Herc Holdings Inc. (NYSE:HRI) Q1 2024 Earnings Call Transcript

Herc Holdings Inc. (NYSE:HRI) Q1 2024 Earnings Call Transcript April 23, 2024

Herc Holdings Inc. misses on earnings expectations. Reported EPS is $2.29 EPS, expectations were $2.48. Herc Holdings Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. My name is Dennis, and I will be your conference operator today. At this time, I’d like to welcome everyone to the Herc Holdings First Quarter 2024 Earnings Call and webcast. [Operator Instructions] I would now like to turn the conference over to Leslie Hunziker, Head of Investor Relations. Please go ahead.

Leslie Hunziker: Thank you, operator, and good morning, everyone. Welcome to Herc Rentals first quarter 2024 earnings conference call and webcast. Earlier today, our press release and presentation slides were furnished, and our 10-Q was filed with the SEC. All are posted on the Events page of our IR website. Today, we’re reviewing our first quarter 2024 results, with comments on operations and our financials, including our view of the industry and our strategic outlook. The prepared remarks will be followed by an open Q&A. Now, let’s move on to our Safe Harbor and GAAP reconciliations on Slide 3. Today’s call will include forward-looking statements. These statements are based on the environment as we see it today, and therefore involve risks and uncertainties.

I would caution you that our actual results could differ materially from the forward-looking statements made on the call. You should refer to the Risk Factors section of our annual report on Form 10-K for the year ended December 31, 2023. In addition to the financial results presented on a GAAP basis, we will be discussing non-GAAP information that we believe is useful in evaluating the company’s operating performance. Reconciliations for these non-GAAP measures to the closest GAAP equivalent can be found in the conference call materials. A replay of this call can be accessed via dial-in through our webcast on our website. Replay instructions were included in our earnings release this morning. We have not given permission for any other recording of this call, and do not approve or sanction any transcribing of the call.

Finally, please mark your calendars to join our management team at three industrial conferences this quarter. We’ll be at Bank of America’s conference on May 14th in New York, KeyBanc’s conference in Boston on May 30th, and Wells Fargo’s Chicago conference on June 11th. This morning, I’m joined by Larry Silber, President and Chief Executive Officer, Aaron Birnbaum, Senior Vice President and Chief Operating Officer, and Mark Humphrey, Senior Vice President and Chief Financial Officer. I’ll now turn the call over to Larry.

Larry Silber: Thank you, Leslie, and good morning, everyone. Let’s turn to slide number four. We’re off to a solid start in 2024. Revenue and adjusted EBITDA were first quarter record highs, driven by continued strong volume growth and a 5% increase in rental rate year-over-year. These results reflect total company performance, including our Cinelease business. Our flexible business model, diverse customer base, and broad equipment portfolio, enabled us to generate topline growth in the first quarter across both core and specialty categories, and local and national accounts. By capturing an outsized share of market volume, generating rate growth to offset fleet inflation, and delivering operating efficiencies, adjusted EBITDA increased 10% over the prior year.

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Q&A Session

Reported adjusted EBITDA margin in the first quarter benefited from operating leverage and the early stages of recovery in the Studio Entertainment market after last year’s labor strikes. Mark will take you through the core business performance, excluding Cinelease, in just a minute. The core business is where we align with our full-year guidance. Moving to Slide 5, you can see that the successful execution of our strategies is driving our continued improved performance. As we scale our business for sustainable growth, we are investing in expanding our branch network. In the first quarter, we completed four strategic acquisitions, and opened four greenfield locations in key markets. We also invested in our high-margin ProSolutions fleet to address growing demand, capture cross-selling synergies, and support new specialty locations.

Our specialty offering is expanding, with our investments in trench shoring over the last two years. In fact, in the first quarter, we acquired our largest trench shoring business to date, bolstering our expert solutions offerings for our customers. Our innovative customer-facing digital capabilities are also improving the customer experience, while streamlining transactions and enhancing productivity. When it comes to capital allocation, our current strategy reflects where we are in terms of our opportunity to grow the business. With all of the capabilities we’ve built over the last eight years, from systems to procurement to logistics to product and end market expertise, and at a time in the cycle where federally-funded mega projects and manufacturing reshoring are setting the stage for a multi-year foundational growth, investments in fleet and M&A continue to be priorities of our capital allocation framework.

We view capital allocation as a strategic lever for us to generate value, and we feel really good about our progress on that front. One of the ways we’re ensuring we create value from those investments is through the rollout of our business operating system E3OS. Through standardized processes and continuous improvement mindset, E3OS touches every aspect of our business, with the goal of ensuring Herc Rentals is easier to do business with, expert at what we do, and efficient in serving our customers. E3OS initiatives are already being put in place across the organization, and incremental progress will go a long way toward delivering a superior experience for our customers, and greater operating leverage for our business. With that, I’ll turn it over to Aaron to take you through the first quarter operating details, and provide some color on market trends, and then Mark will walk you through a more detailed financial review, both with and without Cinelease.

Aaron?

Aaron Birnbaum: Thanks Larry, and good morning, everyone. There is a lot to like about how our teams are delivering for our customers. Everyone is laser focused on leveraging our scale, go-to-market approach, pro control and next-gen technology, and one-stop shop equipment offering to support our customers’ success. In the first quarter, new accounts are up year-over-year, and contributions to revenue growth are being delivered across the board. I’m really proud of the way our team continues to focus on delivering a superior customer experience while executing well against our strategic growth initiatives. Execution starts with safety, and of course, safety is always at the core of everything we do. As you can see on Slide 7, our major internal safety program focuses on perfect days, and we strive for 100% perfect days throughout the organization.

In the first quarter, on our branch by branch measurement, all of our operations achieved at least 97% of days as perfect. Equally notable, our total recordable incident rate remains better than the industry’s benchmark of 1.0, reflecting our high standards and commitment to the safety of our people and our customers. On Slide 8, you can see that we are making great progress on our urban market growth strategy by expanding through greenfield locations and acquisitions in the top 100 metropolitan markets. In the first quarter, we spent $148 million in net cash on four acquisitions in the west and in the northeast, adding a total of 11 locations to our network. We also opened four Greenfield locations in the first three months of the year, bringing our total over the last 12 months to 22, which is nearly a 50% increase over the comparable trailing 12-month period.

As you know, we are focused on opportunities in high growth markets that complement our current branch network and fit our strategic, financial, and cultural filters. Moreover, many of the mega industrial and manufacturing reshoring projects being announced, are in the geographies where we have focused our acquisitions and greenfield additions, like Texas, Ohio, Arizona, and along the eastern seaboard of the United States. Our acquisition process is now a core competency, having successfully integrated 46 businesses with 98 locations into the Herc network since initiating the strategy in late 2020. As a result of revenue efficiencies, we’ve been generating synergized multiples of approximately 3.5x to 4.5x. New acquisition opportunities are as robust as ever, and we are actively focused on those that make the most strategic sense for our business in the top MSAs. On Slide 9, in addition to acquisitions, growing our core and specialty fleet through new equipment investments is a key strategy to expanding our share and keeping up with the increasing demand opportunities.

Our fleet composition at OEC is on the right side of the page. Total fleet is now a record $6.4 billion as of March 31, 2024. Cinelease fleet represents about 5% of the total. So, when you exclude the Cinelease assets held for sale, our base fleet would’ve been about $6.1 billion. You’ll note that higher margin specialty fleet represents approximately 24% of the total today. Excluding the Cinelease fleet, specialty makes up about 20% of the total, with plenty of room to continue to grow. When it comes to fleet investments, you can see we’ve slowed our intake to a more seasonal level in the first quarter this year versus last year, when the recovery in the supply chain meant we were onboarding a high level of backorder deliveries of 2021 and 2022 fleet out of season.

For the full year, we still expect to spend in the range of $750 million to $1 billion on new fleet purchases. That gross amount, along with last year’s growth fleet purchases, should provide for incremental demand from general market expansion, greenfields, and the mega projects that are either underway, or that we have a high probability line of sight to. Our level of fleet investment this year also reflects our goal to improve fleet efficiency. Now that we have more confidence in delivery timing, disciplined investment will support that goal as we head into the peak season. Finally, we are planning for a lower level of replacement fleet compared to last year when we worked aggressively to get caught up on deferred fleet disposals as the supply chain recovered.

This year, you should expect to see a more normal seasonal cadence of dispositions where first quarter and fourth quarter are the highest levels of fleet sales, and second quarter and third quarter are lower as we focus on bringing in new equipment. You could see that last year’s trend was unusual, with dispositions peaking in the third quarter. In the 2024 first quarter, fleet disposals at OEC were essentially flat compared to last year, but we continued to gain traction on our retail channel capabilities, utilizing technology, training, and sales force incentives to participate more in this higher return channel. The amount of fleet at OEC that we sold to retail and wholesale customers increased 900 basis points from last year. Proceeds at 50% of OEC were slightly lower year-over-year, despite the successful channel shift due to the more favorable mix of equipment being sold in the first quarter last year.

So, a bit of a tougher comp year-over-year, but overall, we have a nice opportunity ahead as we execute our more profitable channel shift strategy. We are still planning for about $550 million to $650 million of planned fleet disposals at OEC in 2024. Turning to slide 10, today, our fleet is well positioned to address the needs of large national accounts and local contractors operating in North America. Local accounts, which represented 55% of rental revenue in the first quarter, are growing due to Herc’s penetration through our acquisition and greenfield strategy, as well as regional growth and infrastructure, education, local utilities, and facility maintenance and repair. Our national accounts are capitalizing on new projects for battery and EV utility maintenance, renewables, semiconductor plants, and data centers.

Long term, we’ll continue to target a 60/40 revenue split between local and national accounts. Turning to Slide 11, overall, we are continuing to see solid demand across a variety of end markets, customer segments, and geographies in 2024. This diversification provides for growth and resiliency. Based on the timing of our mega projects this year, revenue growth will be more weighted toward the third and fourth quarters. And our disciplined fleet onboarding, which starts building through the second quarter, is aligned with the expected seasonal ramp and demand to October’s peak. Team Herc is already gearing up, and I want to thank them for their commitment to operational excellence and safety. Their professionalism shows up in the execution of our services to our customers every single day.

It’s a big reason for the long tenure of our national account customers and for the new business we’re winning on local and mega projects. Now, I’ll pass the call on to Mark.

Mark Humphrey: Thanks, Aaron, and good morning, everyone. I’m starting on Slide 13, with a summary of our key metrics for the first quarter. For clarification, these are our GAAP results and include the Cinelease performance. Rental revenue increased 10% year-over-year. DOE and SG&A as a percent of rental revenue improved 50 basis points in the quarter, supporting a 12% improvement in adjusted REBITDA. The adjusted REBITDA margin of 43.1% was a 70-basis point increase year-over-year, and adjusted REBITDA flow-through was roughly 51%. Net income reflected 27% higher interest expense year-over-year from increased borrowings on our ABL revolver to fund acquisitions, and a 75-basis point increase in the Fed funds rate. Additionally, our effective tax rate increased by 910 basis points in the latest quarter, primarily as a result of a reduced benefit related to stock-based compensation specific to the first quarter.

Let’s walk through some of the other key performance drivers on Slide 14. Here, you can see the rental revenue and adjusted EBITDA walks from the first quarter 2023 to first quarter 2024. In the revenue chart, the roughly 10% increase year-over-year was made up of a 5.1% increase in rate, and an 8% increase in OEC fleet on rent. Mix was an offset of about 3%, reflecting the net of higher equipment inflation and a more favorable mix of equipment on rent. For clarification, when it comes to revenue, fleet inflation is included in the mix to adjust the volume measured at OEC dollars to a unit metric. Adjusted EBITDA benefited from higher rental revenue and lower operating expenses as a percent of revenue. Adjusted EBITDA margin was 60 basis points higher year-over-year, driven by a $10 million or 53% increase in Cinelease revenue in the 2024 first quarter, partially offset by last year’s higher fleet disposition proceeds.

Our core financial results on Slide 15 excludes Studio Entertainment from both periods, in order to give you a better sense of how the base business performed in the quarter. The full reconciliation of quarterly performance metrics, excluding Studio Entertainment, can be found on Slide 25 in the appendix of our presentation. Fleet efficiency ratio, rental revenue growth divided by fleet growth, improved sequentially from 0.65 in the fourth quarter of 2023, to 0.86 in the first quarter of 2024, on average fleet growth in the first quarter of 11% as our fleet rotation returns to a normal cadence. Strong rental revenue growth of 9% translated into a 20-basis point improvement in adjusted REBITDA margin as a result of favorable operating leverage.

Core REBITDA flow-through declined to 46.4% in the first quarter of 2024. To preserve REBITDA flow-through at the first quarter 2023 level, we would’ve only needed to generate an additional $1 million of REBITDA Q1 2024. Affecting the flow-through on a year-over-year basis is the transition in 2024 to a normalizing macro environment on the higher cost basis of our new greenfields and acquisitions, compared with a post COVID hyper demand environment, which more easily absorbed these pre-synergized expenses. These locations are strategic investments in expanding network coverage and scale benefits, but initially can put pressure on efficiency for approximately 24 months until we can get them up to speed. That impact is amplified as growth adjusts to more historic average annual rates and shows up in flow-through.

Despite the timing differential of the normalizing demand and the synergy realization, we expect our flow-through for the full year to be at or above 50%, which is still in scope with our 2026 plan as we deliver on the higher targeted 10% to 14% rental revenue CAGR. Trailing 12-month ROIC for the core business declined 30 basis points to 10.9% at the end of the quarter. Absorbing all the backorder in an out-of-season fleet that was delivered throughout 2023, had a negative impact on ROIC. However, with the prudent onboarding of fleet in the 2024 first quarter and the focus on improving fleet efficiency, we expect to see improvement in the coming quarters. Shifting to capital management on Slide 16, you can see we have no near-term maturities and ample liquidity to fund our growth goals as we continue to allocate capital to invest in our business and drive fleet growth into this cycle.

Higher operating cash flow and significantly lower net capital expenditures resulted in $92 million of free cash flow in the first quarter. Our current leverage ratio at 2.5x is well within our 2x to 3x target range and in line with our expectations as we invest in growth. we remain confident in our business model and are committed to increasing shareholder value. In the first quarter, we announced a 5% increase in our quarterly dividend for 2024 $0.665, which represents $2.66 per share for the year. Finally, we’re pleased to report that S&P upgraded our corporate credit rating to BB earlier this month, while also raising the rating on our senior unsecured notes to BB minus. This stable outlook reflects S&P’s view that the US equipment rental industry is poised for continued growth, and that Herc will benefit from our position as one of the largest industry players with a sizable and diverse fleet.

On slide 17, you can see that continued strength in our primary end markets. In the upper left, the ARA estimate for 2024 North American rental industry revenue is $83 billion. On the bottom left is the architectural billing index that recorded a score of 49.5 in the March release, up significantly from February’s 46.2. inquiries into new projects grew at their fastest pace since November, and the value of design contracts increased at their fastest pace since last summer. These are positive signs for future growth according to API. Taking a look at the industrial spending forecast on the top right, Industrial Info Resources is projecting 2024 to be the second highest level on record at $436 billion, on top of last year’s peak $442 billion spend.

In the lower right quadrant is Dodge’s forecast on non-residential construction starts. 2024 starts are estimated to increase 4% to $441 billion. The dotted line on both of these charts reflects growth over pre-pandemic peak levels. You can see that last year and the next three years are projected to be the strongest periods of activity that this industry has ever seen. Additionally, there’s another $333 billion in infrastructure projects slated for 2024. That’s a 10% increase over 2023. Two of our key end markets are industrial and non-residential construction. Combined, these end markets reflect about two thirds of our customer base, and both are likely to outperform other consumer-driven end markets due to new mega project construction, and as the reshoring of US manufacturing capacity continues to gather steam.

If you flip to Slide 18, you can see that we are affirming the 2024 guidance that was set in February. As noted, our guidance excludes the performance of Cinelease, which is held for sale. We feel good about the 7% to 10% rental revenue growth range for the full year based on current visibility, more experience with the pace of the mega project rollout, the normalizing growth trends in the local market, and of course, feedback from our team in the field. When it comes to the quarterly rental revenue cadence, our lower fleet investment in the first three months of the year will result in a sequential moderation of second quarter year-over-year topline growth compared with the first quarter’s 9%. But as the bulk of our net fleet investment comes in in the second and third quarters, that will drive higher sequential year-over-year revenue growth in the third and fourth quarters, such that we expect to exit the year above the average rental revenue growth rate for 2024.

With improved fleet efficiency and operating leverage, we estimate adjusted EBITDA will be between $1.55 billion and $1.6 billion, representing another year of profitable growth ranging from 6% to 9%. When comparing the adjusted EBITDA growth rate with the equipment rental revenue growth rate, the roughly 100 basis point difference is our expectation for a lower amount of used equipment sales versus 2023. Overall, the strong demand we’re experiencing across the manufacturing, industrial, and infrastructure markets, along with the stability that comes from industrial and commercial maintenance projects, is consistent with an industry in an upcycle, and our guidance reflects that. We intend to continue to deliver strong financial metrics as we execute on our proven growth strategy.

With that, Operator, we’ll take our first question

Operator: [Operator Instructions] Your first questions from the line of Rob Wertheimer with Melius Research. Please go ahead.

Rob Wertheimer: Thank you. Good morning, everybody. So, my question is going to be basically on supply demand in the industry and trying to kind of square up a few numbers that are pointing in different directions. And so, specifically, the rental PPI kind of released by the government is in theory a broad metric, was basically zero for March and February. You had really strong rate, up five, and I’m curious if you guys see the numbers and we don’t, but does the rental PPI tend to track what you think of as being the rate environment? Sometimes, it looks like it. Sometimes it diverges. I’m curious if you think there’s any signal in that weak number.

Larry Silber: No, we don’t. That’s not one of the metrics we actually focus on. It’s got a lot of volatility in it and it isn’t representative of what’s going on at the local markets on rate and pricing. It’s our experience on that.

Rob Wertheimer: Okay, perfect. And then, so if I got it right, your average fleet, I’m doing total average fleet, was up 10. Your rate was up five. Implied time mute is down. I know it’s 1Q. There’s seasonal. There’s weather. Is there any kind of weakness in the market? Are you losing any business on having to, or choosing to push aside any business on having higher rate, or how would you characterize I guess the time you market, if you can?

Larry Silber: Yes, look Rob, there’s always weather in every year, at every time, and we don’t really sort of report out weather as being any kind of a significant factor, unless of course there’s a major hurricane or something like that, that has a significant impact. So, we wouldn’t even turn to weather, but no, we don’t believe we are losing any business on the basis of rate or any kind of pricing. We do see a normalizing of the seasonality of the business more back to pre-COVID levels, and I think that’s what we’re experiencing, and that’s what we’ll continue to see.

Rob Wertheimer: Great. I’ll stop there. Thank you.

Operator: Your next questions from the line of Steve Ramsey with Thompson Research Group. Please go ahead.

Brian Biros: Hey, good morning. This is actually Brian Biros on for Steven. Thank you for taking my questions. On the large trench shoring acquisition, can you maybe just talk about, one, the qualities of that business there, and maybe two, the valuation of that deal versus your usual multiples paid?