Goldman Sachs Industrials Conference 2016

Nov 2, 2016

Okay, great. Good afternoon, everyone. Thank you once again for joining us. I'm Jerry Revich, and we're excited to have the full team with us from United Rentals. We have Michael Kneeland, Chief Executive Officer, immediately to my left, Bill Plummer, Chief Financial Officer, and Ted Grace, Vice President of Investor Relations, in the back. First, we're going to run this presentation in a fireside chat format like the others, and then we'll open it up for Q&A. Gentlemen, thank you so much for making the trip. Thanks for having us. Maybe to start the discussion, can we talk about your strategic priorities in this cycle? Over the course of your tenure, you've meaningfully reduced the cost structure, focused on logistics, pricing. What's the priority list over the next 3 to 5 years as you look across the business? Well, I'll start out, and Bill, please chime in. Since 2008, we wanted to leverage our size, and we focused on our footprint, driving a lot of efficiencies. Started out with our EBITDA margins in the 30s, and our last reported EBITDA margin was just north of 49%. What we've been doing since then has been leveraging our customer footprint. What I mean by that is expanding our depth with them by expanding our specialty side of our business. We had substantial growth in our specialty business. As far as where we seem to go forward, Jerry, I'm going to have to pause on that because we're going to have our investor conference on December 1st. So for those of you who'd like to join us, please see Ted, and we'll talk more specifically about our strategy going forward. Just to add, strategically and operationally, tremendous improvement to Michael's points, but also financially. We've really improved the capital structure of our company, a vitally important aspect of a company that's highly levered, and that really serves to offer balance sheet capacity in the form of temporary rental of equipment. So continual reduction in our leverage ratio as measured by net debt to EBITDA, pushing out the maturities of our debt, reducing the absolute amount of debt in the recent quarters, all in service of supporting that strategy and the operational execution of the business. On your last conference call, you spoke about your digital strategy gaining traction. What's the ultimate opportunity as you see it? Is it every small contractor can get access through URI at, hopefully, accretive pricing? Is that the ultimate opportunity? Well, first and foremost, it really was to be of more value to our customers. As I mentioned on the call, over a 12-week period, it went from zero to $1 million a month. Actually, for me, it was rather impressive, given the fact that we really hadn't spent a lot of time and effort on trying to market it. We did most of it was internal marketing. That being said, 50% of that revenue came from existing customers, who find the ease of transaction conducive to their business and their business model. The other half of that business was completely new customers. Again, it's in its infancy. We don't know where it's going to go. We just thought it was an important value proposition that we could bring to both markets to expand that channel. But really came down to simplicity and ease of customer transaction and use. Can you talk about what platform you're using for the underlying system? Is this in-house development, third-party development to your specifications? How should we think about spending towards this area? Well, it's in-house. We did get advice of external to make sure that the usage and the way in which it was designed was for the customer. We have a tendency to try to add five pounds in a two-pound bag, and we had to step back and say, "What were the biggest value, and how do you make it simple and easy to use?" With that, we brought in external resources in to help our internal team with the programming to make sure we got it right. Going forward, is this out of the CapEx budget? Is it a significant part of the budget? How should we think about how this flows through from an investment standpoint through the financials? Well, it's too early. It's $1 million a month. You can do the math. You can look at it and say, "Okay, we're getting mark-to-market rates, which is a good thing," particularly on the new customers. The existing customers are dealing with their account pricing that's set. You eliminate any kind of error rate because of human intervention. So you can place the order, you can set up a time frame. It's completely automatic, and it also takes less people, obviously, that's involved. So I think as it builds in time, it could drive some further efficiencies, but it's really too early to determine. You've been working on rolling out telematics across the platform. Where are you in that process? How much do you expect the digital sales to increase as you get better tracking? Yeah. As far as the GPS, the rollout will be completed the first quarter of next year. We're retrofitting all of our assets that we want to make sure has a GPS unit on it. We allow our customers that information at no charge. There's certain things that we can show to them. We call it You Are Near Me. They can go online, and they can identify the assets that are in close proximity. They see the movements, see one to hour meter readings. In some instances, we have geo-fencing set up for customers. In other instances, we have fueling, so when it's low on fuel, we can notify a customer. That may sound redundant, but if you think about being in harsh environments or environments where as far as the transportation, it's pretty far out, it becomes very important in their planning process to make sure the assets are fueled. Whether you're in the middle of nowhere or you're in a very harsh environment as we go into the winter months, it's very important. So it's just another value proposition. Having said that, we also are looking at ways to drive efficiencies for us. How can we pick up assets quicker? How can we service our assets better? How can we utilize our current maintenance force to do that? Then what Bill and his team are looking at, and it's very early on, is we're building up data. What can we learn from that data? How can we take that data to make better decisions? How can we take that data to our customers to help them make better decisions? Those are the things that we think about in the future, of what we can do with it and how we can leverage it. As you think about the industry structure within rentals today versus 10 years ago, you spoke about the changes at United. What about the changes in the industry as a whole? How did the crisis impact behavior that you're seeing out of the competitors today? Any change in behavior, any change in structure that's notable from your standpoint? Well, I've seen a lot of changes over my close to 40 years in this business. I would tell you that out of the last downturn, I think that the result of data, the usage of data, the commonality of the ARA metrics has enabled the industry to make better decisions. Clearly, not everyone is following it. We understand that. But we have a set of standards today that we didn't have 10 years ago. We have data that can be reported back to us to help us make better decisions. All that, I think, is going to be value add to our industry as a whole. I think also when you look at it, we are focused on returns, we're focused on cash flows, and we've learned a lot over time. I think the industry is maturing as any industry would, and we still have a long way to go. It's still highly fragmented, and I think that there'll be opportunities for further consolidation down the road. But I think overall, the industry is being more responsive and making better decisions. In terms of the bid process with your national account customers, how has that changed at all with a couple of number 2 and number 3 players increasingly focused on that business? Has that changed at all? Are you seeing more or less competition? No, I don't think it's changed in character dramatically. I think the customers still have their processes, and we've got to respond to that. In terms of the competitive environment, there's been some consolidation for the players who can conserve those large national accounts, primarily us acquiring RSC back in 2012. But there's also been folks who've focused more on that market as well. I would characterize the competitive environment as not dramatically different. It's always been very competitive, and our expectation is that it will always be very competitive. What we've got to do is to deliver a value proposition that allows us to win consistently. We've been able to do that so far. We think we can in the future, no matter who shows up. In terms of switching gears to talk about end markets, as you look across the U.S. for construction applications, where are you seeing the strongest activity levels? Where are the pockets of softness? Same question for industrial applications, if you have that level of visibility in terms of where the equipment's used. Sure. Maybe I'll start geographically, where we've said pretty consistently recently that the pockets of strength we've seen are on the coasts. Both coasts have gone pretty well. The pocket of weakness that you can point to is Canada, and Western Canada in particular, and that being primarily an oil and gas-driven phenomenon, with some scattered weakness in the U.S. The Upper Midwest is probably on the weaker end of things as well. If you want to focus in on customer types and verticals. We've seen strength in some of the industrial verticals and slight weakness in some of the industrial verticals as well. Outside of oil and gas, I'm talking about. Oil and gas, the downstream oil and gas, has been consistently strong for us, and you all know the upstream oil and gas story. You move out of oil and gas in some of the other industrial verticals, and we've seen some strength in power generation, some strength in some of the manufacturing buckets, automotive in particular, and a few others. A couple that are on the slightly weaker side. So, that's sort of a run of some of the verticals that have been stronger and weaker for us. Ask another question, and I'll keep going. You folks mentioned on the call that there might be an opportunity for $50 million higher CapEx in 4Q. Obviously, not a big number versus the fleet size, but it's interesting because seasonally, you typically look to scale back the fleet size. Are you seeing stronger than normal seasonal demand, or is it specialty equipment? I guess I should have finished with project types because that's really one of the key drivers of that incremental spend. We've seen some projects that have kicked off recently that represent pockets of strength. Some infrastructure-related projects, like bridges, like airports, some industrial projects where we've had some significant wins recently, and some other commercial construction-type projects that have been awarded recently that we're going to be on. We've seen those pockets of strength, and enough strength and enough promise of long-term demand that we thought it warranted spending a little bit more capital to help support. That's why we're talking about going up to $50 million over the plan that we've been tracking toward. Hopefully, that is a harbinger of some strength that'll carry into 2017. Time will tell, but for right here and now, it's the right thing to do to service our customers and to solidify our position on these projects. Jerry, the thing I would say is that that discussion was a robust discussion. We have a lot of discipline around our capital. As you go through each year, you learn a little bit more. You try to be a little bit smarter. We tried to make sure that we exhausted whatever we can before we go ahead and spend any more CapEx. I just want to remind everybody that in the gen rent side this year, we really didn't give them any growth capital. It went to the specialty side of the house. A lot of these projects that Bill's talking about is on the general side of things, and they are long-duration projects. As we think about oil and gas and market equipment rentals or oil and gas regions, 18 months ago, pricing was at a 10%-15% premium versus non-oil and gas regions. Where is that today? If the rig count picks up back to, call it, 900 rigs, do you think you can get that pricing premium back in those markets? Yeah. Without commenting on the specific premium, I think it is fair to say that we're still today being paid a premium rate for oil and gas-related equipment when we have it. The truth is, we need to be. That operating environment for drilling completion work is harder on the equipment than some other operating environments in terms of the hours of operation. They're running 24/7. You need to earn that premium in order to justify having the equipment there. So it's still there. There's just less of it now than there was a couple of years ago. We are looking at that business very much in the same light that we looked at it previously. Again, it's just less of it to go around. What we need to do is to make sure that we're on all of the drilling and completion projects that we can, and that we're servicing those customers well so that we'll be positioned when that market does eventually rebound to take even greater share there. Bill, when you say less of it, do you mean less of a percent premium or less volume of business? Less volume of business is what I was talking about. The premium itself, honestly, I haven't looked closely enough to be able to say if it's significantly different than what it used to be. Obviously, the competitive dynamics might suggest that it probably has come down, but I can't say that based on fact. That's just gut. Okay. In terms of the Canada business, you've worked through the headwinds for a number of quarters now. When do the comps get sufficiently easy enough where if demand flattens out sequentially versus normal seasonality, we'll see the year-over-year comps effectively move to zero? Sequentially, demand has flattened out already. We believe that we've seen the bottom in Western Canada, and that's certainly corroborated by the data. You go back a couple of months, and you can see that sequentially, we're flat to up slightly in fleet on rent in Western Canada. If that continues, then the comps will start to get better when we anniversary the last couple of months. Obviously, we're still going to be down year-over-year for some time to come, just based on where we've come from over the last two years. But if you look right here and now, the business has bottomed and is trending flat to slightly positive on a sequential basis. When is that good enough to get neutral sales on a year-over-year basis? When will you anniversary? Did it bottom in the second quarter? Can you just give us more context on that timing? Yeah. I think second quarter is where we would say it put in a bottom. Let's talk a year from now, and I'll be able to say, "Hey, Western Canada's up. Looking forward to it. In terms of the rental cycle overall, can you talk about how you see the cycle playing out from here? It's a bit unusual to have the type of oil and gas headwind that we had to absorb in this cycle. Are there any historical time periods that look similar to you, and how do you think the pricing cycle plays out from here? I can only tell you that every cycle is different. Each one has its own personality, both up and down. That we're going through this cycle here, I think the general consensus of a lot of companies is flat growth is the new normal with low interest rates. When we look at it, we look at what are our customers saying? What's the data telling us? On the call you heard me say that in August and then sequentially in September, we saw improvements in construction. We saw employment numbers improve in construction. We also saw our customers, just listening to our customers, more optimistic going into next year than they were last year. So those are things that play well where the cycle goes. I think there's a lot riding right now, or a lot of people are on the sidelines trying to understand where the election comes out and what that means. But if you take a look at rental as a whole, when you have uncertainty, that actually bodes well for rental. People, if you recall, going back to 2009, 2010, 2011, it wasn't until 2011 that we started to see non-res construction start to improve. We were growing in 2010, and that's because people were shifting away from owning towards renting. The sharing economy is gaining more than it's losing, and my sense is that we'll continue to see that momentum play out over time. Where the cycle ends, that's anyone's guess. What we say is we see 2017. We're right here and now. So far we're pretty optimistic. Cautiously optimistic, I would say. We're not in a vacuum. We hear what you hear. We watch what you watch. But some of the fundamentals that we're tracking would suggest that we still have some more runway ahead of us. Michael, is that a comment, presumably on volumes, or do you feel the same way about rental in terms of having more upside to rental pricing off of current pricing levels? I think pricing is really going to be based on demand versus the supply. Right now we're walking through an imbalance. It's getting better, but we're not there yet. I think also what is yet to be determined is the 4Q, 1Q seasonality, and the impact that the weather or winter may have. Those all play out. Those are unknowns. The way in which we look at it is how can we manage this business, not just only on rate, but also looking at our utilization and how can we drive profitability? It could come from customer mix, could come from product mix, it could come from increased utilization in certain categories. Our job is how can we improve the business overall, not just on one metric on rate, but a combination of several. One headwind that you folks have been public about is the factor of inflation on the fleet, where flat pricing, you're actually looking at a negative 2% effective yield. Can you talk about what areas you're focusing on to help offset that? I'm sure mix is one, but maybe you can expand on the last couple of points, Michael. Sure. Absolutely mix is one of the ways that you can try and overcome that. So focusing in on where we get the highest contribution to economic profit is something that we've been really intent about over the last several years. We use the metric we call contribution margin, but if you think about it as revenue less variable cost and less the cost of capital, we use that metric to try and guide us to where we can mix our fleet successively higher each year to overcome that inflation on the fleet cost. Then obviously you do whatever you can in the operations, both revenue and cost side, to continually expand margins as well to overcome the headwind and the increased inflation on your capital. We've talked over the last three years, almost three years, about our lean initiative, for example. That's one of the ways that we're squeezing more out of whatever cost we incur in our business. We set a target of $100 million of run rate improvement by the end of 2016. We're at $96 million at the end of the third quarter. We're going to hit that $100 million goal, and we're not stopping there. We recognize that the inflation on our fleet, as well as the normal operating inflation, is never going away. As low as inflation might be today, it's going to come back, and you're always going to have to deal with it. The way you deal with it, one of the ways you deal with it, is just continually look for productivity enhancements, mix enhancements, as well as just good old-fashioned trying to realize basic factors like rental rates. All those things have to work together to overcome what is a challenge, a headwind every day. As you work Tier 4 into the mix, can you talk about what impact it's having on the residual values? It's probably still early for you to be selling them outright, but how has the performance been of the Tier 4 machines overall relative to the residuals and any impact on potential ability to get priced as effectively we get closer to seven, eight years post Tier 4 regulations? Yeah. Tier 4, as we blend the new Tier 4 compliant units into our fleet overall, just compounds the overall fleet inflation issue that we talked about just before. The question of how it might impact residual values is pretty early to start making statements about that, right? Clearly, you're not going to see many of the Tier 4 units being sold into the used equipment market. But it could be having a positive effect on older units as people compete for those more in order to avoid the Tier 4 cost. Hard to say that, hard to point to any evidence of that. But over time, you would expect that to be a dynamic that plays out. Right now, used equipment values, while they've come down off the absolute peak, are still pretty high historically, right? We realized north of 50% in the last few quarters of original cost on our used equipment sales. Is Tier 4 part of what's keeping prices up at those high levels? Maybe, but it's hard to say exactly how much. In terms of its impact on rental rates, again, over time, we would expect that the higher cost of Tier 4 equipment will incentivize rental companies to keep their rates up or move them higher. You just have to in order to offset that higher cost of capital. We think it'll net to a support for rate, but it's hard to point to how much that's happening right here and now and exactly when that might start. But we look at those things as a backdrop that says, you know what? At least we got them going for us instead of going against us over the next intermediate period of time. From a CapEx standpoint, you mentioned earlier focusing on products with the optimal returns profile. How will the direction of your CapEx budget by product compare over the next 12 months compared to what we've seen over the past 12 months? What are the categories where you expect more investment? Where do you expect to see less investment? It's going to certainly respond to the demand that we're seeing from customers and the market overall. Obviously, we have a significant portion of our fleet that's in aerial work platforms and forklifts. We're going to have to support that significant share of fleet with a significant portion of CapEx. But I think the areas where you'll see a disproportionate investment, I'll start with specialty. Our specialty lines of business have been growing very rapidly, and very clearly, we want to support that growth with additional capital. Trench Safety, power HVAC, pumps, and tools, I think will all see a disproportionate share of our capital spend. And then we'll look around at the specific CAT classes within general rentals that promise us the best growth opportunity and the best return, that contribution margin I mentioned earlier, and we'll shift more fleet, more of our CapEx, I should say, toward those CAT classes. It'll be one thing one day and another thing the other day. But you can look for us to look at those CAT classes that have historically been the most appealing, and start there with where we want to emphasize our fleet. Let me open it up for questions. We do have microphones, so if you have a question, please raise your hand, and we'll circulate the mics. Yes, up here, please. Would you talk about your fleet mix as you look out over the next 5 years? Does aerial become bigger with the forecast of the highway bills and things like that? A little bit of conversation on the lighting market. I've always been surprised it's such a small part of your business. It looks like a lot of the road bids that have been released have been coming out with night work requirements and things of that nature. Thanks. The mix, I would say, as I said before, we are significantly AWP and forklifts. I think over time, that share of our portfolio is probably stable to maybe declining a little bit as a share, not absolute terms, because we're growing in these other areas more rapidly. So I think that's probably the biggest statement that you can make about our mix overall. That and the fact that specialty is going to continue to grow disproportionately when you aggregate all of those lines of business. So I think that's about as much as we can say with certainty right here and now, because as I said, we're responding to customer needs and the market demands overall in terms of how we tip the balance of our capital spend toward or away from given CAT classes. Regards to the lighting part of our business, light towers are one of those CAT classes that have worked fairly well for us historically. We will look for opportunities to grow that set of categories as we go forward. The thing you got to remember is we are always looking for the growth opportunity without over-fleeting in that growth opportunity, right? That is the debate that we always have with ourselves is, how do we pursue the growth without killing the goose that laid the golden egg by putting too much fleet into it and driving down rates? So we are going to be looking at that as an opportunity to continue to grow, but to do it responsibly as we find the opportunities that come out of the road work or any other work that might need lighting equipment. Sure. Can you talk about how you are thinking about acquisitions from here? You were aggressive early in the cycle with RSC, as you pointed out. What is your M&A appetite at this point, and then just your broader capital structure priorities? Well, we have always had an appetite. I think that is proven in our history. We have often said that it is a three-legged stool. Strategically, it has to make sense. Financially, we have to say, what gives us the right to own it, and how can we not only possibly get synergies, but also how can we grow the business? Then the third thing is cultural. We have got a lot of experience in integration that we have learned from, and we want to make sure we do not repeat our errors. So culture is another one that is important. As I mentioned earlier, consolidation will be continuing to be on the forefront of our industry. We are active players. We are very select. We want to make sure that we hit all three of those items. Our discipline is such that if it does not fit one of those three buckets, we have no qualms of walking away. We understand that. But we do have a good pipeline, things that we are looking at, and we will make the determination and announcement when appropriate if, in fact, there is something that makes it over the gate. But the discipline is there, Jerry. We are not going to just do it for the knee-jerk reaction of doing it. The team is doing a great job. We have had some small bolt-ons, and clearly, you have seen that in our power, in some of our specialty segments, and then we built it out. That was a win-win for everybody. So you can see some more of those. But we are not shy of gen rent either. We think those are opportunities as well. In regards to capital structure priority, first and foremost, we want to use the cash flow that we generate to fund our organic growth. That's how we're going to assure the future of our company, right? Support the growth opportunities that serve customer needs. We set our CapEx levels first before we then ask, "Hey, are there M&A opportunities that we should be pursuing?" And we've done, I think, a good job recently of positioning the company so that we can spend whatever CapEx that we need and then be ready to pursue whatever M&A opportunities, even up to the biggest ones, if they became available, and meet the three criteria that Michael just went through. If we don't see those M&A opportunities in front of us, well, then we have the choice of paying down debt or buying back shares. Our choice recently has been to do both. Driving down our leverage ratio, recently driving down the absolute level of debt, and buying back shares at the same time. But we continually assess, before we get to that choice, whether there's an M&A opportunity that makes sense and that fits the three criteria. Okay, great. Well, please join me in thanking Michael, Bill, and Ted for joining us. Gentlemen, thank you. Well, thank you.