United Rentals Keeps Going Up: Count Me as Worried

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 |  About: United Rentals, Inc. (URI)
by: The Keating Letter

United Rentals (NYSE:URI) popped 5% on Monday a price target revision by UBS. This follows a similar revision from February 2 by Oppenheimer. UBS now believes United Rentals is worth $50, while Oppenheimer’s target is $36. It’s also interesting to remember that Cerberus had offered $34.50 per share in 2007. That’s notable as United Rentals shares approach that figure again, with the equipment rental industry revenue still 25% below 2007 levels and United Rentals revenue figures even lower.

Let’s delve in to that a bit more to highlight what happened in the industry over the past few years. United Rentals shows in their most recent investor presentation that 2007 North American revenue for the industry was $40 billion after a near lockstep rise from $3 billion in 1986. 2008 was flat and 2009 fell off a cliff to $32 billion.

To illustrate just how badly construction spending has been hurt during the financial crisis, it’s not expected that industry revenue will get back to 2007 levels until at least 2014. Since United Rentals is the largest industrial equipment rental company in North America, it’s understandable how much pain they’ve experienced.

The company reported earnings on February 1, and on their conference call (see transcript here) they seemed to be extremely bullish. In Q4 they reported non-GAAP EPS of $0.16 after accounting for a non-cash charge. On a GAAP basis, they lost $0.29 for the quarter and $0.38 for the year. Non-GAAP full year EPS was $0.33. Revenue for the year was down by $0.2 billion, with total revenue at $2.2 billion for 2010. The company believes they can increase rental rates by 5% in 2011, and they expect free cash flow between $10 million and $50 million. That rental rate increase projection is why management is bullish. They were able to increase rates in Q4 and they believe the market is ready for this to continue through 2011.

On the balance sheet side, United Rentals is good on the debt side through 2013. This gives them the ability to reinvest their cash flow into CapEx in 2011, which they’re doing, rather than worrying about coming maturities. They’re 2010 EBITDA was $649 million, their best showing since 2007, and they generated $227 million of free cash flow in 2010. They’ve announced that they’re ramping up 2011 rental CapEx

UBS came to their target by assigning a 6.0 times EV/EBITDA multiple to 2012’s EBITDA. This is the same multiple that Cerberus had pegged for United Rentals with their bid, which included better future prospects I'm sure. The stock has traditionally traded between 4 times and 6 times, so that multiple is definitely on the rich end.

While I don’t disagree that significantly more cash will be generated by small price increases, I’m a bit more skeptical that the industry and the company have completely turned the corner. I’d like to see more than a quarter or two of bullishness when there is so much uncertainty in the economy. For example, the company highlights the ramp up of equipment rental needs for government stimulus funding. With the current political environment, I simply don’t believe the projections.

The stock has already run up 4.5 times from its low this year and hit its 52 week high again on Monday. This should worry investors, not comfort them.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.