Citi North American Credit Conference

Nov 5, 2013

Slides

I am Manish Somaiya. I cover industrials, autos, and services on the high-yield side for Citi. Obviously, a distinct pleasure to have Michael Kneeland seated right next to me, CEO of United Rentals, and to my left, we have Bill Plummer. Also in the audience, we have Fred Bratman, who is always so helpful with any questions. I do want to make a quick announcement. Michael has a plane to catch in about 10, 15 minutes, so he will be leaving, but Bill will be staying. And of course, we have Fred, and I guess to a certain degree, we also have Gary McConnell in the back to the extent we have specific industry questions. United Rentals. I cannot help you. Well, just on the industry, Gary. Why do I just kick it off? I guess, Michael, the first question would be, why do you think the non-res recovery has taken so long to turn? And I guess, what do you see going ahead? Sure. It has taken some time for non-res construction to start to show what I consider a meaningful recovery, the early signs of recovery. If you take a look at all of the recoveries, at least in my 35 years, almost all of them were followed after residential construction started to show some positive trends. There is a direct correlation between non-res and residential. If you go all the way back, you will see that there is probably anywhere between 12 to 18 months. If you take a look at the ABI index, the ABI index since 2009, each year has gotten better. I think this year to date, we have only had one negative month below 50. I think all trends are pointing towards a recovery. That being said, we do not expect it to be a hockey stick. We think it'll be a gradual recovery overall, and it'll be broad-based across North America with some pockets obviously busier than others. Why has it taken so long? I think that we went through a very deep recession. There was a major disruption to the capital structure, and it's taken that long for us to heal. Most of the recovery that we have seen to date financially, to me, has been engineered by the Fed overall to try to stabilize and provide that opportunity for growth. Michael, I'm going to ask you all the questions and leave others for later for Bill. You've talked about ROIC target of 10%. Is that through a cycle? Is that at the peak? What are the key drivers of getting there? Well, I think the key drivers for us is going to be a combination of both efficiencies as well as rate improvement and overall, plus how we deploy our capital going forward. 10% is our immediate goal. Ultimately, I'd like to be able to achieve an ROIC, on average, through a cycle. That would be the one that I would say is the most pressing for me. Keep in mind that there will probably be some years or a year in a recession where we fall below that. But on average, when you blend it through a cycle, we should be above our cost of capital. I guess in terms of the marquee transaction with RSC, it's been 15, 16 months since the close. How has the competitive landscape changed? What observations can you make? Then specifically, what have you learned as a company? Well, we've learned an awful lot. RSC was a great transaction, a combination of two good companies, and the best of both worlds is easy to be said, hard to implement. I think that took a lot of rigor in order to make sure that we honored that statement, and I think we've done a very good job in doing that. As far as the competitors, the way I look at it is I think that we get better every time we go through. As the industry is maturing, we get better at it. We have better resources, better tools. We have now metrics. You mentioned Gary. Gary has a set of metrics that he measures, and it provides that information to operators on how we can become better to improve our cost of capital. I think on top of that, the ARA metrics, so that we can all be measured on an even playing field, makes sense from a standpoint that one and one is equaling to two. It may sound simple, but in a lot of industries, and I've learned this through ARA, even the ag industry has standards around what a Grade A egg is. For us, I think the rental industry has evolved over time and will continue to evolve. But I think our competitors are good stewards, getting better. All of us are. We're all striving to implement our own strategies. I guess there's a lot of talk about consolidation. Maybe if you can touch on acquisition opportunities that you see on the general rental side, on the specialty side, and then just kind of more broadly as you kind of think about international growth at some point in the future. Where does all this kind of stack up, and where do you see the opportunities? Sure. Well, I think there's a lot of opportunities right here in North America. I mean, this is still the largest market. I think when I had my third quarter call, I mentioned that I was in China. To be clear, I was only in China because at the request of Fred to speak on behalf of the industry in China, which is just starting, and it was an international presentation. To be clear, we have no intention of going to China, so you can rest assured of that. At this conjuncture, there's a lot of other things on our plate. We're inquisitive. We look at things, and we pass on things. It's not a question of growth or just size. We are large. We can provide our own internal growth. We're looking at ways in which we can enhance our returns. One way we do that, and we've been very vocal about it, is through our adjacencies, our specialty business, the power, the HVAC, the tools. Leveraging our customer footprint that we have with the acquisition to our RSC. A lot of other customers re-rent. We have visibility through some of the programs that we have with Total Control. So we have an understanding of what customers are looking for, and we can do the analysis to say, "Is it viable? Can we utilize this? And can we, in some way, enhance our returns and our value proposition to our customers?" We're very aggressive. If you take a look at our growth capital that we deployed this past year, a large portion of that growth capital was dedicated towards that specialty side of the business. We had 18 cold starts this year. Those are the areas that we've been focusing on. We're not afraid of looking at acquisitions. We think acquisitions will be part of our game plan. But they have to be, each one, judged on its own merits. Strategically, does it fit? Is it accretive? And culturally, does it play well with us and, more importantly, with our customers? Michael, we shouldn't read too much into the share buyback and the potential for perhaps scaling back on M&A aspirations because we have been getting some questions around that. What does the share buyback mean? Does it mean that the URI story is kind of more organic in nature and self-sufficient? I guess basically what I'm understanding is that that's two different things. Yes. I would say, and please, Bill, chime in. I would say that the share repurchase had more to speak about our capital allocation strategy. I had to point out that we are a different company. We wanted to make sure that we were speaking to, and our job is to all stakeholders. That includes debt. That includes the growth. That includes the non-growth side, the long-only. So we wanted to make sure that we were looking at all of our stakeholders. When we look at what our capacity is as a company and our capital structure that Bill and team have put in place, we could do a lot of different things. This is not just to say one size fits all. We can do acquisitions. We can provide organic growth, and, oh, by the way, we can also do a share repurchase, and still be within our realm of between 2.5 and 3.5 times our debt-to-EBITDA ratios that we put in place. I think on balance, we've got a pretty good story, and we have a lot of options in front of us. Just not to put too fine a point on it, but I think it's fair to say that our view of acquisitions have not changed from what they were before we announced the share repurchase. Acquisitions still represent a way to enhance our strategy and enhance the returns of our business if we find the right acquisition. If we find that right acquisition, we're not afraid to go ahead and do it. RSC, I think, was a great model for how we think about finding the right acquisition and then diving in, and managing the company to a better place, after you've gotten it done. We still have that same point of view, even though we've announced the share repurchase program. I think one of the things that we don't really talk enough about is Cat Rentals. Obviously, it's a big part of the rental industry. Maybe it's a bit camouflaged with being part of a bigger equipment company. What are their long-term intentions? How do you guys think about Cat and the competitive nature of that model? Yeah. I look at Cat, great name, great brand, outstanding dealer network. I think that everyone's got their core competency. I think for them, they are very strong in the earthmoving side. They have that capacity. They have the know-how. They have the distribution network. They have the support mechanism in place to be able to do that and do that very well. I know that a lot of their dealers are independently owned, and I think a lot of that choice is driven by those independents. We run into some independents that are very active and very strong in some markets. In others, they have a different strategy. But I think Cat is a great name, and they have a great product. Did you have a question? I'm sorry. Speaking of M&A, didn't the company recently say that they first put their equipment on Oh, I think the- Have you had conversations with them, or are you just sort of putting that out there in the public domain? Well, we haven't put anything out in the public domain about that. We would not talk about potential acquisitions. I would only say that if, in fact, it were to ever come to market, we would be inquisitive. We would look at it, but it would still have to fall within the merits that we've talked about, which is it has to be strategic. There's some things we know, and some things we don't know. It would have to be accretive. How would it be structured? And what kind of synergies we could resolve from that. But to me, it's not just about synergies, it's about what you can do with the enterprise after the fact. And then the other one would be is it cultural? Make sure that culturally it would fit. So, that's how we would look at it. But beyond that, nothing is occurring. You just talked about potential synergies of any sort of acquisition that you would do? I'm sorry. Can you repeat that? Synergy, like, realizing acquisition. Maybe we can do it by referring to the RSC synergies that we have talked about, right? We said with RSC, our latest statement is that we are going to realize cost synergies in that $230 million-$250 million a year range, and those synergies will come out of consolidating branches, out of operating efficiencies that we realize, out of headcount reductions that we realize, and so forth. Those are the areas that we would look for synergies in any acquisition opportunity. The size of them would just depend on how much we could take out of the combined United Rentals plus the acquired company. In RSC, we also said that we expect revenue synergies that will come out of cross-selling our fleet into the customer base of the acquired company. That would come out of just leveraging our improved position with key customers out of the acquired company, or the combination of the position between legacy United Rentals and the acquired company. That would come out of any other opportunity to enhance our growth as a combined company. In the case of RSC, we said we expected a run rate impact at EBITDA of about $50 million-$70 million by the end of 2015, did we say? Those are the areas that it is pretty generic, right? Any company you would look for opportunities in, and that is what we would look for in any acquisition that we do. For the smaller companies that we might acquire, you get a little bit less in the way of cost synergies, and you rely more on revenue synergies because you can enhance the growth by folding them into the marketing muscle of United Rentals. For a larger company, maybe the cost synergies are more of a driver like they were in the case of RSC. Does that help? No problem. Yeah, thanks. Yes, sir. What percent of the way there do you feel are the revenue synergies? In the RSC case, I think we are fairly far along. I am trying to remember what Matt said in the earnings call, just so I do not go any further than that. But I think we are fairly far along, but there are still revenue synergies to be realized. Certainly in the case of cross-selling. So in putting trench product into some of the legacy RSC customers who did not rent trench products, for example, or power HVAC displacing the re-rent transactions that they had done, I think we have done a really nice job in those areas. And there are some other areas of revenue synergy that we have made some progress on, but still want to continue to enhance the revenue synergy performance going forward. Yes, sir. Are you finished with all of your branch consolidations? Is there anything else left from a consolidation perspective on branch? Out of the consolidations? I think we've reached a point where there aren't any, and I always hate to say never, but there aren't any significant consolidations yet to be done as a result of the acquisition. We will always continue to look, and as we go forward, maybe there's a one or a two here that we say, "We should have taken this out back in sort of the summer of 2012." But I think we've got the vast majority of them done. Michael, a question for you. National accounts, I think are just over 40% of revenues. Where do you think they get to? I guess when you compare the profit margin differences between national accounts and general rentals or specialty, how does that stack up? Well, we're not chasing a specific percentage. We're going through and looking at all of our customers to see what the return metrics are. Not everyone's painting with the same paintbrush. So we want to make sure that we're getting our market share with our top performers. There's similar characteristics between national accounts and some of even our smaller regional accounts. So I think it's very hard to pinpoint that. The one thing I will say is the trench to power the HVAC, as Bill mentioned, is a lot of the cross-selling is with the industrial accounts, which happens to be in some of the larger national accounts that we have incorporated through RSC. That business You can see it in the dollar utilizations, and you can see it in the reported numbers that we put out there. One is growing strong double digits, and two, the return metrics are much higher than the general rental segment. So that is one of the things that attracts us towards those specialty businesses. When you think about 2014 and the Tier Four engine implementation, the higher cost of equipment, what is your confidence level in kind of getting the higher rates on the equipment? Just kind of generally speaking, as we go into 2014, what kind of a tailwind should we expect in terms of rental rates? Well, I think our rental rates tailwind should be somewhere between carry over of 2% to 2.5%, somewhere in that range. I do not know that we have pinpointed it. It will wait until we finish out the year. With regards to the Tier Four engines, we do not parse things out in that format or by age. We take a look at it, and we want to get a higher return for all of our assets. Areas where customers will ask specifically for a product, clearly we will see what we can do to make sure that, one, we can honor that commitment, and two, that we get the returns that are needed. When you look at our Tier Four engines, they are not coming in all in one fell swoop. They are coming in, they are phasing in over time. In some assets, for an example, a 120-foot boom or 135-foot boom, the engine is just a small component of the total asset. Whereas you take a generator, the engine is an enormous part of that asset. So you have to balance that in both ways. But Tier Four is here to stay, and we are trying to utilize that as a competitive advantage for a lot of our customers. I think if you look at most of the forecast for 2014, the estimates for non-res recovery are positive for a change. Although, I guess we've had false starts. When you think about CapEx, and I think you've kind of outlined $1.5 billion of CapEx, how do we kind of think about URI spending on growth, but at the same time, generating free cash flow? Yeah. What we've said, and we've been very specific, that over the next three years, we'll generate approximately $1.5 billion of free cash flow. We took up our growth capital. As I mentioned before, we're going to be enhancing and putting a larger proportion towards the specialty side of the business. We're going to be disciplined. Could we spend a lot more if the field had their way? Absolutely. Do we have the capacity? Absolutely. But that's not who we are. We are a different company. We are focused on driving returns. We are going to be, I consider our capital allocation is going to have a lot of rigor around it. That's the discipline that we're instilling in the company. So, we want to make sure that whatever we get, for every dollar we bring in, that we're getting our biggest bang for our buck. It's change management, and I think it's discipline that the industry needs. The easiest thing we can do is buy more equipment. I can put it out on rent. But I don't know that that's going to give us the biggest bang for our buck longer term. It's something the industry's always done. Einstein's theory of insanity, right? Is doing the same thing over and over again, expecting a different outcome. I think that Bill and Matt are firmly behind this, and we've dedicated ourselves on enhancing our returns. I guess when you talk about free cash flows, Bill, what are the key drivers of free cash flow over the next couple of years? I mean, obviously you have the cyclical recovery. Right. Are there different buckets in addition to that? I think Bill, maybe Michael talked about sort of additional synergies from cross-selling. Maybe is that something that you can kind of help us break down? Yeah. Certainly, the drivers will be the drivers that have been there in the recent past with the possible exception that we won't have the tailwind of the synergies coming in on a year-over-year basis. Michael's got to go, so. Thank you. Great seeing you. Thank you. Thanks, Mike. We'll see you tomorrow. Just as the recovery continues, we'll get some volume growth, we'll get some rate growth. Those are very important parts of the improvement in operating profitability and the cash from operations that come from that. Then that'll be enhanced by some of the improvements that we think we'll have in the cost structure of the business over the next couple of years, coming out of some initiatives that we're focusing on right now. Lean management techniques and how they might apply to our business as one example. Then there will be a real consideration of what's the right level of CapEx for the business. We certainly don't expect CapEx to go down. In fact, we think CapEx will be about the same level next year as it is this year, maybe a touch higher. So $1.6 billion this year $1.6 billion, $1.7 billion, in that area next year. But managing the CapEx prudently, not letting the growth in CapEx get completely out of hand, is one of the ways that we will help drop free cash flow to the bottom line as we go forward in the recovery that we expect over the next several years. Any questions from the audience? Tim? Yeah, Bill, maybe two parts. One is just on the growth in specialty, and how do you think about that as that becomes a bigger piece of the company overall? How does that factor into that return threshold, that 10% return on capital target? Then separately on the carryover that Michael talked about, the 2.5%. On its own, does the scaling Tier Four would give any kind of additional boost to that, or should you just link that into 10%? Yeah. Well, we certainly expect that Tier Four will be a pressure on the industry overall that will support higher pricing. It has to be. If it's not, then the industry is even less rational than maybe you used to think. We have the Tier Four pressure, but everybody has the Tier Four pressure, and therefore everybody has the incentive to recover that increased cost from their rental rates. We do think that Tier Four will be a support. How much of a support? Hard to say right here and now. But certainly, it should be a positive in realizing better rental rates. Just to be clear, the carryover that we have is just from what we've done so far. So as we've raised rates during the course of 2013, we have a higher starting point at the beginning of 2014. That's the carryover benefit. We wouldn't have to get any rate increase next year in order to realize that carryover. For the record, it's probably closer to 2% than 2.5% as we think about next year. Again, we wouldn't have to get any further rate increase, just maintain what we start the year with in order to realize that 2% kind of number. Then the pressure from Tier Four should just help that even more. On specialty and the growth thereof, we certainly look to ramp up our specialty operations aggressively. You've seen that in the last several quarters that they've been delivering growth well in excess of the average for the overall company, in the north of 20% area, and that's what we want to continue in the trench and power HVAC area, and to a lesser extent in our small tools rentals. We certainly see that as high return business, nice growth, nice margin. The only challenge is it's still fairly small. It's still a fairly small portion of our business. We want to grow it to something like 5%-10% of our overall revenue. But even then, it's still reasonably small, and so while it helps, it's not going to all of a sudden make us overnight that 10% average over the cycle return business that Michael talked about earlier. Bill, can you talk about EBITDA margins and what the potential for further growth there? Clearly, you had a very strong performance in 3Q, close to 50%. Is it possible to kind of see EBITDA margins above 50% on a sustained basis? What are the operational directives that are going on at the company to get you there? Absolutely. We certainly expect that we will continue to drive EBITDA margin expansion over the next couple, several years, assuming that we have a continued recovery. We do not need a dance on the tabletop type of recovery. We just need a steady, moderate recovery. With that as backdrop, we think we can continue to expand EBITDA margins. Using the midpoint of the ranges that we have given for revenues and EBITDA this year, that puts us at 46.2% this year at the midpoint. Can we go higher than that? Absolutely. How much higher? How high is up? It is a hard question to answer. I think as we look inside the business, some of the operational initiatives that we have that will support higher margin, I mentioned lean management techniques that we are starting to roll out across the business. We talked about 5S as one of the ways of organizing our maintenance shop. We are going to sponsor Kaizen events focused on improving turnaround times so that our drivers can do more pickup and deliveries, much in the way that airlines turn their airplanes around faster to keep them operating more. We are looking at improving processes around order accuracy, improving processes around order matching. Equipment that we may have in one location that is needed in another location. How do we marry up those needs more efficiently than we do today? All of those things we think we can improve and deliver cost improvements and/or productivity enhancements that will help continue to drive margin expansion. That is one area that we will be devoting a lot of time and energy to. We call it Operation United Two. Those of you who know the company know that Operation United was initiated back in 2008, 2009, where we reoriented the strategy of the company on key customer segments to help enhance our profitability. It worked. It worked very well. Operation United Two is an internally focused effort to help support that focus on those customer segments with operational excellence that will take cost down and improve productivity. That is a major focus for 2014 for us, and I think you will hear us talk about it more as we go forward. Beyond that, you have to remember the basics of our business. The basic mechanics of our business are large fixed cost base. If you can drive more revenue through that fixed cost base, you are going to expand margins. That is one of the reasons why we want to continue to grow our fleet. We want to do it prudently. We do not want to get out of control, but we want to continue to grow. If we are growing our fleet high single digits next year, and if we are doing it at slightly higher utilizations and at the rental rate realization that is in the neighborhood of what we are doing this year, all of those are going to drive margin expansion next year, and then we would use that as a base for continuing margin expansion in future years. Those are the things I would point to. Rate improvement, growing your fleet, Operation United Two focus on improving the profitability and improving the cost structure and the productivity of our business. All of those will keep margins expanding. And specifically on rates, what we have seen in the past in a non-res recovery is that rate inflection has been up high single digits. What is the possibility of seeing something like that as far as the rate improvement in a recovery? Certainly, you could see it. I will remind everyone that we had rental rates that were up last year quite robustly. Fred's out there. What was it, Fred? 7%, 6.9% I think it was last year. So that is pretty doggone good. By the way, that followed a year that was above 5% the year before that. So we have already seen some very robust rate improvements in the current recovery cycle. Now, you can argue the recovery really has not gotten going yet because non-res really has not joined the party. One could argue that there is another pop in rates coming when non-res really does get rolling. That could be the case, and if it is going to happen, we certainly will be leading the charge. But the key message that we have been communicating is we do not need that to happen in order for our business to continue to get better. We do not need 7% rate in order to be able to deliver margin expansion, improve returns, and higher profitability. If we get 3%, 4% kind of rate improvement, that is enough for our business, and we can get better. Then if it goes better than that, then it is all gravy. That is the way we are approaching the business. How far are we off from the peak pricing back in 2005, 2006? You said rates have improved the last two years. When you look back to 2005, 2006, the peak years Yeah how far off are we from that level at this point? I won't speak for the industry, but for us, we are right at about the peak that we saw. We saw a peak in the first quarter of 2007 as a company. And when you look at the weighted average of the business that we do today, we're right at about that peak again. Our daily and weekly rental rates are actually both above the peak. The monthlies aren't quite there yet, but they're closing in. And so we're back at about that peak level. We get this question all the time, and it's always interesting to me because when I hear the question, I respond to the question, but in the back of my head I'm thinking, why does the prior peak matter? What is it about the prior peak that fascinates people so much? All that matters in my mind, the only reason it matters is as a marker. But there is nothing that says that we can't go well beyond the prior peak. And in fact, I would argue we need to go well beyond the prior peak in order to overcome the cost pressures that we've been having since the early part of 2007. You mentioned Tier Four earlier. Tier Four is going to continue to drive rental rates higher. It has to. And so the prior peak, in my mind, doesn't mean an awful lot except as a conversation piece. I guess with about three minutes, I just wanted to see if anyone has any questions. Bob? On the topic of prior peaks, whether they matter or not. Clearly they matter to you. Where is your OEC with respect to the prior peak? Is there a level at which you say, "You know what? This thing's turning quickly, we've got too much? We are well beyond the prior peak. Even if you exclude the impact of the RSC acquisition, we are well beyond our prior peak. Your question was, is there something that would tell us we have got too much fleet and we need to defleet? Or just as you do your risk management, if we rapidly enter a period like we did in the Great Recession, is there a point where you say, "You know what? We cannot sell this fast enough. I do not know that there is a point that we say we cannot sell it fast enough. I think the way we would think about it, if we saw another recession, or another Great Recession in particular coming, first and foremost, we would say, "Whoa, let us dial back on the amount of new fleet that we buy." That is a huge lever for cash flow right there, right? That is $1.6 billion this year that we could cut back pretty significantly. And then we would say, "Okay, we were planning on spending 900 and change." Excuse me. "We were planning on selling 900 and change of original cost as used equipment this year. Well, maybe that number should be $1.3 billion, $1.4 billion." And then we ask the question, how can we get rid of that much? What are the channels that we would use in order to access that amount of demand for used equipment? We would make an assessment based on the market environment that we see at the time. If you go back to 2009, I am at risk of getting the numbers wrong here, but this was standalone United Rentals. We sold something like $650 million of original cost equipment in that environment. During that year, we sold it at a margin of only 3%. We did that because we judged that that was the right thing to do in that market environment. We were aggressive about selling, in other words. I think we would do that again if we saw another 2009 coming. We would be all hands on deck, making sure that we defleeted to the extent that we think is appropriate. I will ask you one more question. Sure. I am kind of curious about this one. Obviously, the company has had a lot of success, and typically, what you see is competitors trying to attract your best talent away from the company. Have you seen some of that? How do you sort of manage to keep the key employees intact and focused on the larger mission? Yeah. Certainly, they are looking for opportunities to take key people where they can. The way we have approached making sure that we keep our key people, and note that our turnover has been very low. In fact, our highest potential employees, the turnover has been very low. The way we do that, I think, is to position the company so that it has got a future that people can see, and they can believe in, and they can feel good about participating in driving that future. I think we have done that. It feels good to be on a winning team. It feels even better to be on a winning team that has the prospect of winning even more in the future. We will continue to position the company to be that story, right? To be a very attractive place to work. As long as we can do that, I think we are going to hang on to our people, and they are going to feel good about what they are doing. That just builds the potential to actually deliver. So knock on wood, things have gone well, and we will keep delivering, and by doing so, we will keep our people. Great. Well, thank you, Bill. Thank you. Thank you, Fred. Thank you, all.