Equipment rentals is a market segment that is somewhat fragmented in the U.S and isn't dominated by any one player, providing ample opportunity for growth via acquisition. These companies are also poised to benefit from president Trump's infrastructure expansion plans, and they are currently experiencing a rentals rally.
The largest equipment rental company is United Rentals, Inc. (NYSE:URI), with a Market Cap of $10.9 billion. In this article, I would like to compare URI to a similar, although much smaller equipment rental company, Herc Holdings (NYSE:HRI), a recent spin-off from Hertz Global Holdings, Inc. (NYSE:HTZ). The HRI spin-off was completed in June 2016 which makes comparing fundamentals a little difficult, but at the same time presents opportunity for profit.
The stock price for URI has been steadily outperforming the stock price of HRI since the latter began trading as a stand-alone company.
(Data Source: Quote Media, Charting Tool: MS Excel)
The spread between the two highlights the growing disparity between the two stock prices.
(Data Source: Quote Media, Charting Tool: MS Excel)
Since HRI has only been a separate business since July 2016, I decided to only compare fundamentals for the latest quarter with the understanding that there may be seasonal differences between the two companies. I have also had a look at the trailing twelve months figures provided by Portfolio123 which gets its numbers from Capital IQ and the quarterly figures aren't too dissimilar to the trailing twelve months, therefore I feel comfortable using the quarterly figures.
I have also included aggregate fundamentals for the entire GICS industry as reference, but keep in mind that the industry is 'Trading Companies & Distributors', a very broad classification, at least in my opinion.
(Data Source: Portfolio123, S/W Tools: MS Excel)
I have taken the liberty of highlighting the better number for each fundamental factor in green. URI wins this contest by a landslide with a grand score of 8 to 2. I guess this shouldn't come as a surprise as HRI is still coming to grips with being a stand-alone company. Listed in the Q4 report are some of the issues impacting HRI's results:
- Additional headcount, primarily in operations and sales
- Increase in interest expense related to debt as a stand-alone company
- Lower activity in upstream oil and gas markets
- Negative currency impacts
- Ramp up of new locations and the addition of new fleet categories
- Spin-off costs related primarily to higher IT and professional expenses
I would like to note that URI also has exposure to oil and gas markets and foreign exposure (locations in Canada) so at least two of the items listed above are not of major concern.
It appears that HRI has two issues relative to URI. The first is that they need to improve their operating margin. This will obviously result in better P/E Ratio, ROA, ROE, and interest coverage. I expect that improved operating margin will occur over time as the dust settles on the spin-off. But it won't happen instantaneously. The second issue is the higher level of total debt to equity which will ultimately be a concern in a rising interest rate environment, although not necessarily immediately. The higher debt level may also impact their ability to grow by acquisition relative to URI.
The proposed trade is to go long URI and short HRI with equal dollar amount. Based on the short price history of HRI, I expect this to be a fairly volatile position and negative swings of 15% will likely be the norm. I don't have a target for this trade but instead plan on monitoring HRI's operating margin to see if they are closing the gap with URI.
Why I like this Trade
URI tends to exceed analysts' EPS estimates as shown below.
This probably means that URI management provides conservative forward guidance. Analysts' estimates for HRI on the other hand have been all over the map. In fairness, this could partially be a result of uncertainty due to the spin-off activities. But I suspect that erratic numbers will continue for some time into the future.
Analysts have overestimated HRI sales estimates each quarter so far while estimates for URI sales have been pretty close.
URI has nearly 4x the revenues that HRI has. This gives URI more purchasing power. Between added purchasing power and less debt, URI should be able to maintain a higher earnings yield than HRI into the future.
URI has better fundamentals extending through the next fiscal year, at least according to the analysts, who have estimated next year's P/E Ratio at 12.5 for URI and 33.8 for HRI.
It isn't clear what level of foreign exposure that HRI still has after divesting of their French operations, but URI has locations in Canada that could become a 'drag' on results under certain economic conditions.
It is also possible that I have underestimated HRI's ability and length of time to turn around their operations with new initiatives. It is also possible that analysts are in error with future EPS and sales estimates.
Equipment rentals is a market segment that is fragmented in the U.S, providing ample opportunity for growth via acquisition. Equipment rental companies are also poised to benefit from president Trump's infrastructure expansion plans, and they are currently experiencing a rentals rally. The stock price for URI has been steadily outperforming the stock price of HRI since it began trading as a separate entity. HRI is a recent spin-off from Hertz and is saddled with spin-off issues. HRI scores significantly worse than URI on several fundamental factors. The proposed trade is long URI/short HRI. Risks include URI's Canadian operations, and an incorrect assessment of Projected P/E Ratio.
If you are not familiar with pairs trading then please read ETF Pairs Trading 101.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.