United Rentals, Inc. (URI) Earnings Call Transcript & Summary

Next presenters, very happy to have United Rentals joining us. We're fortunate to have the CEO, Matt Flannery; CFO, Jessica Graziano.

Obviously hearing from the horse's mouth, CEO, CFO. Happy to get your perspective on what you're seeing in the marketplace. Obviously, a little premature to have real impact from coronavirus yet, but I'd be curious if any conversations you've had with customers are really starting to contemplate incremental equipment needs earlier to get the work done versus maybe slowing things up and really just give a little lay of the land, what you're seeing in the marketplace?

Well, I would say, generally, let's talk about the marketplace first. We're in a similar place that we were when we talked about on our January call. We still see a slowing but still growing environment for us, mostly driven by the construction end markets, and we haven't seen anything that makes us change our view on that. We feel that the industrial end markets will be a little more choppy. We're within -- embedded within our guidance is counting on a flat industrial market, and that's with -- that flatness is with absorbing about a 10% year-over-year decline in upstream oil and gas. So we haven't changed our view nor would a typical first quarter being the smallest quarter seasonally for us in the space really and for us to think stronger or lighter about the overall year. The coronavirus question is interesting one, very interesting times here. We're fortunate enough to not have had that much exposure to it. We'll see what the coming weeks and days even bring, but we're not expecting a huge impact right now. I don't think our crystal ball is any clearer than anybody else's on this. Personally, we're more focused on making sure our employees and then, therefore, our customers are operating in a mindful manner of what's going on around them. Supply chain seems to be what's been disrupted in most industries right now. We have not had this disruption. I wasn't here for all of Terex's commentary, but our suppliers have not pushed out any lead times for us, the things that would be meaningful for our business. We haven't had any of those impacts. That's one of the areas where we think coronavirus is showing up early. So we don't necessarily see a huge impact right now, and we don't expect a huge impact on our end markets. But you know we're going to stay tuned. The good news is we don't need to know. We have enough flexibility within our annual CapEx cadence and within the way that we can run our business that we don't have to the basis point predictability of the end market. We're just going to adjust accordingly. But right now, the end market sees that 2.7% growth that we have at the midpoint of our guidance holds for us.

So no Sunday morning emergency phone calls, CEO of -- I don't want to mention big contractors. But anybody reaching out, saying, hey, Matt, next year we get this equipment earlier, we're trying to accelerate this work or we're getting a project postponed, nothing of that nature yet?

No. No meaningful cancellations. Really, no cancellations to speak of since Q3. We haven't had a large -- what we would consider, large project cancellation. And no kitting up for trying to get things wrapped up ahead of time and trying to beat the clock, so to speak, here. So it's really been pretty steady for us.

And obviously, a large competitor of yours today reported and the CapEx discipline is definitely out there. Can you take us through your thoughts on the market this year, different than other downturns so I think it's encouraging for the industry, is more about price. And they're trying to control utilization by pulling back on the CapEx.

Absolutely. I think -- and we talked about this in January on call, right? So I think that the way the industry is responding to this extra capacity or this, let's call it, mid-single-digit demand versus double-digit demand and all of us building up with that double-digit demand is appropriate. And I'm happy to see that one of the other large players has caught up to that. I think their view is appropriate. I think you hear it in the forecast for 2020 for the OEMs. We're very pleased that their forecasts are of slower growth and that their backlogs are down. And that's the appropriate response to maybe having a couple of points of extra capacity in the industry going into the back half of the year. And we responded pretty early on with that, and we're happy to see the industry follow suit.

And I know you don't give rates and utilization anymore; you talk productivity. But is it fair to say at this stage, even though the dealers are sitting on a little more inventory, they're bigger in rental today than 10 years ago. But especially when you think of the National Account, big competitors as well who serve those National Accounts, it still feels like this is a year, if we're disappointed, it's going to be about utilization and try to manage the fleet than it is necessarily about rate. Would you say that's a fair assessment of any lever you're going to pull is try to pull back on the size of the fleet to keep you up, but rate is not something that we should expect to be a lever that you'll pull to keep utilization higher?

So as you accurately noted, we'll be terribly consistent here with fleet productivity as opposed to rate, time and mix. But all kidding aside, the interplay matters. It's significant because it'll matter what assets we're investing in and what assets the customers are demanding. But let's call it all general. We think that the extra capacity absorption will impact how much CapEx we put to this. The rate management will not change, right? It's still -- even though we don't report it separately, getting the maximum opportunity for the appropriate customer set and asset is still a huge part of fleet productivity and mix is a bit of an output of what are they renting while you're managing those other 2 levers. So we talked in January about capacity being our opportunity and we will certainly manage the inflow until that opportunity is absorbed.

So just one comment on mix. Just to add to what Matt's saying, the mix is important from the perspective of our growth strategy that leans on specialty growth, right? And the growth that you'll see in specialty through growth in rental revenue will come in large part through that mix component. So just to reiterate, the importance of that interplay as this is more of a reporting mechanism than it is how the branches are operating day in and day out is to continue to optimize for time, rate and mix as we grow the business.

Yes. Because a few have said a year ago, hey, markets can slow, but this cycle is about rate, not chasing utilization. That should be very positive for margins, right? Price is more powerful than time U. But the margins have had some issues the last few quarters. Can you remind us of, obviously, oil and gas was a big part of it, but it's not everything. Even when you say industrial is flat, not oil and gas. Can you help us understand some of the issues that played out in the back part of '19, in particular, that you feel absolutely are transitory due to its digesting deals? Or where do we think we are on rightsizing, especially the Texas fleet with oil and gas? Just help us get comfort if this is a year where if we're going to be anxious at all about revenues, it's going to be about you, but the pricing is there because that's the focus. You will play with the CapEx to make sure it's about rate and fight utilization side on fleeting. That should be positive for margins. That didn't play out in '19 as well. Can you take us through your thoughts on margins in '20 versus '19?

Why don't I start '19?

Yes, please.

So the biggest impact we've had on margins in the back half of '19 and even into 2020 if you think about our guide has been the slowing rate of growth, for sure. Now in the back half of '19, it was aggravated by a much sharper decline than even we expected in the upstream market, right? Midstream down as well and even some delays that we saw through chemical processing that pulled those numbers down year-on-year as well. So it's really more a function of the slow growth that was weighing in on the margins through the back half of '19. Because of the slow growth environment, what also gets exacerbated is the impact that some of these investments that we're making in these growing businesses has on the overall financials for us for the period. So just by way of example, because I don't know if we dimensionalized this on the call, by way of example, for 2019, the growth that we've invested in, in some of our services business. So servicing our customers' equipment is one line, safety training another line, building out a couple of other service businesses, that was about a 50-point drag -- 50 basis point drag on margins in the period.

And can you help us on the year-over-year? Is that drag diminished greatly, even at flat revenue?

That's just -- the drag is about the same as -- again, it's more of a ramp-up at this point.

So it's still another investment for '20?

Absolutely. Absolutely. So when you think about flow growth and a very deliberate investment in areas that we believe are driving returns and enhancing that competitive moat that we're building around our customers, providing more products and services to them as a competitive differentiation, that's really where the margin drags came from in back half '19 and into 2020.

Is there any thought around some of the, I mean, the oil and gas costs you would think aren't going to repeat? I mean that shock of pulling that much equipment out...

We'll have a little...

Refurbing. You must think year-over-year, what's the impact year-over-year on cost impact in '19? Taking equipment out, refurbing it, selling it or just taking it to auction or refurbing it, bring it to another geography. Those costs in '19 versus '20, I assume there's some reduction?

Yes, absolutely.

There is. But if you look at the P&L holistically, let's say, there's a lot of puts and takes with, yes, the quantum of those costs won't repeat. You do then have going the other way, right, the merit increases that we have across our entire labor force, you have the inflationary costs across some of the other lines of business that we have. All told, when we put it all together, right, at midpoint, it's a 20 basis point year-over-year reduction in the margin. And if you back out, again, that investment that we're making, right, the puts and takes become really important when the growth is as slow as it is in the revenue line.

I think if you think about it from a higher level perspective, so as Jess accurately said, the first reason that you saw the margins [ pulling ] was growth. The second reason was growth. And usually, we can absorb all these normal inflationary costs with our growth. But then when you get to next level, okay, so we have 3% growth, you're not going to absorb it. What are you going to do? Are you going to start cutting fixed costs? Are you going to start not investing into other businesses? Fortunately, we have a very healthy business. We're nowhere near in that world. So I think you're seeing the output of that. And then a little bit of a dilutive margin output from the service businesses that we are promoting that we're investing in, they will be very accretive to returns, which is our North Star. The days of having to chase the 40% EBITDA are long in our rearview and now it's about what are we bringing from a return profile? And that's some of these additional businesses that we're investing in, very asset light, very return positive.

And when you think about the decision internally to split the cash flow usage between billion-ish debt reduction, $500 million repo, can you take us through the thought process on how you made those decisions?

For sure. Absolutely. So the discussion in how we were going to allocate excess cash for the year really wasn't any different than the conversations that we have consistently with our Board, and actually we'll continue to have consistently with our Board, about the framework that we use to get comfortable with, ultimately, the decision on how much would go towards debt reduction and how much would go towards share repurchase. So it obviously all starts with the operating strategy and making sure that we feel comfortable that we're funding the right level of growth that we have to support the organic opportunity we see in the business. Once we have that and we were looking at a free cash flow of that $1.7 billion at the midpoint, the conversation shifted to how are we going to drive the greatest amount of value in allocating that excess cash to shareholders. And as we looked at our journey towards 2x net debt -- 2x leverage ratio, we felt comfortable that 2020 being a growth year, the opportunity we have to earmark $1 billion to continue to take us down into the middle of the bottom half of our recently reduced range, that felt right as far as how much of that $1.7 billion we were going to earmark towards debt reduction. And then that left us with the conversation around the opportunity to do this $0.5 billion share repurchase within about a year to continue to drive value and return that excess cash to our shareholders. That then, of course, leaves us with a couple of hundred million dollars, which we've earmarked towards the tuck-in specialty growth opportunities that we continue to look for to enhance that business.

The decision process you went through, and I know you can say every year, you reevaluate things.

Yes.

But imagine a sort of steady-state business going into '21, same situation, roughly $1.7 billion of free cash flow.

Yes.

Not out of the question that could be the scenario. Should we take this year's decision as if you had a model '21 like we do? Should we not think of next year as we're going to delever complete with the cash flow? Should we look at the decision this year as now sort of the paradigm for we always want to balance a little bit repo and share -- I mean, debt reduction.

So the process won't change, right? So what I want to do is not get ahead of a Board conversation, not get ahead of our planning process, not get ahead of conversations that Matt and me and the rest of the senior team will have in determining what is the best use of cash, where do we believe we're driving the most value, what opportunities do we have? So I wouldn't say you can use this year as a proxy for next, all things being equal, because the conversation is really going to rely on what is the situation of 2021? And what do we think that year is going to look like?

Yes, I was just -- given the hypothetical because you're going to end this year, even with the $500 million repo, somewhere around, call it, 2.25x net debt-to-EBITDA. So not the lowest end of the range, but getting there. But I would still argue, debt reduction is a very constructive thing in a market that's in a still...

Yes.

We obviously tilted that way this year. I think it's appropriate response to the market, what shareholders are asking for. And the great news is this is going to be a choice we're going to be able to make, right? So we have these options. And I think even when Jess is speaking to the mix of share repo and debt paydown, it can be an and strategy. It doesn't have to be an or strategy. So we're in a good spot.

Okay. Any questions from the audience? All right. I'll continue. The specialty business, right? Definitely a little more virgin territory to grow. It's not exactly like 1998 and gen rent is just starting off, but there's still a lot of markets you're pushing into where you become #1 in a blink of an eye. There just aren't big national players. Can you take us through the -- I don't know if many people call it spectrum, there's a lot of different businesses within that. Can you take us through those subsegments and tell me which are the ones, and I don't want to throw any of your managers under the bus, but just help us, which are the ones that you're getting even a little more excited about to invest in? Which are the ones that nice to have, but they're not demanding the same kind of investment? Just to give us a sense of which are the ones we should be really thoughtful about of driving the business if general construction is sort of let's call them malaise for a couple of years?

So without giving too much competitive information, and that's usually more why we don't break it down versus worrying about our managers. If you're going to work here, you know what accountability is, you're pretty resilient. So we're okay there. We've got a great team of leaders. I would say that they're all at different levels of maturity and that probably impacts it. But within that, every year, I go in the budget process and I say, well, these trench guys have been the leader in the space for years -- for 10 years and are they going to really drive this kind of growth, and they do. And as -- if you talk to any of them, ridding the industry of noncompliance is the greatest opportunity. So in Trench, that's even more important than any of the other areas. When I think about Power continuing not just to grow organically in the footprint, but to penetrate new end markets, there's great opportunity in power, we continue to see growth. And in our Fluid Solutions business and when we think about the acquisition of NPS in 2014 and then adding on Baker, what's capable of now having a full solutions go-to-market with Fluid Solutions as opposed to just the Pump business. Or a stand-alone basis, just a tank business, a very good tank business. We think there's opportunity there. They probably have the most year-over-year opportunity, given some of the challenges they had, highly exposed upstream oil and gas when we acquired Baker and just the change of that go-to-market and of bringing these 2 businesses together, we think there's a ton of opportunity there. So we think across the board, specialty has opportunity. And even as some end markets slow down, we're not as reliant upon the cycle in many of these specialty products. Think about the amount of MRO business, it's about 1/3 of our business overall as a company, but specialty's over-index participation in this run-and-maintain business, if capital slows down a little bit, we would see that it can almost be countercyclical. Some portions of this run-and-maintain business or this municipal business, this infrastructure business, we think specialty is probably even better positioned than the overall company in some of these noncyclical or countercyclical spaces.

I'm trying to think then the logic of it's the end of '21, your leverage is down to 2x and you're ready to get back leaning forward. The justification of buy in gen rent from here on out, price can dictate a lot of things. But the value of buying anything of size in gen rent, what would it bring for you? Relatively speaking, it doesn't seem like -- I mean, your geographic coverage is pretty healthy, I mean, unless you make the bigger decision to go global, which is a whole different ball of wax. But in North America, the need and inorganically to get bigger in gen rent, are those days behind us, you would argue?

You could argue that the need was never the driver. It was the math. So when...

Yes, but there are scale opportunities, that customer mix, right? For structure -- and little light on infrastructure. But from here on out, it's not obvious to me why, and we won't name names, but the need to do gen rent purchases in North America from here on out unless the price is just uber-compelling?

And I think you're hitting on it. Our 3-legged stool that we've talked about in the past still remains, right? It has to have the strategic value. It has to have the cultural fit. And we still have a very robust pipeline of deals in all spaces that we participate in that meet those 2 criteria. And then it's that third leg of financial. And that will be the decision. But you can continue, whether it's organically, tuck-ins or large M&A, you can continue to get benefits of localized scale. So when you think about our market share, there's still opportunity to grow. So I wouldn't say that we're not trying to or don't have a desire to long-term grow our gen rent business. And then which tool we use, whether that's organic and M&A, it's just a financial decision point. So we definitely lean, to your point, right now, more towards specialty. We have more growth opportunity to fill out and it's very accretive to the business, and we think it's a differentiator. And that's really going to be the overriding decision for any M&A: is it are we a better owner? And is it a differentiator for us versus the market? And that's what we'll continue to drive it. But I think your general tone is accurate, but I wouldn't say that it would be a no-go just because if the math works, the math works. And we're very good integrators. So why wouldn't we utilize that skill?

And I guess the secret behind a lot of these deals is so difficult to get technicians in local markets, almost just buy the fleet of technicians is usual valuable.

Yes. The capacity and what you can do with that capacity. Just hypothetically, we could accelerate maybe some of our other growth avenues that we're looking at with existing capacity. So whether it's that facility, fleet is really the easiest one to replace whether you're going organically or M&A. So it's -- you're dead on about the capacity.

And to bring a lot of questioning back to the near term. Again, volume makes the math a lot easier, right? So the magnification of a little extra expenditure on an initiative, there's a bigger drag when the volumes aren't growing. Are you seeing enough slowdown in the marketplace to at least be let's refresh in your top desk drawer the what cost do we begin to take out to protect margins? If the fleet management just is what it is, it's not working effectively enough to not see time U slip because you are willing, which I appreciate, I don't know if I would have blessed it if I were you. But fleet productivity is going to be positive this year. That's not that easy. So can you update us on the commitment to taking the actions for cost if we continue to see a slowing in the market that requires it? Or would you characterize it as that playbook is there, we're just not seeing anywhere near that level of slowdown. Can you help us?

Well, certainly, and Jess' team does modeling -- significant scenario modeling. So we absolutely have the playbook. We are certainly not in a cut boat right now. And we don't -- so absolutely not there yet, but we do have the playbook. When we think about investing in other opportunities, when we think about cold starts, when we think -- we would go there before we would go to hard cost cuts, any non-value-added cost cuts or maybe not as essential cost cuts. When you get into a negative growth environment, that's a whole another ball of wax, a whole different lens that we would look at the business with, including fleet disposals. And we talked a lot over the past few years of how different we are. Not that anybody is betting on or banking on that a few years from now there's going to be an '09-like recession. But we have a lot of resiliency. We will utilize that resiliency to do 2 things: continue to generate positive returns and free cash flow in any end market, but more importantly, make sure that we're going to come out of it even stronger. And that's part of the resiliency and the strategy that we've been deploying since 2009 to make sure the lessons we learnt inform the strategy of the future. So I think it'll be a more balanced approach. We don't have any liquidity issues. Jess can go on.

Under any scenario.

No matter what kind of scenario you wanted to paint, we would absolutely look at hard costs, but we will always have a lens on making sure that we're not cutting muscle. And I think that's an important differentiation that maybe we didn't have 10 years ago.

So just to add one point to that. The scenario analysis that we do, of course, take into consideration various severities of what a slowdown could look like. But to Matt's point about wanting to make sure that we're coming out of it very strong and able to take advantage of any uptick, we -- our scenarios also take into consideration different tenures. How long do we think the downturn could happen and what does that timing look like as far as is it something that's dragged out, is it something that's short, all of that with an eye towards managing through the downturn, but positioning ourselves to come out.

You mentioned earlier premature to think of any coronavirus impact on your business this year. But the ability to get time U to a level that makes the math easier to get positive fleet productivity, I guess, is not easy. And what are you seeing in the marketplace that's giving you the comfort that the fleet productivity, which inherently means utilization has got to get close to flat to up in the back half of the year to make the math work? What are you seeing in the marketplace that gives you that comfort? Or is the magic wand there is you forgot about the third piece, mix? Can you help us understand your comfort in saying fleet productivity is positive for the year?

Well, I think number one is we control the denominator, right? So last year, as we're going through integrations, and you heard a lot of talk about integrations, we wanted to make sure that we were giving these businesses time to meld together. To start pulling fleet out of there too aggressively would actually send a totally entirely different message, and we decided not to do that. This year, we're fixed. So we have a clean slate, as we talked about in January. We have the opportunity to run our play on time utilization and all the metrics that we operationally focus on. So that gives me the comfort. But even embedded within our guidance, there is an assumption that you have to have positive fleet productivity. So we wouldn't have put that guidance out there if we didn't feel confident. Now if the world turns out differently, as I said earlier, the good news is we have a tremendous amount of flexibility and we can manage that denominator. We're not seeing any change in the numerator from our view. But if we do, that's why fleet productivity is probably the easiest metric that we'd be able to get to at some point throughout 2020. And we certainly acknowledge some of the comps in the first half of the year will be more challenging. But by the back half of the year, we'll absolutely be in positive territory and I think full year we'll be in positive territory.

Some of the bigger projects out there that maybe last year got pushed a bit like some of the turnarounds at the refineries, can you give us an update on any of those? Any update on some that got pushed out, they just kind of pushed out again so it is happening this year? Or is it -- they're pushed out until TBD? Just some lay of the land of what you're seeing as one of those key maybe swing factors?

I'll separate the 2, I'll separate large projects and -- versus turnarounds because turnarounds is really -- all turnarounds are going until you get the phone call that they're not, quite frankly. So our visibility into turnarounds it's more going to be an internal decision for that customer. And those decisions, they're going to ramp up, so they have that optionality and we're going to be responsive to that. I do think there is a reality of if you delay your turnarounds, which did happen in Q4, you're eventually going to pay the piper. You're going to have to service those assets, especially in a more constricted capital environment. If you're not going to build out or enhance the assets, you're going to have to repair them. So we do think that the turnaround business at some point this year will repair itself. When we're thinking about large projects, as I said earlier, we haven't had a large project cancellation since Q3. As a matter of fact, our January customer confidence index was the highest we've had since August. So we're actually seeing -- and admittedly, our customer confidence index is skewed towards large customers, large projects because that's who we deal with. So we feel comfortable that, that won't be a challenge for us this year.

Can we have a mic brought over?

Yes. The margins this cycle are a lot higher than last. Is that because of industry consolidation? Is it because banks are imposing discipline? Have the barriers to entry increased? And how can we be confident that they're going to sustain, given that everyone's making so much money, you think it might attract some -- more players?

Go ahead.

So I'll take the first part. The increases that you see in the margins since the last cycle have been largely 2 factors. As you mentioned, part of it is the opportunity for us to purchase businesses that have been, all cases, been dilutive to our margins and now we're being able to drive the kind of productivities using our processes and our technologies, enhancing our talent to drive better margins through the business. So that is number one. Number two is also productivity gains that we've been able to drive through the entire network in being able to leverage our scale, and again, use those processes and technologies to drive a much tighter cost base throughout the organization. And I'm sorry, if you wouldn't mind. So the second part of your question, sustainability? So I mean, we...

If normally high margins attract newcomers. But it's now, have you gotten to the point where the industry is so consolidated that it's possible for significant players to enter this and make life difficult?

I think that the -- you look at the differentiation in the industry between the top 10 and the rest of the industry, you'll see a significant difference. I think the build-up scale at this point, not that it couldn't happen, would be a consolidation at the top half of the industry, and we actually think the big is getting bigger, well, is a good thing for business. It would actually help sustain margins, more responsible management, more access to tools and information. And I think that's, overall, why you're seeing this positive response from the industry right now and it's a very quick response to the extra capacity that we have. And that wouldn't happen 15 years ago. There just wasn't enough information. So I think that technology, information and analytics is part of the sustainability. And part of it's structural. The scale gives you opportunities to absorb some challenges that a smaller company would have a little bit harder time to absorb. I can go on and on with differentiation in your end markets, the differentiation of your products, there's a myriad of reasons and it's why we deployed this strategy that we think there's structural resiliency to our business overall.

I mean suddenly, specialty is 40% of your revenues. It's a big number, right? I mean it's in, what, 20%, 25%?

Yes. We're about 25%.

About 25%, yes.

But it's going toward that level. If you look at your -- about 3 to 5 years, if you talked to Paul, it's going to be 90%. But I mean, clearly specialty is getting the growth CapEx.

Yes.

Yes.

And in a way, I mean, it's -- we'll see how it plays out in different down cycles. Some of these businesses you haven't had in size in a true downturn to really test the, are they that less cyclical than gen construction. But I mean it's really over $2 billion on a $8 billion, $9 billion base and it just sounds like it's going to be growing faster than gen rent probably for...

Absolutely. And it's one of the reasons why we don't actually use percentages because $2 billion when we set that target, it would have been about 40% of the business. So we had grown significantly through continued M&A in the gen rent space so we changed the percentage. But that $3 billion goal is an attainable goal. And depending on what portion of the business that ends up is an opportunity for us down the road, but it's going to be accretive to returns and I think that adds to the resiliency we talked about.

One last question for me. With the market having sold off and it bounces back [ sends whatever ] you're looking at the market, but any change in the cadence of the share repurchase from the recent stock action?

No. Our process is the use of the dollar cost average approach towards the way that we buy back our shares. We're not looking to speculate. We're not looking to buy on dips. It's really slow and steady has been the way that we've felt comfortable executing the program.

Okay. Great. If there's no further questions from the audience, we are out of time. So thank you very much. I appreciate it.

Thanks, everybody. Thank you.