Custom Truck One Source, Inc. (CTOS) Earnings Call Transcript & Summary

Good morning, everybody, and welcome to the Custom Truck One Source fireside chat this morning. With me, I have Brad Meader, CFO of Custom Truck One Source; and Ryan McMonagle, the COO; as well as Brian Perman, of Investor Relations. I want to hand it off to Brad.

Great. Thanks so much. This is Ryan McMonagle, I'm the President and COO of Custom Truck, and I just want to, [ Sean ], thank you for giving us the opportunity to talk about Custom Truck, and I'm here with Brad Meader as well. But I thought I'd take just a few minutes and talk about the business before we get into the fireside chat. I want to make sure that as we're talking about Custom Truck, there are really 4 things that we highlight. I think the first is the end markets that we serve. So we have been intentional in choosing the end markets that we serve, and we think they are very strong secular growth drivers and good demand in all 4 of the end markets we served. I'll spend a minute talking about those in more detail. The second thing I want to highlight is the one-stop shop, and we'll go into detail until what does it mean to be a one-stop shop. But for us, it means that we take care of the customer however they want to be taken care of. So whether we are renting equipment to them or we are selling equipment to them or we are providing parts and service for us, it's important to be able to capture the customer regardless of how they want to consume our equipment. The third thing I want to highlight is we are really proud of the merger that has occurred between Custom Truck One Source and Nesco. We think the legacy and the history of both companies is phenomenal, and we think that there have been real opportunities to grow and putting these 2 world-class companies together has been significant, and I'll talk a little bit more about the synergy opportunities that we realized to this point. And then the fourth thing I want to highlight is the organic growth opportunity. We see, as you can see in the chart on the right, we are now 35 locations coast to coast, and we see meaningful opportunity to continue to grow organically, and we'll talk a bit about it in the fireside chat, but we also think that there can be opportunities for inorganic growth or for M&A in the future as well. So we're proud today to talk to you about Custom Truck. And let's go to the next slide, and we'll talk about the end markets. There really are 4 end markets that we serve. The first and probably the most important to us is the utility end market or T&D, which for us combines both transmission and distribution. We are seeing very good tailwind for both of those end markets today on the transmission side as new projects continue to be released. We see a significant backlog of work on transmission. And on the distribution side of our business, we are seeing good tailwind as well. So we're seeing -- we'll talk a little bit about the supply chain and some of the implications there, but are feeling very good kind of about that end market. T&D today accounts for 58% of our revenue. And so it's an important part of our story. The second end market we talk about is telecom. With the rollout of 5G, we are seeing good growth in the Telecom sector. Telecom today is only about 3% of our revenue, but we see that segment growing both in terms of sales opportunity and rental demand as we think about 2022 and looking forward into the future. Rail for us today accounts for about 5% of our revenue. And Rail has been a good, steady performer for us. We're seeing good demand from class-1 railroads, as well as commuter lines and short line railroads as well. So we think that rail will continue to be a very solid performer for us. And then the fourth category that we talked about is more broadly infrastructure. Infrastructure today accounts for just over 20% of our revenue. And so we see really good tailwinds here. We see good tailwinds currently in terms of rental demand and sales demand for the equipment that we rent and sell into infrastructure, which, for us, broadly means refuse and some of roads and bridges, in particular. So we're seeing good demand today. And then if Congress passes an infrastructure bill, we see even more demand. So we feel very good about the end markets that we serve. And then I also think it's important to think about how large the addressable market is for us. So we say that there's about $30 billion addressable market, about $15 billion of that is sold equipment on an annual basis. And then between rental and parts and service, there's another approximately $15 billion of revenue on an annual basis. So sitting here today, we're under 5% in terms of overall market share, so we see significant room to grow overall market share. As you all know, rental is a very big part of what we do, and it certainly is the focus of how we execute the business today. And we think there are good tailwinds to continue to see rental penetration increase. Today, rental penetration is somewhere between 20% and 25% in the specialty product categories that we focus on, relative to more traditional, general rental or some more developed markets for rental penetration is well north of 50% in many of those markets. I think the most important reason that we see the universal rental fleet growing or rental penetration increasing is the fact that there continues to be significant outsourcing by utilities and power producers to contractors, right? So these contractors perform more and more of the work that has to be done in terms of new transmission and distribution projects. We believe that the need for rental equipment will continue to grow. So feel very good about the end markets that we serve, and then we see a significant opportunity to grow our share, both on the sales side of the business and on the rental side of the business, which really is driven by what we call the one-stop shop business model. And so I think it's important to understand, when we talk about one-stop shop, it means, again, that we take care of the customer however they want to be taken care of. So whether they're renting equipment, they're selling -- they're purchasing equipment, what we call new and new sales or they're looking for parts and service. I think being able to offer all of those ways to consume equipment to our customers is critical, and we think that's what makes the one-stop-shop model so special and drives the growth that we've been able to see what I want to make sure you understand is that the first, having integrated production capabilities is paramount to executing the one-stop-shop model. So that means that we're able to purchase our chassis, our bodies and the attachment that goes on the back of the truck independently and that we put those trucks together. So having that production capability really does make our model different. And I think there are 3 things that I would highlight that make it unique. So the first is that there's a real unit economic advantage. So we know that we have a 7.5% to 10% cost advantage when you're thinking about how we put those units together because we buy those units independently and then we put them together ourselves. And so as we're adding those assets to the rental fleet. There's a very real unit economic advantage that we are able to enjoy and appreciate. The second is that we are faster from a speed-to-market standpoint. Because we carry inventory that's available to be put into the rental fleet or to be sold, we're able to react to the market much more quickly. And so -- well, I'm sure we'll talk about that here shortly. But having that inventory on the ground, leveraging our floor plan facility to finance that inventory and then being able to quickly pivot to add assets to the rental fleet or to sell them, I think, makes our model very unique. And then the third thing I'd say is we're thinking about rental economics, in particular, is that we are able to command higher resale values on used assets and on assets coming out of the rent fleet because we have more than 100 salespeople on the ground who day-to-day are renting assets and selling assets. And so really, it is this one-stop-shop model that I think has allowed us to grow. It's predicated on having production capability, and then we see very real unit economics because of that. And I think it ties into how we talk about our segments and our business and we announced this on our Q2 earnings call, and we can certainly go into more detail about it. But there really are 3 segments that we are going to continue to focus on and talk about. The first is the rental fleet, Equipment Rental Solutions, ERS. That business is made up of both the rental revenue that happens on a daily, monthly and annual basis, but then also the sale of rental assets coming from the rental fleet. So that is an important part of our business, and we'll talk about the metrics there around utilization and OEC on rent and on rent yield. The second segment that we talk about is truck and equipment sales, TES. That is the sales business of both new and used non-rental equipment. And so we'll continue to report on both revenue and gross margin on that business, and we'll continue to report our backlog as it comes to TES. And then the third segment is what we're calling aftermarket parts and service or APS. And so this consists of the legacy CTOS parts and service business and the legacy Nesco PTA business that we'll now be reporting together to really understand some of the ancillary parts and service opportunities that come along with renting equipment and selling equipment. So with that, I will stop and I'll hand it back over to [ Sean ] to start the fireside chat.

Thank you, Ryan. I appreciate that high-level overview. So why don't we start with just kind of a review of the transaction. When we think about what really led to the merger of Custom Truck and Nesco. Can you talk a little bit about what was the relative attractiveness/advantage of sort of bringing these 2 businesses together? And what was the purchase price multiple and some of just the 6 sort of surrounding the transaction phase?

Yes. Let me do that. If you take a step back, sort of Custom Truck was owned by Blackstone since 2015. Nesco was owned by ECP until 2019 when they went through the leaseback process. Nesco in the public markets was probably a bit undersized, overlevered, and therefore, the stock price was struggling. From a CTOS standpoint, Blackstone had hit the point where it made sense for them to try and exit. And the combination of the 2 businesses made a lot of sense. Platinum was the kind of the orchestrator of the whole deal currently today, owns about 60% of the stock made a significant investment into Nesco to fund the acquisition. But the businesses where Platinum saw, and frankly where Ryan, Fred and I sold as well, as did the Nesco team is that there was just a lot of complements between the 2. Nesco had a sizable rental fleet about equivalent size of CTOS' size. They had the aftermarket or the PTA business, which was growing. We were serving similar customer basis. And putting the 2 together added incremental scale, size and product offerings to the customers as well as given the fact that the 2 businesses were quite similar, a lot of cost synergies that could be realized, both from a back-office standpoint as well as just taking best-in-class operating performances between the 2 and in layering those in. As a note on that, the -- or one of the opportunities was that CTOS historically had maintained its own rental fleet in-house with our branch network across the country. Nesco had utilized a third party. So obviously, there is a cost spread there between the 2. So as we merge with Nesco, bringing that R&M work, repair and maintenance work in-house as one synergy opportunity, which we've discussed before. So just a lot of complements between the 2 businesses. From a purchase price standpoint, the total investment in CTOS by NESCO was about $1.5 billion. And the combination as a result of -- certainly we've seen really good stock appreciation and the delevering as the business. And the combination of the 2, I think, unlocked a lot of value between the 2. It helped bring our story to the forefront in the market is kind of a best-in-class model.

That's great. That's very helpful. And then I guess as a follow-up to that, since merging the 2 businesses, what are some of the opportunities for growth and prospects for improvement that you've uncovered?

Sure. Yes. I'll take that, [ Sean ]. But when the deal was announced, we talked about $50 million synergy target. I think in the Q2 earnings call, we referenced that we've increased that number from $50 million to $55 million. And there really were 3 broad categories where we talked about synergies. The first was really from an SG&A or a back-office consolidation, which has, obviously, been a function of bringing the 2 companies together. The second was really around procurement. So being able to leverage the size of the purchases, the Custom Truck historically was able to make and now apply that to the Nesco business, I think, this has been significant. We've also found opportunities to drive savings when it comes to some of the legacy parts and service businesses in particular. And then the third was really around service and production optimization. And so there were some markets. There were about 4 markets where we had 2 locations in the same market. We have moved into the larger of the 2 facilities. We've brought all of the technicians over to work in the larger facility. And so it's been important to be able to keep all of the technicians working, which is a big part of our business, but to consolidate into the larger location that made sense in most of those markets. And then we found additional production efficiencies, too, from just now having to build more equipment and to put more equipment through our production capabilities. So we feel very good kind of about the synergy plan. As I said, we've increased that number from 50 to 55. We've also -- originally, we said that we would realize about $25 million of those synergies in the first 12 months. On the last call, we said it would be closer to $40 million that we realized in the first 12 months. So we've seen those synergies come to fruition sooner. And then we have found good growth opportunities, too. And Brad mentioned one of those really thinking about the cross-sell opportunity. So being able to leverage Nesco -- legacy Nesco's great relationship with our customers and now being able to sell equipment into those customers has been a big advantage of putting the 2 companies together. So I feel very good about that. And then beginning to take the aftermarket parts and service business and now be able to sell that to both the sales customers and rental customers of the combined business has been a very positive outcome to this point.

It's a great little overview of the transaction. If we could shift a little to end markets. You mentioned earlier that transmission and distribution is roughly 58% of revenue. What is really driving the strength that you're seeing there? You said the backlogs of P&D contractors are growing? Are you seeing healthier municipalities, higher tax receipts? What do you feel is driving these trends?

I think it's a bit more fundamental than that. I mean you look at -- really 2 drivers. One, the age of the infrastructure itself is requiring a lot of upgrades. You can look at that from a storm standpoint or the weather impacts in California, Texas, the Southeast. The hardening of the grid is real and in need. And so there's a lot of investment going into that. I mean, any time during this time of the year, you can pick up a paper and read about stories going on with either blackouts or either weather impacts and power being down for weeks on end and the hardening of the grid. So we think that, that is certainly driving a lot of the distribution side of things. From a transmission standpoint, there's 2 things. One, the increasing growth in renewable energy. So as you put a wind farm or a solar farm, how do you need to connect it to the grid, which is driving incremental transmission across the country. And then you amplify that by the electrification of everything, electric cars, not only are you trying to connect and relying more and more renewables, but you're actually needing more and more power to support that electrification, which then drives even further demand for enhanced distribution as well as incremental transmission. So it's -- I think it's more of a structural change in the grid network within the U.S. in our view that, that shift is going to take and that kind of investment is going to take several years, which is driving our positive outlook there. Certainly, the municipalities, the IOUs, we believe, are in a healthy spot so they can make the investment, but also the investment is needed and more or less kind of being required by changing regulations around looking in California and kind of their push to go to electric vehicles, you need to upgrade a lot of that grid, which certainly drives demand for our T&D equipment.

One thing that we found is a lot of times people think about electric vehicles, but people a lot of times aren't thinking about the infrastructure that you're going to need to sort of build out the space of vehicle. So I think there were something around 2 million EVs last year in the U.S. And that's supposed to go up to around 40 million over time. Do you think that Custom Truck is in a good spot in terms of sort of being able to expand and grow the infrastructure surrounding the electrification?

I think that we're in a good spot to support our customers who are doing it. I mean our biggest customer base is the contractor, utility contractors who are the ones actually installing the lines or replacing the lines as well as there will be a part of -- we haven't got to this one, but like the 5G rollout. And then if you think about EV stations and connecting lines to those as well. So we think that our -- the equipment and the breadth of the product offering we have fits very, very well with the demand of those contractors. And as the demand for the work that they provide grows and the demand for our equipment, we'll ride along with that.

And you touched on this a little earlier. But just to go back to the rental value proposition for a minute. You noted that these contractors have very large backlogs. They're beginning to outsource more significantly. Is that what you find is driving this rental penetration, it's inability of them to actually do the work they need to basically go out and find others to supplement them.

I'd say it's a couple of things, right? So utility contractors, we think, historically, have typically rented between 30% and 50% of their equipment. And so as utility contractors are performing more of the work for IOUs or for power producers, right, we're seeing that shift from an overall macro rental fleet standpoint. So I think that's been a big part of it. Our view has been to always be the one-stop shop to take care of the customer however they want to consume the equipment. And I think we're really comfortable with the return profile of both renting equipment and selling equipment. And so our view has been, let's make sure we're doing everything we can to take care of the customer. Let's give them no reason to ever have to go somewhere else for their equipment needs. And then to be really comfortable with the economics of renting equipment and selling equipment. And I think that's proving to be the case. I think it's why we've been able to grow historically at the pace that we've been able to grow. And I think it's why we're confident we'll be able to continue to grow right at those paces -- at that pace.

And then if we could toggle over to infrastructure for a minute. You did mention a little of this earlier, but you said in particular, you have strength within refuse and roads and bridges. Why is that? And how do you benefit from sort of being a major part of these 2 areas of infrastructure. So obviously...

I think those are 2 areas...

Sorry, go ahead.

Yes. No. Sure. Yes. Look, I think those are both segments within infrastructure more broadly that we benefit from. I think as we think about how we define infrastructure and maybe how the infrastructure bill is defined, right? I think the infrastructure bill that's in Congress right now touches all of the end markets that we serve. So as you think about utility and the hardening of the grid, as Brad mentioned, as you think about telecom and the rollout of 5G or the continued rollout of broadband more holistically, and then think about rail infrastructure and then thinking about roads and bridges, in particular. I think we are well positioned for the infrastructure build to support all of those segments within the infrastructure category. One of the things that I think is pretty unique as you think about the products that we sell and rent thinking about specialty dump trucks and service trucks and water trucks and trailer is the majority of our utility contractors are using that equipment as well. And so really about half of their fleets are made up of buckets and diggers or what are called traditional utility products. And then about half of their fleet is made up of things like dump trucks and service trucks and man haulers and trailers as well. So really having that breadth of product portfolio has allowed us first to take care of that core utility contractor customer. But then also to begin to expand and to be able to service those additional customers who just focus on that type of thing.

When you think about 5G and sort of the rollout that we've been seeing there, people have been talking about this for a number of years, but have you seen the rollout begin to occur more significantly over the past 12 to 18 months?

Yes, we have. And I'd say, certainly, in the last 12 months and even more so in the last 6 months, we've had many more significant conversations with national contractors and with telecom providers in particular, who are looking to buy equipment and to rent equipment. And so we've seen a move from conversations to transactions that are happening, and we think that it will continue well into 2022 as well.

And then if we could just lastly touch on rail. If you could talk about some of the key characteristics that we've seen driving demand there and how backlogs are doing, that would be helpful.

Sure. Yes, I think when we talk about rail, there really are types of customers that we take care of there. So one of the Class 1 railroads, we're seeing good backlog growth in terms of both sales equipment and rental equipment. We are seeing strong growth from commuter railroads as well. And so that's been a good segment for us where we are renting equipment and selling it to customers and then short line railroad as well, where we've seen good growth on the rental side and sell-side. So we're seeing healthy backlog. We're actually seeing that backlog grow. And then we are also seeing more maintenance work and investment made in the rail network itself. It's being done by all 3 of those railroads and then by the contractors that support that as well. So we're seeing rail continue to be a steady performer for us and are seeing good opportunities to grow across all the different customers within the rail category.

On the rental side of the equation, what are some of the core drivers of activity? And what would you -- would you expect pricing to improve given the strength we are seeing in utilization of railroad?

Yes. I think the core drivers are just kind of the overall strength of the end markets. So we talked about the penetration of rental relative to sales is real. It's slow and steady. But certainly, that is adding to it. But again, it emphasizes kind of the strength of those end markets and the contractors. From utilization standpoint, the unique thing about the end markets we serve and our business model is we're able to maintain a higher utilization that you would expect to see from a gen rent business. We typically average in the low to mid-80% range, which is 10 basis points better than gen rent. The other unique thing and it creates more consistency and steadiness from a cash flow standpoint is the duration of those contract. So our rental -- the average rental out is about 11 to 12 months. So it's a very steady and consistent business. From a pricing standpoint, the dynamic we see right now, there is significantly greater demand than there is supply, which is allowing us certainly to press price within reason. We're not out there to take advantage of our customers at all. But certainly, as with everything: one, you've seen kind of increasing costs across the board, so our rates have to go up as well to cover that. But again, when there is an imbalance between demand and supply, we'll capture on that as best we can, again, doing right by our customer. What I would say also is that while we have those lengthy contracts at 11 to 12 months, it does take time for us to feel and see the full effect of rate increases because it takes us a full year to turn over contracts. So we're not in the business of changing rates for customers that have units actively on rent today. There's the quickest way to lose them. It's not doing right by them. So it does take us a full 12 months really to -- if we implement a rate increase today, you'll feel the full effect across the entire fleet 12 months from now. But we are certainly seeing a good environment from a pricing standpoint.

Does that also insulate the business a little bit in a downturn, the fact that these contracts are longer, 12 months in duration. So if things were to start to turn, you would still have this basically 1 year that the other contracts are still rolling off?

Yes. I mean it doesn't work out perfect one-to-one like that. But yes, I think there's 2 things to that. One is that the contracts and the committed capital, there is longer duration. So you see a bit of a steadier, more consistent utilization pattern. It's also we have focused on end markets, and we've done this intentionally that are less cyclical than others. So even if you go back to the most recent troughs that we had in the depths of COVID and if you go back to like 14, 15, our utilization bottomed out around 70% and only stayed there for at most a quarter. And then generally rebounds and we'll hit kind of mid-70s, upper 70s and the low 80s. So again, it is a very consistent and steady end market, which we like -- and certainly from a credit standpoint, provides more consistency from a cash flow standpoint as well.

Absolutely. How do you calculate On Rent Yield within the business? And how should we interpret this figure as investors? It's a little bit different than the yields you typically see in the general rental space. I just thought maybe we should clarify that.

Yes. We think it's an important metric in measuring how effective we are at deploying capital. The way that we calculate it is we take our pure rental revenue, so we're not factoring in free, we're not factoring in kind of ancillaries or other things. It's the rate that we're charging to the revenue we're generating in a period relative to the average OEC on rent for that same time frame and will annualize to get a full effect. But it is a good measure to sit there and say, for every dollar we're investing how much are we recovering of that in a 12-month period. And for us, again, it demonstrates how well we're managing the capital. Other metrics that you tend to see are kind of like what's your average revenue per day, it doesn't factor in there, what's the inflation, the cost on your units, it doesn't factor in mix very well. So we think that the On Rent Yield is the right metric to use when evaluating kind of pricing and the recovery on the investment that you made.