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

Okay. I think we're live. So for those of you that don't know me, I'm Nicole DeBlase and I cover the multi-industry and electrical equipment and machinery groups at Deutsche Bank. Next up on today's presentation schedule is Custom Truck One Source. I'm pleased to introduce Ryan McMonagle, who's CEO. Ryan only just took over as CEO this past month -- this past March prior to which he held the roles of COO and President of the company. So I think today, we're just going to dive right into fireside chat. I will open it up to questions from the audience towards the end, if anyone has any questions.

So maybe just starting with the basics for those who are new to the story. How would you describe Custom Truck One Source? And what's unique about your position in the industry?

Sure. We say that we're an integrated one-stop shop solution for vocational trucks, right? So what makes us really unique is that we have a rental fleet. So we have about 10,000 pieces in our rental fleet, about $1.5 billion of capital that's allocated there, and then we sell trucks as well, and then we offer parts and service. We do it all with what we call our integrated production model. So we will buy either builder Freightliner chassis and an attachment from Terex or Versalift and then we'll put those things together. So the ability to put things together, we think gives us a real cost advantage and it makes our model a little unique versus a pure-play rental company or a true truck upfitter.

Yes, absolutely, definitely unique. So I mentioned you recently took over as CEO. So any clue yet what changes you plan to make, if any, to the company's strategy and just general approach? And what do you expect to kind of keep?

Sure. No, I think we're on a great growth trajectory. So for me, it's about delivering growth first, which I certainly feel very confident in the outlook for growth. Two, it is decentralizing how we make decisions. So as we grow, it's decentralizing and empower our team to take bigger leadership roles and take on more responsibility. And then look, we are new as a public company. We're not quite 2 years into being public, and I guess we're just over 2 years into being public. And so it's figuring out how to be a better public company. So those would be the 3 big areas that we're focused on.

Okay. Okay. Clear. So after the combination with Nesco a few years ago, you now have, as you mentioned, a unique business model in that you manufacture and you rent equipment. I think that's -- you're the only example of a company. I've seen that does that. So what are the challenges and the advantages that come along with that model?

Sure. I think I'll start with advantages and then I'll hit challenges, if that's okay. But I think the biggest advantage -- we think there's 3 big advantages: one, we've got a much -- a real cost advantage from adding assets into the rental fleet that we think is real and quantifiable because we are -- we put about 1/3 of the product that we build into the rental fleet, and we sell 2/3 of that product. So we've got some real advantages of scale just from building 3x as many trucks as if we were just buying what we needed for rental fleet. I think that -- the cost advantage is real, which makes rental economics and kind of returns improved and I think stronger versus a pure-play rental strategy. Two, I think that just being able to quickly pivot. So as markets move or types of equipment or needed or as supply chain lead times build the fact that we're buying more inventory and we can quickly allocate more trucks to the rental fleet or allocate different types of trucks to the sales organization. I think that allows us to be nimble in the market. I think it's why we've been able to grow the way and at the pace that we've grown. And then I'd say, third, on the back end of the business, the fact that we have a dedicated sales organization means we're able to command a higher residual value on trucks as we take them out of the rental fleet. So we've got a team, a team who's in place who's selling trucks already. And so it's easy for us to sell kind of direct to our customers. And so I think you see higher residual value in the back end. So those would be the 3 big advantages. The challenge of having the integrated model, I think, is a bit in describing it and making sure people understand the advantages of it. So there's not -- as you said, Nicole, there's not a pure-play comm who's doing both. We're really a mix of the specialty rental business and really a truck upfitter on the other side. And so thinking about how we describe and communicate that and probably we've been the biggest channel -- as we're a newer name to the public market.

Sure. Okay. Okay. Got it. And maybe I think 1 of the unique aspects the story that we really like is the end market exposures that you've got. So can you talk about the main end market exposures that Custom Truck has and some of the growth drivers that come with each?

Sure. So we talk about 4 primary end markets, and we think we're really well positioned with the end markets that we serve. The biggest is the utility end markets, both transmission and distribution. That represents about 60% of our revenue, so it's our largest exposure. And so the drivers of that business are really around new transmission and distribution CapEx are really the primary driver there. Our primary customer in that market are the utility contractors. So we look a lot at backlog and reported backlog from some of those businesses. And so we feel really good there from an overall demand standpoint. Kind of the macro -- the main drivers of that space are obviously the investment that's happening in the grid, the electrification of things with -- and the amount of investment that's required if we're all going to drive electric vehicles. And then the third would really be the federal stimulus that's really driving some additional enhancement there. So all 3 of those are very favorable for us. We think that end market has a lot of great tailwinds, which is very good for us. So that's 60% of our revenue infrastructure more broadly is about 20% of our revenue. For us, that's both refuse and some roads and bridges as well and broader infrastructure projects. We think there's a lot of really strong tailwinds there as well. Obviously, with the federal stimulus, you think we think those tailwinds just get accelerated. And so we feel very good about that. And then both rail and telecom are each about 5% of revenue. And again, we're optimistic and bullish on both of those markets. As well rail for us is a smaller portion of our business. So we see some opportunity to continue to grow market share in that segment. We think the federal -- the infrastructure bill certainly supports that segment growing. And then on telecom, you've got 5G and some of the rural broadband initiatives that are coming that we think are favorable there, too. So we are optimistic on all 4 of the end markets. and are grateful to kind of have those as our markets right now.

Yes, absolutely. I mean, I guess it seems like all of your businesses could benefit from some -- to some extent from all of this government stimulus going on. Are you starting to see those stimulus dollars come through? Or are your customers seeing that as you have those conversations.

We are starting to see more of it in our backlog. So we think we're starting to see some infrastructure spend, in particular, start to show up in backlog as we talk to our customers. So it seems to be first showing up there. not as much yet on the utility side. I think there's so much pent-up demand and so much backlog that's already there. I think it will just -- we just think it will extend the duration of really strong demand. But we'd say we're starting to see it now in some of the infrastructure areas.

Okay. Okay. Understood. And utility, there's been a couple of pieces of the market, like it would be some of the electrical equipment companies that we cover or follow that seem like a little bit of a slowdown in demand recently -- have you guys seen any evidence of that?

We haven't. We're watching it closely. We still see great demand for the work that has to be done, right, and so I think that's what our contractors are focused on. We are seeing a few hiccups in the equipment supply chain on things like transformers. So we're watching kind of how that will play. And does that mean a project may get delayed a few months. So I don't -- we don't think it changes the overall demand story, which is great. It's just going to be the timing of -- some of those projects are able to go to work.

Okay. Okay. Understood. If we do see a recession, right, I feel like we've been talking about this for like over a year now, we're all just kind of waiting for it. But if we were to see a recession, and you kind of go back and look at the performance of Nesco stand-alone and Custom Truck stand-alone during past recessions and couple that with what you're seeing from a secular growth perspective, do you think that this business could continue to grow even in a broader macro downturn? Or is that too optimistic?

We think it can I mean, and I think we start -- we obviously start with the end markets. We think those are largely recession-resistent or -resilient or -- not recession-proof, but we think will come through very well because demand is strong. So -- and then if we look at history, if we go back to really even stand-alone Custom Truck back to the great recession. It was -- it grew EBITDA through that time period. It's all a shift in business. So business it's all sales decline and rental growth. And so we think that could be 1 of the ways that things play out is that if people are less ready to purchase equipment that they will still need the equipment to get the work done, and so we'll shift towards rental. So we think that could play out that way. And that's 1 of the things I think is really unique about the model. We just have never seen significant volatility in our utilization numbers. The lowest utilization has ever been. The Custom Truck for a quarter has been in the low 70s from a percent standpoint for a month, it's been 69%, right? So to me, if you're bound -- if your lower bound is kind of 70% and your upper bound is in the mid-80s. We feel like it's a great place to operate. So there could be some headwinds, there could be some slowdown, but we think we should be able to grow through anything that's coming in the near-term.

Definitely a lot better than the general rental business.

Yes. very different, right, [indiscernible].

So maybe we could talk a little bit about telecom as well. I think for us, we have less exposures [ through ] the other companies over to telecom. So it's harder to get a read on what's going on there. Is 5G actively happening now or what's going on in telecom? It seems like it comes with fits and starts.

5G feels like the kind of the demand driver that's been -- about to come for forever. It -- We are seeing customers purchase more trucks, right? So we're seeing that. We're seeing more demand to put additional cable places and some of the equipment that we -- that is used in telecom in our rental fleet as well. So we're seeing real demand. We see real backlogs build in that category. So -- but it's also a very small part of what we do. It's 5% of revenue. So there's still some market share or -- but we're talking to both kind of the providers and the contractors working for them, and we're seeing opportunity on both of them.

Okay. And what is rental penetration like in -- or is that just a market where you're selling trucks? Like...

Telecom is a bigger sales market than a rental market. And that's -- utility is probably the most developed rental market of the end markets that we serve. And we think rental penetration is somewhere around 25% of the universal fleet. So we still see room for that to increase. A lot of that is driven as contractors are performing more and more of the work, contractors certainly have -- are more likely to rent equipment. And so we think that will continue to increase. Things like telecom, rental is much less developed. So the majority is selling equipment, but we're starting to see some contractors. And certainly, some of the utility contractors start to do more telecom work, we're seeing some growth on telecom rental. Rail, there is a reasonably well-defined rental market there for both -- for Class I and short line and the Commuter Rail and the contractors as well. So we're seeing some good opportunity there.

Okay. And I think you mentioned a rail market share opportunity. Can you just elaborate a little bit on that?

Just a small player there. So they're -- and it's the different competitors in the rails -- in the rail end market than there are in the utility end market. And so we made the acquisition of HiRail Leasing the business in Canada last year, which has been a good business for us. And we just see opportunity to deploy more capital in our rental fleet to grow and to continue to take share. And then we're starting to see some good wins on the sales side of the business with some of the Class I railroads. So it's one of those markets Class I kind of set the standard and then Commuter and some of the contractors will then look for the same type of equipment.

Okay. Understood. If we kind of look across the markets where you operate, how fragmented are these? Are they very fragmented? Are you like a dominant player?

We said [Audio Gap] in dollars and we're on $1.5 billion, $1.7 billion or 5% total share. We actually think we're one of the larger players across all those segments. It's different by industry. In utility, it's -- utility is a very large player in Altech, who we think is the largest player in that segment, but doesn't participate in some of the other end markets that we compete in. So we see a lot of fragmentation, which we see is a reason continue to not only grow but to also grow but also share and also some interesting M&A opportunities because of that model.

Of course. Okay. So rental penetration, you've mentioned in utility, it's about 25%. Now how has that changed over -- I don't know what time period you want to put on a decade, past 5 years, whatever? And how do you think it can grow over time?

We think it's growing. It's not great data, right? So it's more subjective than kind of objective data. But we think it's growing. So we think rental penetration has increased when you look at how the Custom Truck and the Nesco and how think the Altech fleet have grown over time. So we think the rental penetration is increasing. If you look at GenRent, right, you'd say if you get to 50% or 60% it's kind of -- as an upper bound from a rental penetration standpoint, I think it would take a lot of time. I think the market dynamics are different. I think the owners of equipment, the IOUs and power producers. I don't think they'll ever go to a completely asset-light or rental-focused model. So I don't think you'd ever quite be able to get all the way there. But we see that as a place that market share absolutely can grow for the next few years.

Okay. Got it. Stepping back and thinking about things geographically. So you guys have a very broad national U.S. footprint at this point. Are there any aspirations to move outside the U.S?

We're in Canada. So the of 36 branches, 4 are in Canada. So we think Canada is certainly a good market to grow in. We are primarily focused on North America. So we still see plenty of places in the U.S. where we can add locations, the Pacific Northwest, the Southwest, the Carolinas, New York, New Jersey we're pretty light in those areas in terms of footprint. So we see those as logical places continue to grow to either open up greenfield sites or to acquire other businesses. And then we see Canada as a good market to continue to grow our footprint in as well. We're not looking in Europe as much so we -- we're really focused on North America.

Understood. Okay. So utilization, I feel has continued to surprise the upside as long as I can remember, maybe as long as you've been covering the stock, and it's reached new record levels. So is it fair to say that at this point, utilization is likely to moderate from here, especially as supply chain eases?

I think it will -- yes, I think it will moderate some. I think we can run kind of in that low 80s, low 80s to mid-80s band. I think that -- I think we're proving to ourselves that we can operate there. We used to say that 85% was kind of a theoretical max that you really couldn't run higher than that. We've obviously proven that you can. But we feel like with the fleet and the team and the investments that we've been making, we can maintain kind of that low 80s as a utilization number, which is down a little bit from where it's been historically, but still a great number kind of in the grand scheme of rental utilization.

Yes, definitely. And would you say that, that low to mid-80s is kind of like your ideal zone where you feel like you're kind of operating, I don't know, on all cylinders.

I think so. Yes. And the team is doing a lot to think about how do we turn equipment more quickly which allows us to keep utilization higher. And so the ops team has done a great job of making some investments there to make that possible. But yes, I think kind of that low 80s is a new normal that we really -- asset returns are great. The financial results are certainly commensurate. And so we're really comfortable operating that.

Okay. Great. Shifting to OEC on rent yield. We recently saw a little bit of a step up to 40%, I think, in the past couple of quarters from really steady 39% growth previously. What's your view of the right level of yield if we look forward?

It's -- we think that's about right in terms of yield. And obviously, we're dealing with increased input costs, right? So we're having to increase rate to cover, obviously, the increase in input costs. And so I think we've been able to do that we feel like we're a premium-priced offering in the market, and so we feel comfortable that our equipment justifies that premium price, but we think that yield is about right.

Okay. And you mentioned input costs, so let's go ahead and dig in there. Are there any aspects of input costs that have started to moderate? I mean, what's the inflation picture looking like across your input.

Yes. I think the pace of inflation has slowed. There are some areas that we've actually seen input costs decrease. Those are the exceptions for sure. But things like some of our steel input costs certainly have begun to decrease. But we're still seeing inflationary pressure on our major inputs on the chassis side and on our major attachment side. So we're still seeing inflationary pressure. It is less than it was. So we are seeing the pace of it -- inflation slow, but we're still seeing it increase.

Okay. Okay. Got it. Let's talk about rental equipment sales. So definitely elevated in the first quarter. What's the expectation of how that might trend as we progress throughout the rest of the year?

Sure. No. I think we've commented that overall for the year, it should be fairly consistent to what we did last year. So I think that's a pretty good indicator. There's a couple of things right in play there. One, we always see that as a really good indicator of demand so if customers are asking to purchase equipment, they feel good kind of about the backlog that they're working on. So I think that's positive. We've seen residual values or recovery rates remain elevated. And so because there's a lack of supply right now. I think we've seen kind of the increase. So there is some increases there. We are seeing probably 10% higher from a residual value standpoint than we have historically. So that increases that number a little bit. And then we've talked about now for several quarters that from the merger, we've been intentionally investing now that supply chain has improved to continue to replace some of the older equipment in the fleet. And so we've been intentional about pulling out some of those assets out of the fleet.