Ashtead Group Stock: Long-Term Growth Might Be Fully Priced (ASHTF)

I rate Ashtead Group (OTCPK:ASHTF)(OTCPK:ASHTY) as a hold, as even when the company has interesting drivers ahead that might support it to keep delivering growth in the next few years, most of those drivers might be priced in. Even when I rated the stock as hold, I could use the strategy of buying a few shares now and keep buying more if the stock goes down. There are interesting intangibles behind Ashtead’s growth strategy in the construction and infrastructure sectors that are worth mentioning, although it is a very intensive-capital business. In the last few years, Ashtead’s ambitious plans were reflected in its double-digit revenue growth, supported by the successful Sunbelt 3.0 strategy implemented in April 2021. Ashtead operates under the name Sunbelt Rentals.

The chart might support a bullish thesis, but I am not sure if the company will grow at the same rates as those shown in the last decade. However, I expect decent growth rates in the future while seeing how the company evolved from April 2012 to April 2023, increasing substantially its number of locations, which helps it to reinforce its cluster strategy that enables a faster and more efficient delivery of equipment needed by customers in many locations in North America. But there are more factors behind this company that will support its future growth despite its recent reduction of guidance for the full year 2024 in November 2023.

Later, I will compare Ashtead with its main competitor in North America, assessing different metrics that might help us decide which of them seems like a better bet for the long term. Finally, I will offer my intrinsic value, taking different assumptions, and given the cycle of the business, I assume a limited period of holding until 2026. This is my first article about Ashtead, but I’ve written about another excellent German company in the construction sector with a global footprint, Nemetschek, that I think is worth reading. Now, let’s dive into Ashtead.

Context

Results accumulated as of October 2023, Q2 2023-24, revenue growth was 16% YoY whereas operating profit grew at 12% YoY. EPS grew only 5% in the same period which was explained by the higher interest expenses paid by the company as it holds a relatively large debt, which is part of the nature of the business and which is something I will discuss later.

As of October 2023, free cash flow (FCF) was $-373 million compared to $139 million one year later which was driven by the higher purchases of plant, equipment and property in this period, specifically, a replacement of a significant portion of its fleet. In the Q1 2023 results, the company established guidances for each of the countries where it operates:

However, in November 2023, the company reduced that guidance as it expected that some of its businesses would experience a revenue slowdown, such as lower emergency response activity due to fewer naturally occurring events and a deceleration of the film and TV business driven by the recent actors’ and writers’ strikes.

In order to understand more about these results, it’s important to know more about Ashtead’s business model to understand its nature.

Business model

In simple words, what Ashtead does is very simple since the company purchases an asset, rents it to its customers through its platform, and generates an annual revenue stream for each year. Ashtead holds that asset for, typically, an average of 7 years. Now, the amount of money spent on each of those assets is relatively high compared to the revenue stream of the first year, so that’s why the FCF has been a bit volatile over the years.

In the chart above, it’s shown that in the years 2012-2016, the company delivered negative FCF despite its annual revenue growth in those years of more than 20%. The high requirements of capex can make the FCF negative some years; as such, Ashtead is very intensive in CAPEX, so this is an important variable that we need to follow up on in this company. I think that as the company keeps expanding its operations, it might be more efficient in its CAPEX management, reducing the possibility of generating negative FCF. This is related to the company’s strategy, which I will explain later.

In the table above, it can be noticed that rental revenue is the most important source of revenues, representing around 90% of the total revenues. As I mentioned previously, Ashtead buys these equipments and then rents them to its customers; once those equipments need to be replaced, the company sells these used rental equipments to the secondary market, being another source of revenues. The sale of consumables and merchandise is another source of revenues, but it’s not significant, with a participation of around 3% of total revenues.

In the same table, I notice that the US is by far Ashtead’s most important market, representing 85% of total revenues in the first six months of 2023. Not only that, the US is the most profitable market, with a segment profit of 33% in the same period, whereas Canada and the UK generated segment profits of 20% and 10%, respectively.

Ashtead offers its services in different sectors, such as the construction sector, where the company provides support in the construction of airports, highways, and bridges, data centers, schools, manufacturing plants, green energy, etc. In the response sector, Ashtead provides support in mitigating fires, hurricanes, residential emergencies, alternative care facilities, etc.

Ashtead also offers facility maintenance to schools and universities, shopping centers, office complexes, etc. Finally, Ashtead is exposed to entertainment and special events, offering support for national events, concerts, films, TV productions, etc. The company is really well-diversified through different economic sectors, which contributes to its resilience.

As you can imagine, despite being a company from the UK, the analyst’s focus should be on the US market, which is the source of most of the company’s growth and profitability.

In the chart above, it is noticed that Ashtead’s market share, under Sunbelt’s name, has grown from 4% in 2010 to 13% in 2023, being the second biggest after United Rentals (URI). Most of this expansion of these two big players in the industry comes from acquiring small local independent companies and setting up new stores in different locations.

Now, I’ve explained that this is a very capital-intensive industry, so the size is very important to dilute the fixed costs to offer more competitive prices and a wider range of services; for instance, Ashtead buys its rental fleet from one or two suppliers while limiting the number of model types of each product. Thus, Ashtead gets important discounts from a few suppliers for more standardized fleet purchases. Smaller competitors would be unable to get these discounts, given their smaller demand.

In this sense, the biggest players have all the advantages compared to the smaller players, as the latter cannot offer a wider range of services at lower prices. On the other hand, there is an underlying strategy behind this success of gaining more market share that makes the company confident enough to reach a future market share target of 22% in the US market: the cluster strategy.

Cluster strategy and Sunbelt 3.0

The easy way to explain the cluster strategy is to imagine different geographic markets; in each of these territories, Ashtead sets up stores. The number of stores in each territory could range from 2 to more than 15, depending on the market’s size.

For example, one customer located in a certain territory in the US or Canada is demanding more than one service that involves different equipment or fleet for a specific purpose, so one store located in that territory could deliver a specific type of fleet and another store located in the same cluster could deliver another type of equipment as part of the customer’s requirements. So the customer is served faster as Ashtead has closer stores to the customer’s locations while responding efficiently to the customer’s requirements.

There are several benefits of the cluster approach that help Ashtead reduce its costs, such as sharing spare parts between stores in the same cluster, which helps minimize the risk of overstocking. All these stores that are grouped in the same territory enable frequent use of the assets for rent, avoiding the idling time of those assets. Also, this strategy helps Ashtead cross-sell between construction and non-construction businesses. Construction activities represent 40% of Ashtead’s total revenues in the US, while non-construction accounts for the remaining 60%. Residential construction is just a small portion of the entire construction segment, as this sector is not a heavy user of equipment.

Ashtead has significantly reduced its dependence in the construction area to reduce the cycle associated with the sector while widening its product offering and customer base, reinforcing its business model in the non-construction sector, such as the “specialty area,” which represents around 30% of Ashtead’s US business and 65% in the UK business. In this sense, Ashtead is developing specialty areas such as power and heating, ventilation and air conditioning (HVAC), climate control and air quality, scaffold services, flooring solutions, etc.

Sunbelt 3.0 is the strategy that Ashtead started in April 2021 for 3 years, seeking sustainable and profitable growth. Before Sunbelt 3.0, Ashtead established a very successful strategy in 2016, named Project 2021, achieving a total revenue growth of 75% from 2016 to 2021.

Under the strategy of Sunbelt 3.0, Ashtead planned to open more than 298 new stores to add to its already established 936 stores as of April 2021 in order to have 1,234 stores in April 2024. As of April 2023, the company has already added 1,213 new locations in North America, which means that, most likely, the company might surpass its goal of 1,234 in April 2024. In the chart above, it’s clear how Ashtead is working to expand its operations to deliver long-term growth, taking advantage of the cluster approach.

In the UK, the strategy is different, taking into account its smaller geography, implementing a few larger locations combined with smaller local locations, which is not so different from the cluster approach to be adapted to the UK’s customer base.

Megaprojects: Another source of long-term growth

Megaprojects are becoming more important in the last few years, and, according to Ashtead, these projects could be named megaprojects when their value is higher than $400 million. These kinds of projects include data centers, healthcare facilities, airports, liquid natural gas plants, semiconductor facilities, electric vehicle and battery plants, solar and wind farms, etc.

Ashtead is taking advantage of megaprojects, as it has an overall market share of roughly 30% in these projects. CEO Brendan Horgar said in the last call for Q2 2023:

I think – well, first of all, those projects that were in the early phases of today, we would expect that peak or crest, as I referred to it to last quite some time. So you’re going to see that in FY ’25 and FY ’26 because really the crest of these projects is about a 2-year time frame in many cases. And I think it’s worth highlighting to a degree just the state of those 499 projects that we talked about.

Just to put it in perspective, I think what’s important is how early we really believe we are in this landscape of megaprojects. So of the 499 that we would have pointed out, actually, only 336 of those are underway. So they are in start or construct as Dodge would calibrate. Of course, we track every single one of these. So that leaves the balance of 163 that are in some form of prestart.

This indicates that Ashtead has important long-term drivers not only from its cluster approach and expansion but also from these 499 megaprojects, of which 366 are at their early stages and could reach their crest in 2025 and 2026, and the remaining 163 would reach that crest beyond 2026.

It should be noticed that these projects require an important scale, experience, wide solutions and products, and an important financial capacity. I think that this relatively new trend in the industry might contribute to strengthening this process of consolidation and strengthening the position of companies like Ashtead.

It’s worth noting that there are three US laws that favor these kinds of projects: i) The Infrastructure Investment and Jobs Act, with $1.2T in investments in different infrastructures; ii) The Chips and Science Act, which involves $ 250 billion for these purposes; and iii) the Inflation Reduction Act, which will provide $ 370 billion to support solar field construction, battery factories, wind farms, electric vehicle production, etc.

Ashtead compared to its main competitor

United Rentals is Ashtead’s main competitor in North America, and it is taking advantage of its position to deliver double-digit revenue growth in the last few years, but I would like to see how its performance in the last five years has been to compare it with Ashtead.

The metrics shown in the table above include the last 4Q 2023 results from United Rentals that were recently released and boosted the stock price by more than 12% in one day. Looking at these metrics, Ashtead has earned better returns on capital (ROIC) and almost a similar ROE with that of United Rentals, but even when I like more ROIC than ROE as the latter does not take into account how high the debt levels in a company are, I needed to use other metrics that indicate how efficient each of these companies was to get more FCF by investing $1.

In this sense, I built a ratio by adding the sum of the CAPEX from the last 5 years in the denominator and the sum of the FCF from the last 5 years in the numerator; the goal is to know how much FCF is earned by $1 invested in CAPEX. In this sense, Ashtead earned 44 cents per $1 spent in CAPEX on average in the last 5 years, whereas United Rentals only earned 28 cents per $1 spent in the same period.

Ashtead is showing better FCF margins combined with better revenue growth on average in the last 5 years and more efficient and profitable capital management than United Rentals. Something that I do not like is how Ashtead’s management uses the ratio of total debt to EBITDA to gauge the financial leverage, which is something that might mislead investors since EBITDA is not a good metric, particularly for a company that is very intensive in capital requirements.

Indeed, I prefer to use the FCF over the EBITDA to have the ratio Debt/FCF, since the EBITDA does not take into account the CAPEX requirements that are needed by the company to continue its operations. So, it’s expected that players in this industry show high debt/FCF, but looking at the table above, Ashtead shows way lower debt levels than United Rental’s.

Furthermore, Ashtead has a ratio of repurchases/FCF (55%) lower than that of United Rentals (93%), which has a correlation with the debt levels of each company. This seems unrelated, but a lower allocation of repurchases or share buybacks enables the company to have more money available to reinvest in its own business; if the company does not have enough money for reinvestments, it needs more debt, and that’s United Rental’s case with higher capital allocation in buybacks and higher debt levels than Ashtead.

In United Rental’s case, I’ve seen that in most of the last 5 years, the company was allocating more money for buybacks than what it was generating in FCF, which does not surprise me to see higher debt levels than Ashtead. However, United Rentals stock has appreciated more than 700% in the last decade, whereas Ashtead stock has appreciated around 400% in the same period; there could be several explanations for that difference.

It’s possible that United Rentals is a more well-known stock among institutional investors or that the company is the leader in the US with 17% and Canada with 22%, whereas Ashtead has 13% and 9%, respectively. In any case, both companies will take advantage of the consolidation process in the industry, as both are the most important players.

However, looking at the metrics in the table above, I like Ashtead more; therefore, my portfolio would be more exposed to Ashtead stock than United Rentals stock, given its higher ROIC, higher FCF generated by $1 of CAPEX, lower debt levels, higher growth, and higher FCF margins.

Valuation

The different multiple valuations do not give a clear picture of how attractive Ashtead’s stock price is now.

I propose another method to find the intrinsic value:

Assumptions

• Outstanding shares: 441,682,600 (as of October 2023)
• FCF Margins: 12.8% (average of the last 7 years)
• I assume that Ashtead stock is held until 2026.
• Revenue growth for 2024: according to management’s guidance
• Revenue growth for 2025 and 2026: according to consensus
• P/FCF 2030: 24x (average of the last 6 years)
• Discounted rate: 9%

Based on my assumptions, I make a projection of revenue growth of 11% for 2024, 9% for 2025, and finally 9% for 2026. So, I take the revenues projected for 2026, and then I multiply those revenues by the FCF margins of 12.8% that are part of my assumptions. Then, as a result, I get an approximate FCF of $1,631 million for 2026.

Now, I take that FCF of $1,631 million and divide it by the outstanding number of shares of 441,682,600 to get a FCF per share for 2026, getting 3.69. In this sense, I take the FCF per share of 3.69 and multiply it by 24, which is Ashtead’s average P/FCF of the last 6 years. Then, I get a target price of $88.7 per share in 2026, so I calculate the present value to bring it back to 2024.

Thus, finding the intrinsic value:

Intrinsic value = 88.7/(1+discounted rate)^3

Finally, I get an approximate intrinsic value of $68.47 per share, and the current stock price is $67.68 per share, so there is not enough margin of safety to buy strongly. However, as I said at the beginning of this article, I would buy at the current stock price some shares while being prepared to buy gradually more in case the stock price goes down.

You should take into account that my intrinsic value is conservative and might help you build up a margin of safety since an intrinsic value of $68.47 is considering relatively lower revenue growth for the next 3 years than the growth shown by the company in the last years. I will follow up on the stock to see how the company behaves in the next quarters in order to be able to anticipate higher revenue growth than those of my assumptions, which would boost the intrinsic value.

One reference was the recently released Q4 2023 results of United Rentals, whose revenues grew 23% and net income grew 15% for the full year 2023, so the market reacted very positively, boosting the stock by more than 12% in one day. However, the guidance for 2024 is a revenue growth of 4%, so that’s why I need to be very conservative in the Ashtead’s intrinsic value.

Risks and final thoughts

The cyclicality of the business could impact the utilization levels in certain periods of time, with the consequence of poor FCF given the high capital requirements. However, given my long-term horizon, I like the business to be held for several years, and in the worst scenarios, I would add more shares as the business has diversified its growth avenues through different sectors, as we’ve seen in the article, which reinforces its resiliency.

Another risk might be the change in the US administration, which could halt some of the megaprojects that are part of Ashtead’s long-term drivers of growth. Nevertheless, the majority of those projects require private funding in a wide range of sectors, such as semiconductors, LNG, airports, ethane, rail, refineries, data centers, etc. So, the diversification of those projects and Ashtead’s ability to adapt itself to different scenarios would mitigate that risk.

Finally, another risk that we should be aware of is the high debt associated with Ashtead’s industry. We’ve seen that United Rental has the same problem, though its debt levels are way higher than Ashtead’s. Anyway, I do not like a company with high debt levels, but I would not be worried about Ashtead as the company has a serious strategy to keep delivering strong long-term growth and great management that is able to take advantage of the different opportunities to have a good level of asset utilization and hold under control the debt levels.

I like companies like Ashtead with good management and a solid long-term strategy that have proved their resiliency in COVID-19, delivering double-digit revenue growth in those years. I put a “hold” because I like to be conservative with the price I pay for a high-quality stock, and Ashtead surged 6% recently because of United Rental’s results. However, even when I put a hold rating, I would buy some shares at the current price while following up on the stock to increase my position more strongly as the stock price falls from my intrinsic value of $68 per share.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.