United Rentals (NYSE:URI) jumped 7.6% on Sept. 4, 2012, from the previous day's close of $32.31 to day's high of $34.65, before settling to the day's close of $34.42.
The knee jerk reaction on the stock price was probably because of the earlier news that the rating agency Standard & Poors raised the company's credit rating a notch and said that it has improved its operating performance and credit measures.
A Year's Following
I have owned United Rentals' stock since August 2011, when the price bottomed at $14.87, and it has always been an extremely volatile component in my portfolio. Ten percent swings are not uncommon for this stock. On June 21, 2012, I had discussed a comprehensive list of catalysts that could potentially result in United Rentals' outperformance in 2012 and 2013. An excerpt is included below:
So what is the best time to buy URI? I believe, over time.
URI's beta is 2.47, and it easily swings 10% both ways in a week's time. With the Fed's latest Twist, the market might be heading towards choppy trading, treading waters for next few weeks or going lower, causing good entry points for investors. After this 8%+ slide, investors should not panic. For new investors, this is the time to start nibbling on URI, instead of taking a huge bite.
Source: "Top 12 Reasons URI Must Be On Your Summer Shopping List"
Why URI's operating performance matters
In response to the June article, a gentleman had rightfully raised the point in the comments section that the Debt/Equity ratio for the company is high, and that if it "sneezed, it'd lose it all." My rebuttal in the comments was the following:
Total debt/total capital is 97%, agreed, but the industry average is high already at 75%. Of course, there is this risk and "if they sneeze, they lose quite a bit if not all", but the company did reduce the percentage of debt used in its capital structure this year which is encouraging.
Operating performance for a company that is this highly leveraged is very important in this economy. United Rentals' free cash flow is negative and is expected to remain negative for the remainder of the 2012. Looking at the Interest Coverage and Quick Ratios of the company, there is a risk for investors that the company could face trouble servicing its debt (if the market sees rental rate declines), considering that its operating profits or current assets alone are not high enough to satisfy its interest obligations.
Apart from the overall sluggish recovery in the U.S. (note that United Rentals operates in U.S. and Canada only, so there is no business impact due to the recessions in Europe), this was one reason why, in spite of an extremely high TTM EPS growth, the company's stock kept wobbling up and down without conviction even while it kept rising from the teens.
So when a rating agency like Standard & Poor's raised the company's rating from B to B+ on Tuesday and stated that the "outlook is stable," traders jumped in to make hay.
Catalysts Still In Play
The 12 catalysts discussed in the June article are very much still in play. The July earnings showed that the company swung to a loss due to the RSC Holdings acquisition, but revenue jumped 58% and more importantly, the margins improved considerably.
The two most important catalysts that will continue to propel this stock for the next six quarters or so are the following:
- Equipment rental rates (7% increase in 2012) and utilization rates have improved in 2012 and the trend has remained positive since 2010 and is expected to continue into 2013. Increased rental rates contribute the United Rentals' revenues as well as margins, especially when the company is working hard in cutting its costs.
The business cycle is another reason why United Rentals is the right investment in the Industrial sector. Commercial constructors and industrials coping from the bone breaking economic conditions are forced to rent rather than own the equipment.
Even if the economic recovery speeds up unexpectedly, there are additional advantages for stakeholders to continue renting the equipment versus buying. In a high speed economic recovery scenario, one would prefer to use capital investments for growth purposes rather than cutting costs on rentals, especially because they usually need many types of equipments and buying all the required equipments could damage rather than help their balance sheets.
United Rentals is thus well positioned to gain in either scenario.
Apart from the above mentioned fundamental factors, there are other positives that investors should take note of.
- As shown below, the company has given positive EPS surprises consistently since 2011.
- Revenues are expected to rise substantially from 2011 levels until 2014. In the chart below, the 2011 numbers are actuals and the numbers for years 2012-2014 are estimates.
- In July 2012, United Rentals announced pro forma financial guidance for the second half of 2012. The company said it was positive for the second half, with the EBITDA margins improving by 5% from 40% in the first half to 45% in the second. It also stated an expected 6.5% year over year increase in the rental rates and an improved utilization rate of 68%.
- Construction activity has bottomed in the United States and is expected to pick up from here. This bodes well for United Rentals as increased activity in the commercial construction and industrial space will bring higher revenues for the company.
- With the RSC Holdings acquisition, the company's fleet now contains a broader selection of equipment and has added flexibility to meet high demand, making United Rentals an 800 pound gorilla in the equipment rental domain.
- The company has made successful attempts of improving its balance sheet, by improving the Debt/Total Capital ratio from 97% to 83%, bringing it much closer to the industry average of 75%.
In July 2012, analysts at Credit Suisse had raised the target price for United Rentals to $47, close to its 52 week highs. At $47, the stock would be trading a little over 10 times the average 2013 EPS estimate of $4.63. If the company keeps giving positive EPS surprises as it has in the past many quarters, taking into account the highest estimated EPS of $5.02, the stock could trade well above $50 in the next 12-18 months.
As with any other investments, there are risks associated with investing in URI.
- Utilization rates have improved slightly in 2012, but if this trend discontinues, investors should start getting cautious.
- Further slowdown in the economic recovery in the United States could result in a delayed increase in industrial and construction activity, making the stock out of favor for investors.
- As discussed above, increasing rental rates are an important catalyst for URI. Any hiccups in this rising trend could impact the company's revenues and stock price.
Disclosure: I am long URI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.