Herc Holdings Inc. (HRI) Earnings Call Transcript & Summary

Good morning, everyone. I'm Jerry Revich from Goldman Sachs, and I'm delighted to have with us from Herc, Larry Silber, CEO; Mark Humphrey, CFO. Gentlemen, thank you so much for joining us.

Larry, to start the conversation, since you came to Herc in 2015, the financials are drastically different margins are 10 points higher. Dollar utilization is 10 points higher. Talk to us about the journey so far over that time frame and your top priorities going forward?

Yes. Great. Well, thanks for having us, Jerry, and we appreciate being here. Also in the audience is Leslie Hunziker, our Senior Vice President of Investor Relations. If anybody has any questions after Leslie is available. But yes, thanks. It's been a wild ride over the last 8 years. And yes, we've had a tremendous improvement in the business. Some of that has been helped, obviously, by the environment in which we're operating in. We went through some challenging times in COVID, but that spurred on even more activity. We went through just about everything in the business from fleet modernization, to systems and technology modernization to sales force investment and training and education of our organization. Pruning, first pruning the facilities and then building back facilities in the right markets. We pruned all of our -- majority of our international operations. Obviously, we operate in 5 Canadian provinces and 39 states I got here in '15, we had operations in China and Saudi Arabia and Qatar in Europe and Latin America. We've pruned all of that to where we're a North American-focused company only. And then as we improved our capital structure, rebuilt our business, focused on margin improvement, getting the fleet right, turning over the fleet, focusing and consolidating manufacturers to where we only have a few manufacturers per category, gave us purchasing leverage in those areas and allowed us to really have the strength to grow and then we started adding specialty businesses to our core business mix, which great give us even greater margin opportunity as you solutionize rather than just supply products, solutionizing enables you to you grow your margin and grow your value to those customers. And then about 2 years ago, a little over 2 years ago, we felt our capital structure was right. to where we can enter the world of M&A, begin to acquire companies to improve our density in large urban markets, which is where we're focused and add acquisition companies to our portfolio, and we've done about 30 acquisitions added nearly 70 locations over the last 2 years to the organizational structure. Also, again, focused on large urban markets, focused on area where there's growth opportunity where there's hot activity. And then we implemented a dividend over a year ago and which was a good return to shareholders, and we did opportunistic buybacks of our stock. So it's really been quite a journey. We still have more room to grow to expand, continue to improve margins and continue to improve the business. So it's we view it as still a very vibrant industry, one which we can continue to grow and develop.

And Larry, I remember one of the first areas that you focused on was getting the right fleet in there. As you've implemented your purchasing process, is there a natural uplift that we should be looking for in terms of dollar utilization as we continue to have the entire fleet purchased with your current run rate purchasing process?

Yes. I mean I think there's certainly -- there's a recipe there, right? I mean how we purchase fleet is an absolute huge component of that, right? But I think at the end of the day, you have to look at it from: one, pricing and in this environment. And as Larry was just speaking about, right, I mean that has been a focus of ours since Larry came on board. So really, you're talking about pricing and then you're talking about fleet efficiency. And then lastly, you're talking about just being able to lever a significantly different company today as Larry was talking about from even 2020, right, we're up about 100 branches. So I think all of that plays in when you think about ultimately specialty mix inside of the strategy that Larry was speaking of is sort of the third component there of the overall lift in dollar utilize.

And looking at your performance versus your 2 biggest public competitors, you've really narrowed the margin and dollar utilization gap nearly closed it. There's still a bit of a gap. I know you folks are focused on closing it completely. Talk to us about the path to get there, if you don't mind.

Yes. No, look, I think we have made great progress on narrowing that gap and we're within striking distance in the next year or 2 of equaling that, but it's really around continuing the focus on disciplined pricing, adding to our fleet mix specialty products that drive that higher margin and drive that better capability from a solutionizing standpoint, and then maintaining that mix between national accounts and customers, we're at about a 50-50 and that might go 45-55. And then depending upon the seasonality, it could even go 60-40. But we'd like to try to maintain that mix to where you can get higher margins from the spot market and the local customers than you can from some of the national accounts, but plenty of opportunity there. And then finally, scale, as we continue to scale up, we add more fleet to the existing footprint, that revenue drops to the bottom line and helps you close that gap because you have a fixed cost structure and you're putting more volume through that fixed cost structure. So that helps you close the gap. So plenty of opportunities to do that.

And Larry, based on your comment a moment ago, it sounds like you wouldn't have to ramp up headcount as you add more fleet. Is that right?

Yes. I mean I think in context of 20%, 30% fleet growth, which is sort of the last couple of years, right? I mean I think -- and Larry mentioned this, there will always be a focus on the sales force and making sure that, that ramps up along with the fleet, right? And generally speaking, that's compensation that we're not afraid of. I think as it relates to sort of the core base business, yes, I mean, there's runway there to add significant fleet without adding significant headcount.

And can we shift gears and talk about your ability to react and manage the cost structure to the economic environment. So 2020 was really interesting, given the drawdown in utilization and your margin performance. Can you talk about whether that's representative of the type of performance we can expect the next time we see a meaningful slowdown in activity.

Yes. I mean I think -- and as I just stated, right, I mean we're -- while there was, I don't know, 160 basis point uplift from '19 to '20 during the COVID downturn, right, even from '20 to now, we are a very different business, more mature, more diversified fleet. And -- but at the same time, right, the same levers that we utilized back in 2020 are at our disposal today, and we would utilize those levers to sort of maintain that margin profile that we've sort of continued to grow into.

And can you talk about those levers, so you pulled back on third-party deliveries? And what are the other pieces?

Yes. Look, I think a lot of levers to our disposal, which we employed during that COVID period that sort of we woke up on a Monday, and we reacted by Friday and took it very seriously. And the main lever is cutting off incoming fleet, right? We have 30-day commitments to all of our OEM vendors where we're only obligated to take what's in sort of the manufacturing channel 30 days out and scheduled for delivery within a 30-day period out. So we would -- we could and would turn off incoming fleet, which would reduce CapEx. During COVID, we cut off -- we reduced $400 million worth of incoming fleet within a 1-week period, and it didn't come in. So that would happen. We would look at disposal channels on what aged fleet do we want to dispose of because we'd have an issue with terms of utilization. So we disposed of fleet, I wouldn't necessarily be at distressed pricing. It would be a normalized market pricing, probably below what we're seeing today because we're at all-time high in the used equipment market. But you're always able to dispose a fleet, you generate cash from doing that. As you said, we'd reduce third-party freight we'd reduce over time. We could freeze merit increases and annual increases in the business. There's a number of different -- obviously, we stopped hiring, and we look at attrition, not replace that attrition until it was needed. So a lot of levers that could quickly be employed that would allow us as a business to maintain that margin profile even on a reduced volume level.

So just to make sure I'm on the same page with you, you think you can maintain the run rate margins where whenever we go in through a downturn, do you think you'll be able to maintain prior year levels?

Yes. I mean, I think, again, I would -- the journey, the margin expansion journey as we've talked about, right? I mean it sort of resets as you sort of continue to mature inside the business. And so yes, I mean, I think that the margin expectation, obviously, the nature and extent breadth and depth of a downturn notwithstanding, we would expect to maintain margin profile.

And can you just help us understand the variable part of the cost structure better. How much do you cut third-party transport just because not a lot of businesses have that type of profile where volume is down 5%, 10%, and they can maintain margins.

Yes. I mean I think this is a very sort of recession resistant, -- nothing is recession proof, right? But the recession-resistant aspect of this business does allow us to -- Larry was talking about it, right? You can -- from a fleet side, we've discussed from a P&L side, all of those things, people, salary, et cetera, is about 30% of that P&L on an annualized basis. And so those levers are there for us to pull, again, depending upon sort of the breadth and depth of what it is that we're facing.

And the other interesting thing about this business is during a downturn, we generate cash. And when we're generating cash and then we're reducing our leverage, whereas a number of companies have to go out and borrow to sort of sustain their business until that business goes back. Not in our case, we generate cash, leverage -- we pay down debt, leverage goes down. So the business really sort of functions maybe countercyclical to what many other manufacturing or normalized businesses do so.

And can we continue to pull down that string on what the next downturn might look like when we saw pricing in the industry over COVID down 1%. -- great financial crisis down 15%. What would you attribute the difference in performance for the industry, too?

Yes. Look, hard to predict, right, what the next downturn is going to look like. It was hard to predict COVID and certainly, it was hard to predict '08-'09 downturn. But the industry is much more disciplined today than it was at any time in the past. Certainly, the top 3 and even the top 5 rental companies in North America, all have professional management in place all have great systems in place, all have pricing tools in place, things that will help enable more discipline to the market so you don't see sort of a runway down. Obviously, we would turn off the fleet purchases as we've discussed generate a lot of cash, we'd rotate the fleet where we needed to in a normal rotation, we'd rightsized the staff. And it would really depend on how pronounced and prolonged that downturn would be in terms of what we would do to the base organization, right? As during COVID, we've maintained our entire base organization throughout and we have very few furloughs at all in the business. So if it was much more prolonged, we probably would have had to take some greater action. But fortunately, we didn't. And we'd have to see how that went. But I'm expecting the business will be -- or the industry will be well disciplined and well managed through any downturn period.

And how much of an impact does data availability help rouse in particular?

Yes. I mean that was going to be my point, too. I think that is probably one of the biggest differences between the 15 to the 1, right? You have sort of 50% to 60% of North American rental companies reporting into Rouse, and we see that data weekly and then more rolled up monthly. And that certainly goes to the discipline in the overall marketplace in the industry that Larry was speaking of. I think it's invaluable.

And in terms of the pricing landscape today, one interesting dynamic in the cycle is higher rates and the impact it has on operating costs essentially for your competitors. Are you finding pricing is surprisingly strong given that dynamic. So I was pleasantly surprised by your pricing number for the second quarter, in particular, given the tougher comps. I'm wondering... Yes. Well, and the outlook for what Mark said in the first half.

Yes. No, we were happy with that. And I think a little bit above our expectations as well because I think we guided to mid-single digits and it came in much stronger than that. And we feel that the market is accepting the price increases that are being put forth because everybody knows what's going on around inflation and what those inflationary pressures are. So it was a little bit higher than what our expectations are, but we were happy to see it. So -- and I think the market -- one of our competitors came in much stronger than us in the pricing scene. So that means maybe we left a little bit on the table who knows.

H&E?

Yes.

And in terms of opportunity to continue to push pricing, can you talk about customer receptivity to pricing on a spot basis?

Yes. On a spot basis, quite frankly, it's much stronger than it is on a national or a contractual basis. We saw low double digits in that area, and we were able to push that pretty well on a spot basis. On a national basis, obviously, those are annual contracts that roll over ratably over a 12-month period. And we've implemented over the last 18 months in what has been traditionally a very difficult environment to raise prices, we've been able to raise prices at the national contract level. And those have been accepted and received and understood by those customers, and we haven't had any real significant pushback at all. So we're seeing that to be pretty firm.

And Larry, you spoke to this earlier, you want to get the right mix of national account versus spot. Can you talk about where the margin differential stands between those 2 different account types?

Yes. I think you're probably looking at mid- to high single-digit differences in terms of margin and on a core basket of goods. But on a national account, what you have to think about is you might bid a core basket of goods that might have a margin differential. But then you have all of the other products that aren't priced that you can get book or near book, which gives that customer profile and overall very strong margin profile. So we can -- while we do believe the customer -- the local or spot business does give us a higher margin. Our specialty business, international account gives us higher margin as well. So we're able to sort of generate very good margins across the entire portfolio of customers.

And can we just continue down that thread specialty M&A opportunities from here? Can you talk about what type of specialty businesses would fit your portfolio and what the pipeline looks like?