United Rentals Rides on Strong End Market Demand, Costs High

Impressive earnings trend, strong end market demand, accretive acquisitions and prudent investments in fleet have been benefiting United Rentals Inc. (URI.

However, higher costs, trimmed outlook for 2019 in response to adverse weather and temporary challenges regarding the integration of the BlueLine buyout are concerns. Notably, shares of United Rentals have underperformed its industry year to date. The stock has gained 2.3% compared with the industry’s rise of 24.9% in the said time frame. Also, estimates for 2019 have trended downward in the past 30 days, which reflects analysts’ concern over the company’s earnings growth potential.

Recently, the company reported second-quarter 2019 results, with adjusted earnings and revenues surpassing the Zacks Consensus Estimate by 5.8% and 1.1%, respectively. In fact, the company has an impressive earnings and revenue surprise trend. Its earnings surpassed expectations in 13 of the last 14 quarters. Moreover, second-quarter earnings and revenues rose 23.1% and 21.1% year over year, respectively. Also, adjusted EBITDA increased 18.3% from the prior-year quarter’s tally to a record of $1.07 billion.

Meanwhile, the company’s ROE of 42% compares favorably with the industry’s 12.7%, which indicates the company’s efficiency in using shareholders’ funds. The company believes that positive construction market outlook and recent acquisitions will boost results in the upcoming quarters.

Let’s delve deeper into the factors that substantiate its Zacks Rank #3 (Hold).

Key Growth Drivers

Strong End Market Demand:  United Rentals serves the following three principal end markets for equipment rental in North America — industrial and other non-construction, commercial construction as well as residential construction. In second-quarter 2019, equipment rentals contributed 86% to the company’s total revenues. Overall construction market scenario were positive through first-half 2019. The company expects upbeat results in the second half as well, given improved demand condition in construction end-markets served. Infrastructure, especially transportation and power are major tailwinds.  However, end-market demand is broad based, with strength in the United States and Canada.

Meanwhile, the company generates a substantial portion of its revenues from the energy sector. Courtesy of this factor, United Rentals is well poised to benefit from any improvement in energy sector activity in the upcoming months. The company also expects its equipment rental services to experience solid demand in 2019. Notably, weakness in the upstream business was observed during first-half of this year but downstream or midstream businesses are still strong.

Expansion Via Acquisitions: United Rentals is expanding geographic borders and product portfolio through acquisitions and joint ventures. On Nov 30, 2018, the company announced the acquisition of WesternOne Rentals & Sales LP, a leading regional equipment rental provider in Western Canada. The acquisition enabled United Rentals to expand services to Alberta, British Columbia and Manitoba.

Moreover, the company acquired BlueLine on October 2018. The buyout continues to be significant as it boosts United Rentals’ capacity across the largest metropolitan areas in North America, including the U.S. coasts as well as the Gulf South and Ontario. The buyout is likely to increase the company’s fleet by more than 46,000 rental assets across 114 branch locations.

For 2019, the company is focusing on its strategy to improve profitability through superior standard of service to customers and acquisitions to expand core equipment rental business along with continued expansion of trench, power and pump footprint as well as tool offerings.

Headwinds

Acquisitions Pressurize Near-Term Margins: Although consistent acquisitions are expected to generate long-term growth for United Rentals, these have exerted pressure on margins. Adjusted EBITDA margin was 43.5% in the first quarter, calling for a decline of 150 basis points (bps) year over year. In the second quarter, adjusted EBITDA margin contracted 110 bps to 46.9%. The downside was primarily caused by the impact of BlueLine and Baker buyouts. The company also trimmed full-year guidance to reflect a slightly slower-than-expected pace for the BlueLine integration as well as historic bad weather in several key regions in the past quarter. Adjusted EBITDA is projected between $4.35 billion and $4.5 billion (versus $4.35-$4.55 billion projected earlier) compared with $3.86 billion in 2018.

Higher Costs: Ongoing higher freight and fuel costs mar growth prospects of the company. Also, labor shortages are a problem. In the first half of 2019, total cost of revenues rose 24.5% year over year. Also, cost of equipment rentals rose 24.7% in the first half of 2019.

Stocks to Consider

Some better-ranked stocks in the Zacks Construction sector are Frontdoor, Inc FTDR, Aegion Corporation AEGN and Construction Partners, Inc ROAD. While Frontdoor sports a Zacks Rank #1 (Strong Buy), Aegion and Construction Partners carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Frontdoor and Aegion have an impressive long-term expected earnings growth rate of 15.5% and 10%, respectively.

Year to date, shares of Construction Partners have surged 58.2%.

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