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

Good afternoon, everyone, and welcome to the Deutsche Bank 2022 Industrials Conference. It's our first session of the conference. So thanks for being with us. I'm Nicole DeBlase, and I cover multi-industry electrical equipment as well as machinery as lead analyst for DB. We're kicking off today with Custom Truck One Source. And from the company, we have Chris Eperjesy, who is CFO. He's been with Custom Truck since August 2022. And previous to that, he was at Clarios as well as Cooper Tire and Rubber, where he served as CFO of both companies. And then we also have with us here in the room, Brian Perman, who's Head of Industrial Relations for -- oh sorry, Investor Relations for Custom Truck. So I think Chris is going to kick us off with a few slides, and then we will go ahead and dig into the fireside chat.

Yes. Perfect. Thank you, Nicole. As Nicole said, I've been with the company 75 days. So you can imagine the steep learning curve I have been up. But I think this presentation is actually a good presentation, kind of a precursor to the conversation because it's actually why I joined the company, a lot of things that are exciting. So the way we kind of position ourselves as a leading integrated provider of specialty equipment, so one stop shop. You'll see here that we have $1.44 billion of trailing 12-month revenue. We have over 2,000 employees, $364 million of trailing 12-month EBITDA, adjusted EBITDA. And in terms of our rental fleet, we have 9,600 units or $1.43 billion of what we call OEC, original equipment cost. In terms of end markets, 60% of our revenue comes from T&D, 22% from infrastructure and then slightly less than 5% for both telecom and rail. And then you'll see on the top right that we have 35 locations throughout the U.S., and I'll touch a little bit more on that in a little bit when I talk a little bit about potential opportunities for expansion. On the next slide, and this is really probably the #1 reason why I joined Custom Truck is the end markets that we serve. You can see here, all of these are, I think, what we would all call end markets that have significant tailwinds with disproportionate growth to GDP over the foreseeable future. Again, as I said, T&D, telecom, rail, infrastructure, you'll see there both the size of the annual CapEx for each of those end markets as well as the expected spend that's going to come from the infrastructure bill. And you'll see in all cases, it's pretty significant compared to what their annual spend is in rail. It's actually 6x their annual CapEx in terms of what we're expecting to see from the infrastructure bill, whether it's in telecom, as we see the expansion and implementation of 5G or just repairing aging infrastructure and rail. And then certainly, as the grid continues, it need to be upgraded and renewed as well as expanded. All of those are areas that we expect disproportionate growth for Custom Truck One Source. In terms of the addressable market, we estimate our addressable market is roughly $30 billion. You can see there on the top left, the breakdown of that new equipment sales is roughly half. Roughly $5 billion is rental and used sales. And then just under $10 billion would be the parts and service. We estimate that we have just under 5% market share. It is a very fragmented market. We're one of the largest, if not the largest, in the space. So a lot of much smaller, we call mom-and-pop competitors. Another area that really excited me is that rental penetration. If you look at the U.S. general rental in terms of penetration in the market, it's north of 60% sitting here in 2022, whereas in the specialty rental, it's closer to 20% to 25%. And so we really think there's a disproportionate opportunity as our customers look at capital allocation. And we're really seeing an increase in outsourcing by utilities to contractors, and that really is deploying a much more capital asset-light kind of model. And so again, we think that plays well into our overall one-stop shop strategy. Again, this is our model differentiated one-stop shop. We manufacture specialty equipment, we rent specialty equipment, we provide service, parts and accessories, and we're also able, through our Custom Truck Capital, able to finance all of that as well as provide the opportunity for our customers to sell their used equipment as well as selling our used rental equipment. So again, it's an integrated production capability that we have, where we're able to take all the parts, put it together and really have that one stop shop model that we think has been very successful for us and will allow for disproportionate growth. In terms of our customer base, it's a very diverse customer base. You'll see some of the names there in T&D and infrastructure and rail. We don't have any large, what I would call, large customers. Our largest customer is less -- we do have a large shareholder. We don't have large customers. Our largest customer would represent less than 3%. You'll see there that our top 15 represents less than 20%. We do have over 3,000 customers and long customer relationships. And so it's -- in terms of the size of our fleet, in terms of our customers and our customer relationships, we think we do have a pretty significant competitive moat when it comes to our overall strategy. In terms of our national branch network, you'll see here our 35 locations. An earlier slide showed that we had roughly 2,100 employees. 10% to 15% or a little bit more than 15% of those are actually service technicians that are out there in the field. You can see that there's opportunities here for further expansion in the Pacific Northwest, in California, up in this area in the New York, New Jersey Metro area, in the Carolinas and the Southwest. And so I'm sure one question that will come up in terms of organic and M&A growth. Those are areas that certainly we would be looking at to continue to grow our overall footprint, and that could be done. In particular, given some of the supply constraints could be done via strategic M&A activity. In terms of overall performance, I arrived in a good quarter. We did have a 220 basis point improvement in our overall adjusted gross profit. Revenue, while it was flat, it was up in our rental business, a little over 5%. Was down in our new equipment sales. The new equipment sales really was constrained by what we're seeing in the supply chain. But as you've seen through this year, we've seen inventory grow, and we feel like we're exiting this year in a good position with chassis, bodies and attachments. And so that should set us up for a good fourth quarter. And as we head into next year to really see some of the tailwinds that we've been talking about as we continue to work through our supply chain constraints that we've experienced in the first half of this year. Overall, adjusted gross profit was up 7% year-over-year, and adjusted EBITDA was up roughly 9% year-over-year. In terms of our balance sheet, since the deal closed last year in April, we're down just under 1 turn. We exited this quarter at 3.77. You'll see on the lower left there that we've continued to invest and have expanded that investment in our rental fleet. In the most recent quarter, we had almost $100 million of net rental CapEx that was partially offset by some proceeds from sales. But we expect that trend to continue. We've talked a little bit about, as we move forward, our expectation is to try to increase our overall rental fleet by mid- to high single digits of our OEC. So on the high end of that, it's $150 million of incremental investment in our fleet OEC. In terms of our current borrowings, we have -- and I apologize, I can't see the screen very well, and I can't remember every number. We have roughly $330 million of availability in terms of liquidity at the end of our third quarter. Our borrowing base is more than we're able to borrow. So we have about $127 million of additional liquidity that could be unlocked if we chose to. And I think with that, this is the last slide. So this last slide, I think, summarizes why you're here and certainly why I'm here. I think this business has favorable end markets. I don't know that I really touched on the infrastructure bill, but that's another headwind that's not even reflected in our backlog at this point. And we really feel like we're well positioned to see continued growth, continued margin expansion in each of our 3 business segments and opportunity for further growth via either organic and strategic M&A as we move forward. So with that, open up to questions.

Great. Thanks, Chris. So we're going to go ahead and move to the fireside chat. But people in the room, if you have a question, don't be shy, just raise your hand. I'll see you, I'll get to you. For audience listening via the webcast, feel free to e-mail me or shoot me a Bloomberg message, if you'd like me to ask a question on your behalf. So with that, maybe, Chris, just starting with a little bit of a personal question. So you've been in the seat for a few months. Any thoughts on things you might change, ways you want to kind of put your mark on Custom Truck?

Yes, and I have to be careful. My bosses may be listening. But one of the reasons I joined Custom Truck is it's in its infancy kind of on the journey certainly post the acquisition by Platinum Equity. And there's clearly a lot of growth opportunity there. And with that comes some changes. The business -- and one of the things I love about the company that Fred Ross has created is it's very entrepreneurial. It's had significant growth, but now it's also a public company. And so certainly, my 20 years of being largely a public company CFO, building teams, doing M&A, building out governance structures, building out internal controls, some of the back-office stuff clearly are areas that I think I'm going to bring a lot of experience and background. But as you look at the opportunities we have in a market that's constrained by supply, you start thinking about opportunities to take out cost efficiencies, we talked about building out the footprint when it comes to the dynamic of pricing. I think those are all areas that the team was already executing on. And I really do think this model and this business is really about execution risk. I think my wealth of experience over certainly the last 20 years is an area where this probably is going to add some value.

Perfect. Very clear. So I'm going to start with some questions on just the general business model and the strategy. So I think after the combination with Nesco, you guys have what I would call to be a pretty unique business model that I don't see very often in that you both manufacture and you rent equipment. Can you just talk a little bit about the competitive advantage that this creates and why this is the right business model?

Yes. One of the slides I talked about our market share and how it's a very fragmented market. Clearly, being a large player doing renting, buying components, selling, integrating the production, having to service the parts, having all of that together certainly provides a competitive advantage, both from a cost structure because of the number of chassis, attachments and bodies that we procure and the competitors typically we're competing against a much, much smaller organizations, so it's going to provide that scale. But it also provides a competitive advantage when you're dealing with some of the larger customers, when you have that footprint where they know if they have a piece of equipment anywhere in the United States, that there's going to be within a relatively close distance, a location where they can get service work done. And so it's a model that clearly we like. It's a model that we think given some of the white space clearly has opportunity for growth. And just given the overall supply kind of the demand and supply dynamics we're in right now as well as the infrastructure, it's just there's clearly disproportionate growth opportunities as we move forward.

Got it. And why did you say that there's been clear evidence of realization of revenue synergies, wallet share gains since the combination?

Yes. We think largely that has occurred and that we're right on schedule where we want it to be, both in terms of the integration of the actual operations, integration of some of the opportunities that would come, particularly on the supply chain when it comes to some of the things I talked about in terms of acquiring chassis, attachments, bodies. And largely, the systems integration is done as well. And so I think the short answer is it was success. It's done exactly what we thought it would do. And in some ways, provides a model as on maybe a smaller scale. We continue to do some more strategic-focused acquisition, again on that geographic expansion footprint.

Got it. And you brought up the point that I wanted to hit on, which is the geographic expansion. If you look at what you have currently in the U.S., where are you underweight, where are you overweight, where would the regions where you'd be interested in growing organically or inorganically?

Yes. So it's particularly the East Coast -- sorry, the West Coast. If you look at Northern California, the Pacific Northwest would be areas where we think there's opportunity. The Southwest is another area, this area right here in New York, New Jersey Metro area and then the Carolinas. So really, it's those 5 regions that we think both organically as well as potentially through strategic M&A are going to provide the biggest opportunities for us.

And for those in the room that don't have a background in your area of equipment rental and equipment manufacturing world, this is a very fragmented market, right? Is that the case across all of the end markets that you serve?

It is. In T&D -- and this is where maybe my friend, Brian, who has been around a little bit longer can help. Within T&D, that is probably the space where we see the biggest competition from a private company that happens to be our largest competitor. But I think largely going back to what I said earlier, it really is a fragmented market. But I think within T&D specifically, the 2 of us do have a higher market share than our overall market share.

Makes sense. And I mean, the hot topic today is are we going into a recession? Like questions from investors all the time about resiliency into a recession. This obviously strikes me as the end markets that you're focused on are business that should be very resilient, if that were to happen. Would you agree with that?

Yes. I mean if you just look at our, again, our 4 key end markets in terms of T&D, telecom, rail and infrastructure and go back and look how they performed during prior recessions -- I think the global financial crisis is unique, and so you probably throw that one out. But in terms of a recession, they've been pretty resilient. T&D, I think, grew in the last 2 recessions. And so we feel pretty good as we look at our backlog in particular for new equipment as we're getting record demand for rental, both for rental equipment as well as for the purchase of rental equipment. And this is even before we're seeing the impact from the infrastructure bill. We definitely think this business is going to be very resilient.

What level of growth is -- like if we think about a medium term, putting a potential recession outside over a let's say, a 3- to 5-year time horizon, what sort of growth rates are normal in the industries that you focus on?

They're all -- the ones that we're focused on are all going to be -- and they're intentional, the ones we focus on. They're all going to be disproportionately more than GDP. So that mid to high single digits, I think, is reasonable. So we haven't really given a lot of guidance on -- I'll kind of leave it at that.

No, I think that's helpful. And then back on the topic of infrastructure spending, I think you were kind of alluding to this earlier. Have you guys quantified the potential tailwind to revenue? And I don't think you have, but it would be helpful if you haven't answered that. And then I guess, have you started to see the funding come through yet?

So we have not. There's a slide in the deck here that we've kind of laid out what we think the infrastructure bill means to each of those categories. I think in T&D, telecom and rail, all of them are between $60 billion and $80 billion. Infrastructure alone is $200 billion. So just a huge tailwind for us. We don't believe we've seen much of any of that in our backlog. So we think that's still to come. In terms of quantifying or giving a dollar figure to what that could be, we have not. But clearly, it could be significant.

Got it. But I mean, I think the point is you've already seen at least across most of your end markets, the demand pick up even without the benefit of the infrastructure bill.

We have. And so that is one of the challenges we've had. Certainly over the past year is demand is far outpacing supply and working through that. Since the beginning of this year, we've increased inventory, I believe, $140 million. So we feel like as we're exiting Q3 and certainly here in Q4 that we're in a much better position from a supply standpoint. I think Ryan McMonagle, our President and COO, said it best on the earnings call. It really now is one-off things like cylinders, like hose, kits and things like that, that are causing $150,000, $200,000 of inventory to be sitting there as we work through that. But we feel like now in the fourth quarter and heading into next year, we're working our way through some of those supply chain constraints.

Got it. We will definitely hit on supply chain at some point during this presentation. But maybe just finishing up with some of the medium-term drivers. So what about the rental penetration story? So where could penetration go over time in your view versus where it is today?

Yes, that's probably the hardest one to pinpoint. I showed on an earlier slide that overall general rental equipment is close to 60% today. And I think the expectation is it's going to go further sitting here, specialty rental is 20% to 25%. Clearly, interest rates going up, people not wanting -- looking at capital allocation decisions just like we do, we think there's an opportunity there. I think you all know rental is our highest margin opportunity in terms of our segments. And so whether that is on a path to 60% at some period in time, who knows. But what we do know is it's going to grow.

Got it. Makes sense to me. And you just inspired a question. So thinking about the impact of interest rates -- I get this question a lot in the rental space -- how does rising rate environment change the rent versus buy conversations with your customers?

Yes. Again, because of the supply constraints, I think some of this is getting muted and you can't see the real effects, but there's no question that people are keeping equipment longer on rental and there may be a disproportionate demand now for rental. But having said that, at the same time, our backlog is up over 100% versus last year for new equipment sales opportunities. And so I don't know that we've seen a significant impact at this point. But clearly, if rates were to continue to rise, it would certainly potentially could push towards that rental decision, which again comes with disproportionate margin opportunity for us.

Yes. It's like you guys went either way, right?

We went either way.

That's the good thing about this model. So maybe a shorter-term question on utilization. We've seen utilization surprise to the upside really since I've been covering this stock. It's reached new record levels. Is it fair to say that utilization should moderate from here as let's presume that supply chain does ease and OEC on rent grows?

Yes. I think, again, Ryan, I think, said it best on the earnings call. We exited -- or we finished the quarter, I think, just under 84% utilization. He indicated that we finished at 87%. There is a limiting factor at some point because as equipment comes off rental, it has to go through service and then be put back out. So it's you can never get 100%. But I think cautiously, we're saying at that record level of 83%-84%. That's probably the way to look at it. Is there more opportunity as we look at ways to get more efficient at turning rental equipment and things like that? Potentially, there could be upside. But I think Ryan's comments about it, that 83% being kind of the right number, I think, holds.

Okay. And then one of the other big variables in the rental piece of the business is OEC on rent yield. It's been very steady for the company coming around 39%, I think, for 4 quarters now. Is that viewed to be sustainable level of yield for the foreseeable future?

We think it is. We think there may even be opportunity for expansion. And so that's an area that clearly we focus on, whether it's margin expansion or ORY are all areas we're looking at. Ryan touched on the fact that it did dip a little bit in the quarter, and that really is just the timing and how the metric is calculated of using an average of the equipment that's on rent on an end-of-month basis, but on average for the quarter. And so if equipment gets put in at the end of a particular month or at the end of the quarter could be disproportionately weighted. So there was some of that. And then there potentially could be mix that could make that number move a little bit. But if you look at the underlying trend, we feel very good about where ORY is and where it's going.

Okay. Perfect. On the earnings call last week, I think one of the new pieces of news is that you guys plan to step up the sale of used rental equipment in the fourth quarter. Can you just talk about what's driving that decision given how high utilization is?

Yes. A couple of things. Ryan touched on the age of the fleet, and there are customers out there, the demand -- it really comes down to the demand. There's significant demand for that used equipment. We have some aged equipment that we're more than happy to sell and to replenish as we're going through our capital expenditures. And so it's a combination of demand, it's an opportunity to get rid of some of the older aged equipment. But at the same time, we feel comfortable now, as you've seen in the most recent quarter, where we were able to add $100 million to the rental fleet that we're on a path where we'll be able to sustain that mid- to high single-digit growth that we talked about in OEC.

Okay. Got it. And is this kind of like a one-time, I guess, catch-up of used equipment sales? Or should we expect them to remain elevated into '23?