of why they are doing what they do and when they want to do it. I think when you want to do it, you have to have a market that plays well. I see it as a vote of confidence where we are in our cycle, that other companies, public and/or private, are doing acquisitions to the magnitude that we are seeing right now. By the way, it is a very fragmented industry, and we have expected it. Several companies have been playing in the acquisition mode. To your point, it has stepped up, and I think it really speaks volumes about where people feel and the vote of confidence they have in our end markets. Over time, does more consolidation bring better discipline in terms of returns and then rate discipline to the industry, or is that just too kind of utopian dream to think about? Utopian dream or not, I do believe that bringing a level of professionalism. Keep in mind, a lot of these companies are public, and so they have public exposure. That brings a set of standards to the forefront. Not only for the company itself, but also for the industry as a whole. I think as we go through, and I have said this, been in the industry 39 years, and it is maturing in a level of professionalism. Tools and things that are available today, we did not have several years ago. So I see it as a progression towards maturity and a level of professionalism. Mm-hmm. Okay. I guess we've talked a little bit about M&A. Can we talk about capital allocation more broadly? You're obviously, I guess, just about four buckets you can really do with capital allocation. You can invest organically. You obviously guided up $100 million on fleet investment this year. You can do M&A, NES being a great example. You can do debt paydown, and you're at the kind of lower end of your own 2.5 to 3.5 net debt EBITDA leverage. Obviously, you've paused buyback late last year. Is that sort of something that you might reconsider again this year? Or are the M&A pipeline of opportunities so great that that's probably something we should stay on pause for a while? Yeah. We've been thinking about the pause and the repurchase as something that we would reevaluate in, I think I've said late summer or sort of early fall. We continue to think about it that way. M&A is a wild card, right? It comes when it comes. You can't tie your own hands too much in thinking about, "Oh, this deal might happen, and therefore we should be really restraining our share repurchase," for example. At the same time, you can't ignore it completely. That said, for us, the repurchase story is about let's see how the NES integration goes. Let's get past our peak draw on our ABL facility, which happens during the- early to mid-summer period, and see where we stand. We fully expect that our cash flow, and leverage conditions will be such that we'll be able to restart that repurchase at some point. The question is, do you want to restart it in August, September, October, or do you want to wait a little bit longer to see how things develop? That's being discussed over the course of the next, let's call it a couple of months, and we'll certainly let you know what decision we reach. The fact that year-to-date through June, we had $614 million worth of free cash flow, that's pretty darn good start to the year. So, that's encouraging, but we want to make sure we've got a good handle on what's going on before we decide to come back in with the share repurchases. Okay. Just thinking about specialty for a second. Because way back at your December 2016 Capital Markets Day, you laid out some pretty ambitious growth plans for your specialty business. Can you just remind us of those and just, I guess, for those who may be new to URI, how do you define specialty? What are the sort of the key attractions of that in terms of higher returns or lower penetration as opposed to general rent? You want to take that one? Sure. How do you define specialty? I will start there. I guess everybody has their own definition, but for us, it is about businesses that have a need, an offer beyond just the equipment, right? To be able to integrate a little bit more closely with the customer. For a power and HVAC installation, there is an engineering component to how that equipment gets used. Same with trench safety, in making sure that the trenching activities are safe and as efficient as they can be. So it is about the equipment, but also about just how you integrate into the use of that equipment that is attractive to us, along with the fact that the investment, the initial investment, tends to be lower for each dollar revenue. The life of the equipment tends to be fairly long for the dollars that you do invest, and that therefore gives you a pretty attractive return profile. Those are the characteristics that we look for. We think we have them in our specialty businesses, and the opportunity in those businesses has been such that we can grow them at a very rapid clip. That's what we've been doing historically, and that's what we've been talking about doing as we go forward. You're always throwing out a new and higher target, so I don't know what we said. I can't remember the latest statement about where we want to grow it to, but it's very rapid growth that we think can be sustained over an extended period, just like it has been sustained over an extended period already, right? We've been growing specialty disproportionately, at least since I showed up 8 and a half years ago. We think that there is market space for us to continue that growth for quite some time to come. That's what you're seeing us invest in, and it's really helping in terms of top-line growth, margin expansion, and return enhancement for our company, so we want to keep doing that. Yeah. Look, I do throw out these numbers. Yes My job is always make sure that they have a vision of where to go. I think I reported at the second quarter, the significant growth going back 4 years ago, where as a percentage of our total portfolio, it was in probably low double digits close to high single digits. Now today, it's just roughly shy of 20% of our total portfolio. I think the more important point is that we're leveraging our customer base. One of the things that we learned very early on with the RSC transaction is when we consolidated both organizations together, there was a significant opportunity through our customer base that were enjoying some of our specialty businesses that we had at the time, albeit they were small in size. We started adding in new ones, and we've seen significant growth opportunities there. Going back to what I said earlier, it's become a core competency for us, where we can cross-sell a significant product offering to our customers. We think that is an advantage for United Rentals. Okay. I guess within specialty, probably one of the last times I want to talk about this is energy. You've been beaten up obviously religiously over the last two, three years on just energy exposure, which is it now potentially a tailwind going forward for the business. Having been a material headwind for two years, what are you seeing on the ground as it were in energy. You've talked about it, a little bit of an uptick in activity. Is that feeding through to improving rates? Look, Justin was as nuanced to me that we were trading like an oil company. Given the fact that a portion of our business is in upstream and downstream. The one business that was affected the most clearly was the pump business that we acquired. When we bought it was like 50%, 52% of their business was in upstream. We went through that down cycle. Today, it's Q2, they had a 37% improvement. Clearly, they're benefiting from a rebound. But it's also more broad in a sense because we're expanding much further beyond the upstream oil and gas. Today, I think upstream oil and gas is shy of 5%, 4.5% of our business. So not significant, not as heavy as it once was. Are we benefiting from the oil rigs going in? Yes. I think the overall industry is as well. Again, it's not a big part of our business, and that's the biggest variable. The unique thing is that from 100 down to the 50 range, well, actually went far below that, we saw a significant drop-off. But as technology and processes have improved, we're seeing these companies be able to become profitable in that $50 range, plus or minus, which was not the case when it first dropped. So I think more to be had on that, but it is an industry. It is a segment. It's not the only one. By the way, within any cycle, we have various industries that go up and some go down. So I don't think we're as reliant on that segment as we once were. Okay. I am conscious that we have got a packed room in front of us. Are there any particular questions from the floor? Anyone wants to raise their hand with a question? Okay. Well, I guess while still thinking about that, let me just, I guess, re-drill it back for a second, just a big picture. If you think about United Rentals within the industry, they are obviously the leading rental fleet, the largest number of branches. What are your key advantages, as it were, given the scale? Whether it is for key accounts or for big national customers, what do you have as a USP that some of the smaller guys don't have? Well, I think the ability, there is all kinds of advantages. I am sure I will name some, and Bill can name a handful as well. First and foremost, our broad reach, to your point on national accounts is one aspect, but more importantly, markets fluctuate within inside of North America, and we see that today in Canada. Western Canada came down, was impacted by oil, impacted by commodities. We have seen it bottom out. On the flip side, the East Coast of Canada was doing very nicely, as Bill mentioned. The ability to move and allocate assets gives us a competitive advantage, particularly over regional companies. Our technology. We are continuing to invest in technology and driving efficiencies. We are actually out there trying to communicate that it is not just about the size of the rental company, it is how smart we can help our customers drive safety and productivity. We have said this before, it may sound very unique or kind of counterintuitive to our business, but less means more. If we can tell our customers that there is ways in which we can take their cost down on rental, can mean a benefit to us by locking ourselves in as a true partner. So we are using technology as a means for that. We have got several different platforms that we are capable of doing. The scale, you get a lot of different things, whether it is our buying power, whether it is the portability of talent, bringing people in, moving them around, our training programs. United Rentals, I don't look at it as the biggest. I joke with you just privately about it, but in reality, it is about being the best company, and that is where my focus is. The fact that we are large is great, but I look at it and say there is much more to be had. The specialty businesses, our cross-selling is very unique, that we can bring to the plate. Our ability to go out there and introduce new specialty, I think is also a competitive advantage. Our ability to invest in those type of products, I think will also. I think you hit on them. We can dive a little deeper in some of the scale advantages operationally that allow us to consistently operate at higher utilizations. I think that's fair with any comparison that you'd make across the industry. Allow us to consistently maintain the equipment better because we've got a density of maintenance and support. Allow us to consistently operate more fleet per average branch than other companies. All of those are real economic benefits that accrue to better returns, better margins, along with all of the customer-facing strengths that Michael ticked through as well. We think we're well-positioned, and it's just a matter of executing on the opportunities that we have uniquely against most of the, I'd say almost all of the rest of the industry. Okay. Just over the next few days here at this conference, we have Sorry, you got a question? Could you maybe go a bit more into the utilization rate and development, how you see that sort of going on into the second half of the year, and just generally at what level would you see sort of a cap from just general turnover and stuff like that? Won't address the how it's going for the rest of the year, but what I would say is that we've been on a pretty good path of utilization improvement year-over-year, really going back through last year. Last year, I think we did it the sort of the no-brainer way. Cutting back CapEx and basically saying to the organization, "Figure it out with less capital." This year, I think we've been spending more capital and still improving our utilization. And I think that's evidence, not conclusive yet, but that's evidence that we have figured out how to operate at that next level of utilization. So our operational improvements are ongoing, and certainly, I think they'll continue to deliver benefits as we go forward. How much? We'll just have to see. That's a key part of how we're going to drive return improvement going forward. Not the only one, but- A key part. Quite honestly, it's how we've continued to perform well, even with the challenge in the rental rate environment that we've dealt through going through the first quarter. Hopefully, that's starting to turn in our favor, and we're going to keep running hard on the utilization. Next question here. How do you guys view the acquisition pipeline today? I guess summing up what you said over the next six months, is it fair to say we should see another accretive acquisition or the share buyback restart? Then, in terms of the different industry data we see out there for the construction and general markets, does it seem stronger to you than even the data suggests? Well, I will tell you that as far as the strength out there, it is strong. I've been going around town hall meetings, Bill, as well, and other members of senior management. In just about every market we've gone to, we see robust signs of construction and groundbreaking cranes going up across North America. Not just on the East Coast and West Coast, but even in central parts. I was just in Detroit, and there's a renaissance in Detroit. They're bringing that city back to life. There's a significant amount of work that's going to be done there as well. As far as the M&A, we don't really comment on M&A other than the fact that we have been always active in looking at potential acquisitions for a broad reach, whether it be specialty or internal. But again, it's more strategic, economic, and cultural. We're not shy in passing on any one of those. We've learned valuable lessons in our last 20 years of doing acquisitions. As far as our capital allocation, I think Bill framed it up that it's something that we think about very strongly. Can we do organic growth? We're doing an extra $100 million. Can we do acquisitions? We do the NES acquisition. We're not afraid of doing share repurchases. That decision will come probably late summer, early fall, as we think about where we are. But as far as the outlook that we see right now, it's strong. There's a lot of construction activity. Our customers are coming back. In fact, when I was in Detroit, the comment was one of our steel erectors has stopped taking new bids because he worries that he can't be able to man up the jobs that he's got ahead of him. It's pretty good right now. Please. Just in the context of what you just said, when you're thinking about when you do scenario analysis around any possible infrastructure bills being enacted in the next 6-9 months, how would you cope with that? It sounds like you can keep some discretionary pressure. Yeah. It's a great question. We get that quite frequently. People forget that the transportation bill was actually passed. If you drive around or you fly around or wherever you may go, you see quite a bit of activity, whether it be at airports and/or you see it in some of the bridges and roadways. So there's been some activity. The states have been not trying to put off what is necessary. There's also an engineering report out that doesn't give the U.S. very good high marks. I think we have a D+ or D rating on our infrastructure. Even $1 trillion is a good down payment. Having said that, anything that were to come out, if they were to approve anything in the next 6-9 months, you're really looking at another 18 months before it becomes reality. It takes a while to allocate the funds, put those funds to engineering drawings, feasibility studies, contract negotiations, and then breaking ground takes time. So we're not anticipating that. Until it actually happens, it's anyone's guess. But the truth is, we need it. I think the good thing is bipartisan support for infrastructure is on both sides. Jo. During the downturn, a lot of the customers got stuck holding equipment, and as a result, a lot of the development, there was a structural change towards rentals. But now with demand picking up again, given the criticality of having equipment available and accessible, are you seeing any amount of shift back towards ownership? No, nothing significant. ARA did a study, a regression analysis, to take a look, and typically every downturn, there's several pick ups or pick up in points depending upon the degree of the severity of the recession. As to the shift from ownership to renting. It plateaus, and then it will expand based on volume. We're not seeing that, and I could argue that today we're much more of a shared economy as far as the way in which we think than ever before. I'm really sorry, guys. We've been beaten by the clock. Bill, Mike, thank you so much for your time again. Yeah. Thank you. Have a good day. Thanks very much.