Education Infrastructure Needs Appear Key For McGrath RentCorp

Summary

• McGrath RentCorp reported 2020 first quarter results on April 29th. Although the results were healthy, the company does appear at risk due to the COVID-19 pandemic.
• McGrath's Mobile Modular segment has long considered education a key market. The COVID-19 pandemic is impacting three of McGrath's key education markets.
• Because the impact of the COVID-19 pandemic is still uncertain, the nation does not yet have plans to reopen schools.

McGrath RentCorp (NASDAQ:MGRC) has historically believed it should "fare better" during a downturn as companies tend to turn to leasing. The business-to-business leasing company offers solutions in three business segments - Mobile Modular, TRS-RenTelco, and Adler Tank Rentals.

The Mobile Modular segment supplies infrastructure needs for schools as well as commercial businesses. The TRS-RenTelco segment supplies general purpose test equipment and telecom test equipment supporting the roll-out of next-generation 5G wireless networks. Adler Tank Rentals supplies solid and liquid containment solutions to a variety of industries such as industrial, environmental and construction, as well as the oil and gas industry.

But a downturn in the economy isn't quite the same thing as a shutdown of the economy. And, as such, McGrath RentCorp is currently just as uncertain about what to expect as many other businesses.

2020 First Quarter Results

McGrath RentCorp reported 2020 first quarter results on April 29th. Rental revenues improved 8% to $89.5 million, rental operations improved 9.5% to $114 million, and total revenue improved 6% to $129.5 million year over year. Revenues improved 12.5% and 11%, respectively, in the Mobile Modular and TRS-RenTelco segments, but declined 11.7% for Adler Tank Rentals. Average utilization improved 100 basis points to 65.3% in the TRS-RenTelco segment on 18.8% inventory growth. It declined 10 basis points to 78.7% in the Mobile Modular segment on 4.8% more inventory. Adler Tank Rentals' average utilization declined 950 basis points to 47.8% on a very slight increase in inventory.

The direct costs of rental operations only increased 7.8% compared to the 2019 first quarter. Both gross profit and operating income increased over 8% year over year. A lower interest expense resulted from lower rates and less debt which drove a 9.3% improvement in net income. Diluted earnings were $0.81 per share compared to $0.75 per share in the 2019 first quarter.

All in all, McGrath RentCorp's numbers reflected healthy performance in the first quarter of 2020. But the World Health Organization declared COVID-19 a pandemic on March 11, 2020. Between school closings and quarantines and stay-at-home orders, the second quarter will be different. Although, in its earnings call, McGrath did note it is, so far, seeing more business delays as opposed to cancellations.

It appears on balance that in the instance of changes to [commercial] construction projects, the majority are delaying as opposed to canceling plans.

Some 5G infrastructure projects are pushing out resulting in higher than normal equipment returns and fewer new shipments, but we do not currently expect significant cancellations of installation work that major carriers have planned.

Many [storage and containment] projects are being delayed with lack of clarity on future starts as the industry deals with an unprecedented supply and demand imbalance. In other markets, construction projects are delaying. But, we are not seeing many cancellations at this point.

The company even reported acceleration in one of its key markets.

Most education projects appear to be proceeding as planned and a few are even starting earlier due to schools being vacant.

Key Market - Education

McGrath's Mobile Modular segment has long considered education a key market. Of the top 25 largest school districts in the United States, the segment operates in all but five.

McGrath provides education infrastructure solutions to California, Florida, North Carolina, South Carolina, Georgia, Maryland, Virginia, and Texas.

Source

In 2019, the Mobile Modular segment generated $301 million, 53% of total revenue. The educational market contributed approximately 41% of the segment's total or $123 million. Historically, McGrath has been the primary supplier of modular infrastructure to California's educational market. Geographically, across all industries, California provided approximately $126 million or 42% of the segment's total, 22% of the company's annual revenue.

In November 2016, the state approved Proposition 51, the California Public School Facilities Bonds Initiative. The statute authorized $9 billion of bonds to fund improvement and construction of public schools for kindergarten through 12th grade and community colleges.

On March 3, 2020, Californians voted on Proposition 13, a $15 billion bond for school facilities. Preschool through K-12 schools were to be allocated $9 billion. The remainder was to be split evenly between community colleges and the Cal State and University of California systems. The measure failed.

COVID-19 Impact

As of May 3, 2020, three of McGrath's key educational markets, California, Florida, and Texas, are among the top ten states impacted by COVID-19.

Source

Because of the virus, school resumption plans in each of the three states remain vague.

Texas' governor, Greg Abbott, confirmed on April 27th Texas schools will remain closed for the summer.

Florida's governor, Ron DeSantis, closed all schools until August on April 25th. He was to be presented a reopening plan on May 1st drafted by a 23-member task force.

California's governor, Gavin Newsom, is considering several paths to enable school re-openings, including smaller class sizes, staggered start times, and social distancing in common areas. On April 28th, he suggested the 2020/2021 school year could start in late July or early August.

Smaller class sizes and physical distancing at schools imply the need for more space. On the surface, such a need would imply potential for McGrath. However, school systems are hardly flush with funds. That's not likely to change soon, considering states' tax revenues will be lacking due to the current economic shutdown.

Of the nation's workforce that does continue to work, many are working from home. Until schools are reopened and child care reestablished, many working parents may find the need to work from home continue. This shift has bolstered network demand.

In the US, amid the surging demands for streaming and bandwidth, the Federal Communications Commission has temporarily increased broadband capacities for the next 60 days to accommodate surges in consumption.

Performance demands are placing 5G in the position to reach more markets than ever before.

This network demand, in turn, should bolster demand for the equipment of McGrath's TRS-RenTelco segment.

On the other hand, stay-at-home orders and working from home have decreased demand in the oil and gas industry. In April, the nation's attention turned to the lack of storage space for oil.

In any case, if storage tanks are full and it is not possible to store crude on floating tankers at sea, analysts expect producers to start shutting in wells - a process that can physically damage reservoirs and threatens the prospect of reviving future output.

Unfortunately, for Adler Tank Rentals, if storage tanks are full, they aren't likely to be scheduled for cleaning, maintenance, and repairs.

Share Price Action

In mid-February, McGrath's stock price hit a high of $83.95. It dropped to as low as $44.32 on March 23rd. It had since climbed back toward the $60 mark. After the company reported first quarter results on April 29th, the share price dipped to a range of $52 to $55.

At any price less than $56, McGrath's dividend yield tops 3%. The company bumped its dividend rate in February to $1.68 per share annually. This latest increase equated to a 12% bump and secured McGrath's place on the Dividend Champion list, a list of companies with a 25-year history of annual dividend rate growth.

After topping 60% in 2015 and 2016, McGrath's payout ratio throughout 2019 was less than 50%. The company's earnings would have to drop below $2.80 in 2020 for the payout ratio to return to at least the 60% level.

For earnings to drop to the $2.80 level, assuming the company maintained its 2019 profit margin of 17%, McGrath's revenue would have to slide below $400 million.

McGrath's Outlook

Initially, McGrath offered guidance for 2020 revenue in a range of $575 million to $595 million. The Adler Tank Rentals segment was expected to remain soft while the other two segments, Mobile Modular and TRS-RenTelco, were expected to experience healthy growth.

Yet, like the majority of companies, because of the pandemic, McGrath pulled its 2020 guidance when it reported first quarter results. Beyond the pandemic, McGrath's outlook remains healthy.

The need for 5G is growing.

Although COVID-19 has caused a surge in bandwidth consumption, pandemic or not the future rests in endless possibilities around ubiquitous computing and the need for 5G to keep up with real-time for users that are increasingly multi-screen streamers. By 2045, 5G networks are projected to generate $13.2 trillion in global sales. The industries poised to majorly benefit from the tech are manufacturing, information and communication, retail, public services and construction.

The need to address the nation's education infrastructure remains.

Public schools are the second largest sector of the country's infrastructure, after roads and highways, with more than 50 million children and adults setting foot in a public school every day. But half of those buildings are at least 50 years old and many are plagued by chronic facilities issues, including faulty heating and cooling systems, lead pipes and poor air quality.

Takeaway

McGrath RentCorp does have exposure during this COVID-19 pandemic. The question marks surrounding our nation's education infrastructure seem to be presenting the greatest risk currently.

Yet, the nation's education infrastructure needs should, ultimately, drive the company's recovery if it does a experience downturn because of the virus.

Analyst’s Disclosure: I am/we are long MGRC. 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.

I belong to an investment club that owns shares in MGRC.