Goldman Sachs 2015 Industrials Conference

Nov 4, 2015

Okay. Good afternoon, everyone. Thank you very much for joining us for the United Rentals presentation. We're really excited to have with us a full team from United Rentals. We have Bill Plummer to my right, Chief Financial Officer. Matt Flannery, Chief Operating Officer. Fred Bratman, Director of Investor Relations and Corporate Communications Senior Vice President. Gentlemen, really appreciate you making the trip. Consistent with the rest of the conference, we're going to run the session in the fireside chat format and then open it up to Q&A. Maybe just to kick off the discussion, you folks really put up a strong third quarter, and we're seeing a stabilization in parts of the business that had been under pressure. I'm wondering if you could just draw an analogy to any prior cycle that looks similar to what we're seeing now. I think we're all hoping rates pick up steam in the 2016 construction season, and is there any analog that we should be thinking about in terms of giving us the playbook or at least, a similar point in a prior cycle that you think of? First I'll say thank you, Jerry, for inviting us and hosting. This is my first cycle. Even though I'm seven years into the business, I haven't been through a full prior cycle. Matt, maybe I'll defer to you on sort of markers in the cycle and how it's similar and how it's different than previous cycles. I will offer that the current cycle, we think, is different in the following sense. The oil and gas dislocation that we had starting early this year is a very significant impact that is something separate and apart from the general construction cycle. As we think about the current cycle, we're spending a lot of time trying to understand, hey, how much of what we're experiencing right here and now is due to the decline in upstream oil and gas activity, and how much is due to just other factors in the cycle? Those are the things that I think are swirling through our heads as we try to evaluate the current cycle and how it might be the same or different than others. I don't know if you want to add anything else to that. As far as previous cycles, we really haven't had this kind of a mid-cycle disruption. If you want to go back to 2001, after all the integration and consolidation in the space, there was a little bit of a pause, but that might have been as much as people buying new capital before they really properly disposed of the acquired capital, and we've got through that. I would say there's not a fair comp to that. Obviously, although Bill's only been through one cycle, he was through the big one. He came through the big one. But, I would say that Bill covered it right. The thing that's unique here is that everybody was ramping up for a very strong end market, and that non-res end market still was very strong for us, and some of the industrial was still pretty strong for us. But when you got that dislocation that you also ramped up for in the oil and gas, and it went away, I think that was the supply-demand dynamic that put a little challenge on us this year. In terms of what has to happen from here into next year's construction season for rate momentum to return, can you talk about what has to play out to get there? Sure. So, continuing the theme, we need oil and gas to not be as big a drag next year as it was this year. That's hopefully where we're headed, but time will tell. Depending on where oil prices go, will determine how drilling goes, which will determine how equipment demand goes. But if you assume that oil and gas is a fairly stable source of demand next year, then that's a good starting point. Then the overall macro expectations will have to play out in a way that's similar to what we're thinking right here and now. Right here and now, we believe that non-res has got some momentum to it, and that will continue. So that's got to continue to be the case. And we have to be free of any other major unexpected impacts that might come along. Whether it is geopolitical events or the economic cycle in other regions around the world, in particular China being different than what we expect, all of that has to play according to what we think right here and now. If it does, we think next year could be another solid year of overall construction growth. In terms of the impact of the strong dollar on exports of equipment, has that played into the dynamic we saw this year from a rate pressure standpoint in terms of the size of the used equipment fleet? Yeah. It is hard to say how big an impact that has been. Certainly, it has not been a positive in terms of its impact on used equipment values and the volume of used equipment that trades. Strong dollar makes it harder. We see that directly. We have a direct export sales effort within the company. It is not growing as much this year as it did last year. We know that a big part of that is the strength of the U.S. dollar. It is still growing. So we are selling more offshore this year than we did last year, but at a materially slower rate of growth than we saw last year. That means that there is more used equipment swirling around in the North American markets, and that means that, at the margin, it has put some pressure on used equipment values, and probably dampened the volume that any individual seller could get. That said, we are still delivering tremendous margins in our used equipment sales. We are selling equipment at near record pricing in all channels in our used equipment sales. So the market is pretty good right here now for used equipment, even though export sales are a little bit more of a headwind than they used to be. Bill, can you say more about what are your biggest destination markets for your exports? We've been selling a lot of equipment into Southeast Asia. So a variety of companies, Korea, Thailand, and some smaller units going into Vietnam. We've been selling some equipment into the Middle East. That's a channel that we've been developing nicely here. So that's been a nice contributor this year. Then a smattering of sales in other regions around the world, and always looking to expand our presence in other regions around the world. Your ability to continue to deliver growth and direct exports, even though the price of the equipment you're selling to those markets is up 20% in local terms, how have you been able to do that? Yeah. It's a matter of going into those markets and finding the sources of demand, right? Of finding the folks who need the equipment, and establishing that direct relationship with them so that we can put our fleet directly in their hands as opposed to working through brokers in the way that we've done in the past. So we've got a dedicated sales force. It's a small group, but it's a group that's really making a focused effort, and I think that's why we've been able this year to overcome the headwinds from currency. On the earnings call, you alluded to being really flexible with your approach to CapEx over the course of 2016. Can you just say more in terms of at which point do you need to tell your suppliers about your ultimate order size for it to be delivered in time for the construction season? Can you maybe give us a range of expectation for CapEx in the first quarter, relative to first quarter 2015, based on what you said publicly on the call? I think that, what we said publicly on the call, for the last part of your question, Mike had stated that we're going to spend significantly less in Q1. He's right. A big part of that, and we haven't finished our planning process, and we'll get through that and get board approval, but a big part of that is we're going into it with extra capacity in normally slow seasonal time. It makes a lot of sense. I also think philosophically, this year after what we've experienced, we're not as worried about not getting that last dollar of growth that you'd need, and maybe you have to make some fleet purchase bets in May and June to make sure you have it in July and August. I think we're going to be more cautious about that. This is the first year, meaning 2015, in five years that we've experienced we didn't get our peak to the peak that we expected, and that's influenced our thinking and influenced our decision-making going into 2016. I think the key word for us is we're going to be very flexible, and we understand the value of that flexibility, and we're going to maintain it as long as we can. I think the OEMs and the challenges with their backlogs actually plays into our decision as well. I don't think we're going to have 90, 120-day lead times for some of the larger products that we purchase a lot of. I think we're going to be able to shorten that lead time window, and it'll give us the ability to keep that flexibility that we desire. I think we have some in inventory for you here. Yeah, I think. I would say that we all, we were asked a question today. We also won't bite the hook of somebody giving us a real sweet deal Right to overextend and buy too early. We're just going to be very disciplined about the capital spend this year. What's been interesting is with the strong dollar now you have interesting value proposition from Canadian and European manufacturers. I know you focus significantly on your purchasing efforts. How much of a benefit will that drive to your purchasing efforts this year or in 2016, excuse me. There'll be a benefit. We're in the process of determining how much of a benefit right here and now, right? One of our key suppliers in the aerial work platform space is Canadian. One of our key suppliers of other products is based in Europe. So, we're looking very carefully at the cost base that they're facing and the advantage they may have selling in US dollar terms, and we're factoring that into our decisions about how much we buy and what price we pay and the other terms of business that we see from those suppliers. If you're a U.S.-based supplier, you don't get a free pass either, right? We can always say, "Hey, look, we've got an alternative source of supply. Let's see where it goes." That's all being discussed right here and now. The way I characterize it is that we've always been pretty good negotiators in our procurement activities, and we haven't forgotten how to do that. We're in those discussions as we speak. Okay. The other capital deployment focus for you has been M&A. I'm wondering if you could just update us on your thoughts. Obviously, now we're getting closer to a spin of a major player in the early part of 2016. Just recalibrate us, if you could, how we should be thinking about your M&A focus here. Maybe I'll start with the easy one. M&A for us, as we look to grow our specialty business, is very much in the frame, right? We're looking for opportunities either to grow in the specialty lines that we're already in, Trench Safety, power, HVAC, tools, and pumps, or to add adjacencies that have specialty characteristics, right? Relatively lower capital intensity, higher margins, higher return, and true growth. I'd say no major change in our thinking about M&A as it relates to specialty. In the gen rent part of our portfolio, what I'd say is that as we think about large-scale gen rent, I think it's fair to say that if we have an opportunity for a deal, we're going to look very carefully at that deal and say, "Okay, how can we assure ourselves that we're going to get value out of making a big move right here and now?" That partly is a question that we'll be asking about the cycle, right? How much more runway do we have in the cycle? It'll be about where synergy's going to come from, and it'll be about a host of other questions that we'll be asking ourselves. We would certainly still look at large-scale gen rent opportunities that come in front of us. But I think it's fair to say that we're going to look at them very carefully. We've talked in the past about the three criteria that drive our thinking around acquisitions. Making sure that it enhances our strategy in some fundamental way, making sure that the valuation and financial performance is attractive, and making sure that the culture aligns generally so that we can integrate effectively once we get the deal done. Same three criteria will apply. We'll just look at it and ask ourselves some more challenging questions, given the fact that we're deeper into the cycle now than maybe we were a year or two ago. It's not to say we don't believe that the cycle has longer to run. We do believe it has longer to run. But we want to make sure that we're thinking carefully as we look at larger scale acquisitions. Maybe I'll stop there. Anything to add? No, I think Bill said it well. Obviously the attractiveness of the specialty business is we've proven to do a really good job cross-selling to our existing customer base. The opportunity for us in the specialty business, whether it be adding to an existing business or adding new products to our portfolio, is that cross-sell opportunities really get you to pay down that multiple that you're buying it at a lot easier than you would with a large M&A in the gen rent space. On that note, Matt, I think you've had some success on the pump business and cross-selling that. Can you just update us on how much you've been able to cross-sell on a runway basis in the third quarter? Is there another leg higher into 2016? Sure. When we bought the pump business, we had stated two key facts. That our goal was to buy this and build out its infrastructure and its footprint so we could cross-sell to our whole network. The other key fact was not so positive, was that at the time it felt positive, 50% of their business was oil and gas. Well, you can imagine how much of that business has dropped in the last year, probably by 50%, rough numbers. They're only down 10% year over year. We're building out the cold start model for pump. We've done 18 specialty cold starts this year. I can't remember the exact number. I think eight or nine were pump. We're going to duplicate that effort in 2016. We would have liked a little bit more time to build out the pump infrastructure before 50% of their fleet was under-utilized. But the team's doing a great job to only be down 10% on a year-over-year basis in the third quarter when half of their business dropped by 50%. In terms of the pricing characteristic on industrial application for their product, is it similar? Is it as good as it was in oil and gas? No, there's not any products that go into the other markets that the actual rate is going to be as high as the oil and gas. But your cost to serve won't be as high either. So there'll be some rate change, and they've absorbed a lot of that already this year. But I think going forward, they'll be able to get some efficiencies of flow through on the incremental growth of their cold starts as they build more fleet in there, as well as taking some of the underutilized assets and putting them into their cold starts. And I think they'll get a better flow through even without maybe a large rate lift on a year-over-year basis. Bill, coming back to your prior point on taking a view on the cycle, can you touch on how you're thinking about stock buyback versus debt paydown beyond the current authorization? You've made it clear that you're going to execute the current authorization, but thinking about 2016, 2017, the big free cash flow from your business. So what's the direction that you're thinking of it? Sure. So by current authorization, I am taking you to mean the 750 that we had just a little tail left to finish in Q4. Then the billion-dollar authorization that we have authorization for following on to that. As we think about how we execute those things, what we are thinking about now is to maintain a pretty steady presence in the marketplace, buying back shares over the 18-month authorization that we called out for the new billion-dollar program. I think you can reasonably look for us to be in that $160 million, $170 million per quarter kind of timeframe in executing share repurchases going forward. That is assuming that our cash flow performance comes in comparable to what we have in mind as we sit here today. You see in our investor material, we have talked about next year's free cash flow being something north of $700 million. If we do that $700 million, then you can look for us to be pretty steady in that share repurchase program. If we do more than that $700 million for any reason, then I think the philosophy is, I do not think I know the philosophy is as we sit here today, the increment above that 700-plus will go to debt reduction. We will delever the balance sheet a little bit more rapidly than what we have in mind as we sit today. So that is how we are thinking about managing cash flow against the share repurchase. We are not going to be aggressively trying to respond to the share price. If it goes down, you are not going to see us do a $400 million or $500 million quarter. Similarly, if it goes up, you are not going to see us say, "Oh, we are not going to complete the billion-dollar program." Our view is to be pretty steady in executing that program, and that is how we are going to approach it. The other scenario, and obviously what you have in the deck is an illustrated target from a while ago, but if it is below the free cash flow that is illustrated in the deck, if free cash flow is lower than that, will you still look to have a proportionate allocation towards buyback? Is that the way to think about it? Yeah, I think that's probably a fair way to think about it right here and now. The reason that if free cash flow would be below what we've guided to, the only reasonable combination of events would take it down, is because we decided to spend more on fleet for some reason. The only reason we'd spend more on fleet is if the demand environment, and rate, and utilization characteristics of our business are much better than what we're thinking about right here and now. If that's the case, we'd say, "Okay. We think we've got a good cash flow opportunity over a longer period of time." It'd be okay to lever up a little bit to continue to execute on the share repurchase program at the same rate. That's the scenario on the lower cash flow side that I would imagine. On the higher cash flow side, it would be things are a little bit softer, or we decide that we're going to spend less on fleet. That's increasing our free cash flow. Rather than use it to buy more shares, we'll use it to pay down debt. As of the third quarter, as you rolled up all of the performance for each of your districts, you've been clear what the oil and gas areas have looked like. But what about on the stronger side? What have been some of the strongest areas in your footprint? Geographically, we designate our business units into 14 different operating regions, four specialty and 10 geographic. I would say, when you look at that, 9 of the 14 were positive on a year-over-year basis in Q3. When you look at the ones that were negative, it was Eastern Canada, Western Canada. We talked a lot about pump already. Then the South, who had to absorb, after Western Canada, the largest amount of upstream oil and gas detriment. Then I forget the other region, but it was only down a half a point on a year-over-year basis. So you're looking at two-thirds of our regions geographically had year-over-year growth, and there's a handful of them that had double-digit year-over-year growth. I think that points to that the non-res business was very strong for us, specifically on the coasts, where they didn't have any oil and gas exposure. Even when you look at the industrial region. So our industrial region's one of our regions in the Gulf Coast. They were up year-over-year in Q3. We talk a lot about upstream, but the downstream business has been very strong for them. The refining business, the chemical business has been very strong for them. Believe it or not, the Houston Metro. When you talk about contagion, the Houston Metro market, which is our commercial business, has had great year-over-year growth. So there's a lot of strong pockets around our network, and that's been able to help us offset some of the oil and gas challenges. As you look at, I guess, based on what you're saying, out of the individual districts, is there any difference in your CapEx profile that we should be thinking about 2016 versus 2015 in terms of where you see pockets of opportunity? It sounds like pumps here are probably well supplied for at least a few more cold starts. Where are you actually increasing weightings? We'll continue. Our focus on growing our specialty business has not waned. Trench has brought great returns. Our HVAC and our tools business is steadily growing, and that's important because although it's not a huge business on its own, it's a must-have for our customers, and it's kind of the thin edge of the wedge for us to get into some new clients. That tools is hard to get. There's not a huge tool inventory in the rental space right now. A lot of that's self-performance. So we'll continue to focus there, and then it'll be who's absorbing the fleet at the appropriate level of return. It'll be an earn as you go type of capital expenditure this year when you talk about our general rental network, and that's really not too much different than what we've looked at the last couple of years, with the only change of we probably will tighten the rigors on betting on a third quarter ramp up in Q2. I would say that's one of the bigger differences. If you ask me where to guess, I would say the coast. The Southeast has been strong. The Mid-Atlantic has been strong. California's a great opportunity with good end markets for us. To switch gears from a technology standpoint, you folks have been really focused on building out the telematics across your high value-added products. Can you talk about, as you've done that, what that's enabled you to do, and do you envision at some point in the near future where you could have more automated rental processes as opposed to reaching out to the branch, and how far away are we from getting to that point? So far, we're still in the process of implementing the telematics across our fleet. We've got 110 or so thousand units that we've put telematics equipment on, and that's a good start, but it's only partway to fully implementing across the fleet. There's not a lot that we would say that we're getting out of it just yet. We've rolled out some applications that allow our customers to find the equipment on their job sites. That'll be a benefit to them and to us. But we're thinking right now actively about what are the other services or enhancements to service that telematics equipment will allow. Part of the information we get off the equipment, for example, is fuel state. How much fuel is in the tank, as a general statement. Is there a service that we could offer out that just alerts the customers when it's got low fuel? Or can we take it further and say, "You know what? As an additional service, we would provide you fueling." And we've started some experiments around offering fueling as an opportunity in the marketplace that could be enabled by the telematics. We're just starting to think very actively about where the revenue opportunities and the customer entanglement opportunities are from telematics. And we'll talk more about those as we better define them. What about the opportunity to automate the order process? Is that in the works? Yeah. We're spending a lot of time thinking about that, thinking about our presence online, to help our customers make it more efficient and easy for them to actually interact with us online. And how all of that flows through our entire rental process. So in order to be able to offer out a good rental experience online, you have to have reliable availability information. You can't say to the customer, "Enter your desired equipment," and, "Oh, now you've got to call the branch to find out if it's available." It needs to be automated the same way it is when you go onto Amazon to order something. So we're thinking very carefully about the process improvements, along with the technology that needs to be in place in order to give that customer a more robust online experience. And we're thinking about that in lots of places in our business as a way to really enhance our relationship with the customer for the short term and the long term as well. So again, more to come on those areas as we better define them. Well, let me pause to see if there are any questions. Yes, Aaron. Any comments on October? Thank you. October, we always know we are going to get that question. October came in as in line with the guidance that we gave. That is the line that we agreed to stick to here. Yeah. We actually have not even done our business reviews yet for October, but when you look at the metrics that we have laid out, there is nothing in October that would make us change. Yes. Just curious, you can update on the amount of fleet that you are moving around this year, where that stands, and whether it is already done, whether the number had changed. I think $200 million was the original. You're specifically speaking of the oil and gas. It was oil and gas. Yes. I don't know whether maybe Canada made that number bigger because it's been tender. As we reported at the end of Q3, we had moved $170 million out of the oil and gas. There's about another $30 million-$35 million remaining, which gets you to that 200 number. That's in seasonal items. Whether it's light towers or heat, we made a decision not to move those until the demand is there in the other end markets, and come January, we'll know how much of that 30, if any of it, was extra capacity, and we'll deal with it appropriately. This is all maintaining that hour. Forget about the oil and gas end market and the drilling, but that other level of OEC on rent, and you saw that in our investor deck. It's been pretty flat throughout Q3. This is all assuming that that maintains at a flat. We're not assuming any large uptick or any downturn in that relative fleet. If it does, then we'll react to that appropriately. In regard to your comments on expanding capacity if the conditions are favorable for that, are there leading indicators that you generally huddle around and look at and say, as opposed to demand showing up, to say, "We think we're going to need to expand our capacity. Well, we spend a lot of time asking our customers what their expectations are in the near term. We do a monthly customer survey and just ask, "Over the next 12 months, do you think things are going to be better, worse, or about the same as they have been recently?" We've published that historically. The answer comes back 90-plus percent at least as good as this year is the expectation for next year. So we take that as one data point. We recognize that sometimes customers may not see changes in their market as rapidly as others might see. So it is only one data point. We pay close attention to the various forecasts from various economic outfits, whether it's Dodge starts and put-in-place data, or Global Insight does some work for the American Rental Association focused on our industry. Or it's just every investment bank known to man and their forecast for where GDP is going. So we try to look at those as leading indicators. Then we monitor a variety of other inputs. Whether it's commodity pricing and how that's going to feed through, whether it's energy pricing in particular, and how that's going to impact the demand for construction overall. And things as obscure as freight tonnage and gasoline consumption. You try to look everywhere you can, but we also are not so naive that we think that we can tell the future with any greater accuracy than most. So we spend a lot of time saying, "Okay, what is our point of view? But beyond that, what if we got it wrong? And how might we respond if we got it wrong? Got it wrong to the upside, got it wrong to the downside. Then what are the plans that we need to have in place to be able to respond if we got it wrong? I think that is at least as valuable as trying to peg the exact right forecast. So that's a discipline that we try to do in everything that we think about. I was just wondering if you could comment on any change in behavior from the smaller rental outfits, in terms especially whether or not the equipment guys are offering discounts to them, and if that's changing their CapEx behavior at all, or if you're noticing anything in the field. So any information we get would be anecdotal. I'll just talk about some of the real data that we have. If you look at the Rouse report that just came out this week, you'll see that both the small and mid-tier players have all raised their capital expenditures this year, until September. September was the first time in the past year where year-to-year additions to fleet are actually down. It was down almost 50%, if I remember the chart correctly. Yeah. So that's good news for us. That means that people are responding to what they see as far as the time utilization gap on a year-over-year basis in the industry. So that's encouraging. When you look at the recent backlogs that were reported by some of the OEMs, it tells you that people are starting to realize, okay, we got to absorb what we put on our plate here before we go and spend more money. I think you'll see that play through. Our belief is that we'll see that play through the first half of 2016 as well. Then we'll go from there, and it'll have a lot to do about where the utilizations are, where the returns are, and where the demand is. And if we could just circle up to the October discussion. In your guidance, you've got a number of different metrics, EBITDA, pricing utilization. So your comment that October was in line with plan, was it across the board or was that a comment on EBITDA? Can you just clarify? Yeah. Across the board. We're reaffirming the guidance that we gave in our earnings call. So, no change in any of the elements. Okay. In terms of the cost structure, you've been able to deliver pretty good margins over the past couple of quarters, even with softer pricing. Can you talk about how you're managing labor inflation? What are the offsets? Diesel's a tailwind, but can you step us through what levers you have to pull to control the cost structure from here? So, as we think forward, we're going to be looking at really all lines of cost and where the opportunities are. Maybe I'll start with SG&A. In those lines, we think that we've got opportunities in the usual suspects, right? Professional fees, travel and entertainment expense. Maybe a little bit of an opportunity in bad debt expense. We'll have to see if we can play that out. And wherever else we can. Facilities, corporate facilities, just thinking about what are the opportunities in amongst all of those. Wages will. I don't know that I'd say that in the SG&A lines there's going to be a huge focus on driving down wages through headcount actions, but that's certainly something that we'll keep in mind as well. As we look into the cost of rents lines, again, the opportunities are in a number of different areas that we're chasing after. We talked for a long time about our lean management initiatives. Taking even broader advantage of those initiatives is something that we're going to be very focused on in 2016. So, looking at our processes and asking, "How can we do them better? How can we do them better across an ever-growing share of our business?" That's going to be an important initiative in 2016. Also thinking more carefully about how do we use the capacity that our lean initiatives opens up for us, right? Do we use it to support additional growth, or do we use it as a way to take some additional cost out, right? That's one of the key decisions that we'll have to make as we go through the year. As you go through the line items of our cost of rent, we'll be looking everywhere for opportunity. Lastly, we've been hearing from some of the construction materials companies that for folks like home builders and other operators, they're seeing a labor shortage, which is really impacting the pace of construction activity. Are you hearing that at all from your customers? To what extent is that impacting the pace of the recovery? Well, I think it's existing in quality labor, right? That's really been the challenge in the construction industry for a while, whether you're looking for new electricians or new steel erectors. It's an aging workforce that there's not really a great training mechanism for other than you going out and hiring new talent and training them yourself. So there's a productivity challenge that the industry faces there. We face it with techs. We're very focused on it. It's probably for our space, it's techs more than drivers. Drivers are a little easier to find. But we've got nine centers of excellence and a lot of training programs to home grow that because there's not this extra pool of talent that's just sitting somewhere else waiting. Whether it's through the military or just homegrown efforts, it's a big focus on ours, and it is for the construction industry overall. So there is a talent gap in the available labor. Are you hearing that it's impacting the pace of projects? I'm not necessarily hearing that it's impacting the pace of projects. I think it's impacting the productivity. So maybe people have to throw a few more bodies at it than they normally would have or historically would have because of some of the experience gap. Okay, great. Well, gentlemen, thank you so much for joining us. Please join me in thanking Matt, Bill, and Fred for coming out to our conference. Gentlemen, thank you. Great. Thanks. Thanks, Jerry. Thanks for having us. Thanks, all.