Ashtead Group rents construction and industrial equipment across a wide variety of applications. Ashtead is North America’s second largest equipment rental company and operates in US, Canada and UK under the brand name Sunbelt Rentals.
Nice write-up. What are your thoughts on clustering & how that has improved economics & provided a platform to distributed more specialty equipment in a geographic area with a small amount of incremental investment & thus large incremental margins? Also, the strategy of green fielding locations that are clustered to gain market share & using M&A to enter new markets. Equipment rental is a local market share business thus Ashtead can have higher RoA than larger competitors like URI if its local market shares are greater than URIs. IMO your cap-ex estimates include growth cap-ex which has generated the 20%+ growth & does not include the affects of disposals. If you make those adjustments I get a terminal cap-ex of 19% of sales for replacement cap-ex only (as would be implied in a terminal value). The historical 5-yr FCF margins are at 10% including growth cap-ex and 29% before acquisitions (see latest investor presentation page 28). So IMO your terminal FCF margins (AT) should be somewhere between 10% and 29%. Using a current EBITDA multiple in terminal assumes that the terminal will have same capital intensity as today when the company is in high growth mode. This will not be the case for Ashtead so using a terminal multiple of FCF or adjusted NI may be more appropriate.
We like the clustered approach, it seems to be strengthening the competitive positioning of the company and at the same time is increasing returns evident by better EBITDA margins and ROI of clustered markets compared to non-clustered. The improved profitability coming from the sharing of resources between locations (i.e. fleet, staff, etc.) reduces cost per unit and increases dollar utilization. Clustered markets are also good from the customer side as they increase availability and ease.
Regarding specialty, we think that management’s strategy of launching new products in existing locations makes sense as the incremental investment is low and therefore returns on those incremental revenues will be higher therefore improving EBITDA and ROI.
In terms M&A, we think small acquisitions make sense as long as the Company pays a reasonable price. On the other hand, we think that large acquisitions increase the risk of diminishing returns on capital, however they might be necessary in case of entering in new geographic markets.
Regarding CAPEX: What you are saying makes sense as for the terminal year the usual assumption is to keep CAPEX equal to replacement capex which in the long run equals depreciation (unless you expect capital base to deplete). In the case of Ashtead though, we do not believe that the mature phase will be reached in the next 5 years given the ongoing industry consolidation which per our view is unlikely to be completed in the next 3-5 years (we might be wrong but that’s our best guess). That’s the reason we used an EV/EBITDA multiple to estimate the value in 5 years’ time rather than a Gordon Growth model as you suggested. Effectively, the 28% CAPEX assumption for the last projected period, before the terminal year does include a growth factor in it. At the terminal year, we apply a multiple of 7x with the assumption that Ashtead will still be valued at similar levels as its historic average since we do not expect the grow to slow down.
What we could have done instead, would be to extend the projection period to 10 years and subsequently apply a constant growth model with a terminal growth equal to GDP, say 3.5% for the sake of simplicity, and a replacement only CAPEX as you suggested. Doing a quick calculation, in which growth is gradually reduced to get to 3.5% and CAPEX is reduced to 19% (resulting FCF margin is over 21%), yields a similar value (less than 5% deviation).
Thanks. Using the 7x multiple has some circularity & many implicit assumptions such as the stock is fairly in the today & in the past so the only difference you will get in value from today is from your 5 year forecasted FCFs. The period over which you derive your CapEx is higher EBITDA growth than your forecast (15% historically vs 9% for forecast). I believe you are assuming the rental equipment has zero value when it is at the end of its life which is not true based upon the disposal proceeds Ashtead receives. This will add about 5 to 7% to your FCF margins in your DCF.
Both terminal multiple and Gordon growth approaches have their own merits and both are considered widely accepted valuation methods. If you believe that the multiple used was not appropriate, please check the scenario analysis where you can get a better estimate of the value based on your own assumptions.
Additionally, we do not make any assumption that the equipment rental has a finite life nor that the terminal value (which goes to perpetuity) has zero value. Not sure how you reached that conclusion. If the point is that FCF should have been higher, fair enough. On the other hand, we feel comfortable with the ‘prudent’ assumptions used.
On another note, Season's Greetings and best wishes for 2023.
The terminal multiple approach has many implicit assumptions that Gordon Growth makes explicit. It is widely used but IMO used without stating & understanding the implicit assumptions. The DCF method you show in your analysis (you may have another method you do not show) is basically applying an EBITDA multiple to a future level of EBITDA (this is an overwhelming majority of the value derived) and discounting it to today. You can see in your sensitivity analysis that the key driver is terminal EBITDA multiple chosen. Thus it may be useful to provide a rationale for why the chosen multiple is appropriate & what the underlying implicit assumptions are in this assumption (like future growth rates, margins, capital intensity, etc. and how these compare to historical & market benchmarks). IMO DCF can be more useful if explicit assumptions (discount rates, growth rates, investment & margins) can be modeled & sensitivities performed. Ashtead is a rental business & thus there is terminal value in the equipment. By only including the purchase of the equipment in your investment without adding back the receipt of sale of the equipment (which is a recurring activity based upon business model) at end of life the investment is overstated to generate the future cash flows (EBITDA). Have a nice holiday & 2023 also.
Nice write-up. What are your thoughts on clustering & how that has improved economics & provided a platform to distributed more specialty equipment in a geographic area with a small amount of incremental investment & thus large incremental margins? Also, the strategy of green fielding locations that are clustered to gain market share & using M&A to enter new markets. Equipment rental is a local market share business thus Ashtead can have higher RoA than larger competitors like URI if its local market shares are greater than URIs. IMO your cap-ex estimates include growth cap-ex which has generated the 20%+ growth & does not include the affects of disposals. If you make those adjustments I get a terminal cap-ex of 19% of sales for replacement cap-ex only (as would be implied in a terminal value). The historical 5-yr FCF margins are at 10% including growth cap-ex and 29% before acquisitions (see latest investor presentation page 28). So IMO your terminal FCF margins (AT) should be somewhere between 10% and 29%. Using a current EBITDA multiple in terminal assumes that the terminal will have same capital intensity as today when the company is in high growth mode. This will not be the case for Ashtead so using a terminal multiple of FCF or adjusted NI may be more appropriate.
Thank you for your comments.
We like the clustered approach, it seems to be strengthening the competitive positioning of the company and at the same time is increasing returns evident by better EBITDA margins and ROI of clustered markets compared to non-clustered. The improved profitability coming from the sharing of resources between locations (i.e. fleet, staff, etc.) reduces cost per unit and increases dollar utilization. Clustered markets are also good from the customer side as they increase availability and ease.
Regarding specialty, we think that management’s strategy of launching new products in existing locations makes sense as the incremental investment is low and therefore returns on those incremental revenues will be higher therefore improving EBITDA and ROI.
In terms M&A, we think small acquisitions make sense as long as the Company pays a reasonable price. On the other hand, we think that large acquisitions increase the risk of diminishing returns on capital, however they might be necessary in case of entering in new geographic markets.
Regarding CAPEX: What you are saying makes sense as for the terminal year the usual assumption is to keep CAPEX equal to replacement capex which in the long run equals depreciation (unless you expect capital base to deplete). In the case of Ashtead though, we do not believe that the mature phase will be reached in the next 5 years given the ongoing industry consolidation which per our view is unlikely to be completed in the next 3-5 years (we might be wrong but that’s our best guess). That’s the reason we used an EV/EBITDA multiple to estimate the value in 5 years’ time rather than a Gordon Growth model as you suggested. Effectively, the 28% CAPEX assumption for the last projected period, before the terminal year does include a growth factor in it. At the terminal year, we apply a multiple of 7x with the assumption that Ashtead will still be valued at similar levels as its historic average since we do not expect the grow to slow down.
What we could have done instead, would be to extend the projection period to 10 years and subsequently apply a constant growth model with a terminal growth equal to GDP, say 3.5% for the sake of simplicity, and a replacement only CAPEX as you suggested. Doing a quick calculation, in which growth is gradually reduced to get to 3.5% and CAPEX is reduced to 19% (resulting FCF margin is over 21%), yields a similar value (less than 5% deviation).
Thanks. Using the 7x multiple has some circularity & many implicit assumptions such as the stock is fairly in the today & in the past so the only difference you will get in value from today is from your 5 year forecasted FCFs. The period over which you derive your CapEx is higher EBITDA growth than your forecast (15% historically vs 9% for forecast). I believe you are assuming the rental equipment has zero value when it is at the end of its life which is not true based upon the disposal proceeds Ashtead receives. This will add about 5 to 7% to your FCF margins in your DCF.
Both terminal multiple and Gordon growth approaches have their own merits and both are considered widely accepted valuation methods. If you believe that the multiple used was not appropriate, please check the scenario analysis where you can get a better estimate of the value based on your own assumptions.
Additionally, we do not make any assumption that the equipment rental has a finite life nor that the terminal value (which goes to perpetuity) has zero value. Not sure how you reached that conclusion. If the point is that FCF should have been higher, fair enough. On the other hand, we feel comfortable with the ‘prudent’ assumptions used.
On another note, Season's Greetings and best wishes for 2023.
The terminal multiple approach has many implicit assumptions that Gordon Growth makes explicit. It is widely used but IMO used without stating & understanding the implicit assumptions. The DCF method you show in your analysis (you may have another method you do not show) is basically applying an EBITDA multiple to a future level of EBITDA (this is an overwhelming majority of the value derived) and discounting it to today. You can see in your sensitivity analysis that the key driver is terminal EBITDA multiple chosen. Thus it may be useful to provide a rationale for why the chosen multiple is appropriate & what the underlying implicit assumptions are in this assumption (like future growth rates, margins, capital intensity, etc. and how these compare to historical & market benchmarks). IMO DCF can be more useful if explicit assumptions (discount rates, growth rates, investment & margins) can be modeled & sensitivities performed. Ashtead is a rental business & thus there is terminal value in the equipment. By only including the purchase of the equipment in your investment without adding back the receipt of sale of the equipment (which is a recurring activity based upon business model) at end of life the investment is overstated to generate the future cash flows (EBITDA). Have a nice holiday & 2023 also.