It Has Happened, United Rentals Is A Dividend Stock - And A Great One At That!

Summary

• United Rentals is the world's largest rental company for heavy machinery and construction equipment.
• The company has a history of outperforming growth and a high likelihood of continuing this for many more years.
• URI initiated a dividend with a yield close to 1.3%. The company sees a lot of room for both aggressive M&A and shareholder distributions.
• Management aims to consistently grow its dividend.

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Introduction

United Rentals (NYSE:URI) has been on my radar for many years. The company is a fascinating industrial stock with an aggressive growth strategy and a terrific track record of high shareholder returns - despite the cyclical nature of its business. Now, the company is firing on all cylinders as it reported stellar earnings, a higher-than-expected outlook, a huge buyback program, and a dividend - for the first time in its history.

In other words, as someone who has close to 50% industrial exposure, it's time we assess United Rentals again - this time through the lens of a dividend (growth) investor.

So, let's get to it!

United Rentals Stands For Fast Growth

An American Success Story

On May 14, I wrote an article discussing United Rental's potential and low valuation. Since then, the stock has risen 60%, despite the high likelihood of a recession and a (related) steep decline in industrial sentiment.

United Rentals reminds me a lot of another industrial stock I recently covered: Old Dominion Freight Lines (ODFL). Like URI, it operates in a highly fragmented and cyclical industry with low entry barriers. And like URI, its stock price has defied gravity.

Also, United Rentals was founded by Bradley Jacobs, the same man who founded XPO Logistics (XPO), the company that spun off RXO Inc. (RXO) and GXO Logistics (GXO)

URI shares are up 27% year-to-date and up almost 40% over the past 12 months. Not bad for a cyclical stock with an economy on the brink of a recession.

FINVIZ

Despite its market cap of $31.4 billion and its massive footprint of 1,462 locations in North America, United Rentals' market share is just 17%. Don't get me wrong, 17% is a lot, and the company is the biggest operator in the industry.

United Rentals

I'm bringing this up because this fragmented market offers a lot of room for growth. It implies that the company has an addressable market of at least $58 billion. This addressable market is rapidly growing.

URI benefits from an ever-increasing need for outsourcing. Customers are looking to conserve capital and only pay for equipment when they need it. After all, companies aren't looking to spend hundreds of thousands on large machinery if they don't need it almost 24/7. It also saves related costs like maintenance, storage, and risks. You always get access to fully-maintained top-tier equipment when you have a new task.

United Rentals

United Rentals has several benefits itself.

• Size- The company is large enough to service large customers that require substantial quantities of equipment. Smaller companies cannot compete with that.
• Variety- Its size also comes with variety, meaning it has equipment for special purposes. Again, smaller operators cannot compete with that.
• Purchasing power- When URI buys new equipment, it has a much better position when it comes to negotiating better prices. Again, it's related to the "size" benefit.
• The National Account Program- This program establishes long-term relationships with large companies with a national or multi-regional presence. This combines all the benefits above and ties them to long-standing customers.

Thanks to these benefits, the company has strong, outperforming growth rates. These are the compounding annual growth rates between 2012 and 2022:

• Total revenue: 11.0%

Drivers include higher industrial exposure and growth in non-cyclical specialty segments.

• Adjusted EBITDA: 12.2%

Outperforming EBITDA growth was supported by an improvement in EBITDA margins of 2,200 points versus 2009.

• Adjusted EPS: 24.1%

Needless to say, these growth rates are not organic. United Rentals has a history of some major acquisitions to boost growth.

United Rentals

In December 2022, the company completed the Ahern Rentals acquisition for $2.0 billion in cash. The deal added 2,100 employees and 60,000 rental assets to URI's portfolio.

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These growth rates have also provided the company with high free cash flow. As you can imagine, URI is very capital-intensive. In 2022, the company spent roughly a third of its revenues on CapEx. Before 2012, the company struggled to generate free cash flow as CapEx was high compared to operating cash flow. This makes sense. The company was founded in 1997. It's a young company, and becoming the largest equipment leasing company in the world comes with a ton of investment needs.

Data by YCharts

As the chart below shows, the company started to generate a lot of free cash flow after 2015. The company is now generating roughly $0.31 in FCF on every $1 of EBITDA. That's up from $0.20 before the Great Financial Crisis.

United Rentals

Going forward, free cash flow is expected to continue to grow. In 2023, free cash flow could come in at $2.1 billion, which implies 23% growth. The numbers below show the expected FCF growth rates and the FCF margins going forward. Needless to say, they are subject to change as economic developments are impossible to predict. However, it gives you an idea of what URI is capable of.

• 2023E: FCF growth: 23%, FCF margin: 15%
• 2024E: FCF growth: 19%, FCF margin: 17%
• 2025E: FCF growth: 13%, FCF margin: 18%

Moreover, the company's leverage is in a steep downtrend. In 2019, its net debt ratio was 2.6x EBITDA. In 2022, that number was 2.0x. In 2025, it is expected to be 1.2x. Needless to say, share buybacks could prevent that from happening. However, that would come with new benefits, like stronger EPS growth. Its credit rating reflects these numbers. In November, Moody's assigned a Baa3 rating to the company's new first lien notes.

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With all of this in mind, something major has changed.

URI Is Now A Dividend Stock

A Decent Yield And The Intent To Grow The Dividend Consistently

I'm paraphrasing here, but Robert Shiller once said that the aim of any investment is that it will eventually pay a dividend. There are exceptions, but I don't disagree with him.

In addition to buying back shares for many years, URI has initiated a dividend. According to its management on January 26:

We plan to buy back $1 billion of stock this year. And we’ll also be instituting quarterly dividends for our shareholders, totaling $5.92 per share this year. These two decisions underscore our confidence in the durability of our cash generation and the strength of our balance sheet. And together, they’ll return $1.4 billion of capital to our shareholders in 2023.

The company initiated a quarterly dividend of $1.48 per share. This translates to $5.92 per year and implies a 1.3% yield.

This dividend will cost the company roughly $400 million, which is 18% of free cash flow. That is a very healthy payout ratio with more upside - especially if we consider that free cash flow growth is likely to remain high.

One of the questions the company got during its earnings call was whether the dividend would interfere with its plans to grow through M&A. After all, an efficient M&A strategy is based on acquiring companies, boosting synergies and free cash flow, and rapidly reducing debt again. URI has mastered that.

Hence, due to improving free cash flow and lower CapEx needs as a percentage of revenue, the company is now in a good spot to both pay a dividend and engage in future M&A.

When you look at the past two years and the kind of growth we drove, including significant M&A, we still have the capacity and free cash flow to give a dividend. So we had asked that question by someone earlier, are you given a dividend because of less growth prospects? No, quite contrary, it’s because even after supporting growth, we have excess cash to return, and that’s push points to the resiliency of our strong free cash flow through the cycle.

Now, the question is what the plans are going forward. Like most companies, URI cannot promise a specific dividend growth rate. Doing that would be too risky. However, the company's comments provide investors with the hope that the dividend might be raised consistently. According to CFO Ted Grace:

[...] the intent is to continue to grow the dividend over time. It’s fully our expectation. We’ll continue to grow the company over time. We’ll continue to expand margins. We’ll continue to generate more cash. And so one of the things that dividend allows us to do is have another tool to return that excess cash to investors as we keep growing.

So, what about the valuation?

Valuation

Not Expensive Despite A Strong Performance, But Macro Headwinds Weigh On Risk/Reward

URI shares are trading at 6.3x NTM EBITDA, which is based on its $31.4 billion market cap, $10.6 billion in 2023E net debt, and $6.7 billion in 2023E EBITDA.

This valuation is not overvalued by any means. The same goes for the implied 2023 FCF yield of 6.7%.

Data by YCharts

These numbers offer good value. Unfortunately, macroeconomic developments could ruin the party.

The upper part of the chart below shows the URI stock price. The lower part shows the percentage URI is trading below its all-time high (red line). It also shows the ISM Manufacturing Index.

TradingView (URI, URI Drawdown vs. ISM)

It is highly uncommon that a divergence this big occurs. At this point, there are two options.

1. URI is right and indicates a steep economic improvement.

There are reasons to believe that URI is right, as it sees between $13.7 and $14.2 billion in 2023 revenue. That beat consensus estimates of $13.6 billion by a wide margin.

Moreover, its comments were good.

Longer-term outlook for our industry continues to be very favorable, driven by several tailwinds that we believe are largely independent of macro conditions. And we’ve talked about these before, things like infrastructure spending, the Inflation Reduction Act and the return of manufacturing to North America as well as investments in both energy and power.

Also note that the company mentions re-shoring of supply chains, which is a big topic I started to discuss way more in 2022.

Unfortunately, reason #2 isn't unbelievable, either.

2. Economic growth will come down, hurting business expectations.

While I do not doubt that URI sees strong secular growth, high utilization rates, and other benefits, I still believe that economic growth will not come back roaring. The Fed is still fighting inflation and unlikely to provide the economy with the room it needs to start a healthy uptrend.

Hence, I would not be surprised if even expectations of strong companies like URI were to be revised lower in the months ahead.

That would pressure its stock price.

Needless to say, my recommendation remains to buy URI on weakness. Look for 15% to 20% weakness, which would make the risk/reward extremely attractive.

Data by YCharts

Takeaway

United Rentals continues to impress. This time it also comes with a dividend.

I believe that United Rentals is a great dividend (growth) stock for investors seeking industrial exposure with secular growth. While URI operates in an industry with low entry barriers, it has perfected the art of gaining market share.

The company is capable of strong long-term growth. It has a healthy balance sheet, high free cash flow, and the ability to reward investors with long-term dividend growth on top of buybacks.

While the valuation is fair, I believe that economic headwinds will provide us with new buying opportunities down the road.

That's why I give the stock a neutral rating for now.

(Dis)agree? Let me know in the comments!

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.