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Standard & Poor's


09/15/14 10:26:22 AM



This week's Focus Stock of the Week is United Rentals (URI: $116.56), which carries S&P Capital IQ's highest investment recommendation of 5-STARS, or Strong Buy. URI is the largest equipment rental company in North America, more than twice as large as its next largest peer. We think URI's size and scale will serve the company well as we enter into a period where we think we will see accelerating non-residential construction and industrial production in the U.S.

United Rentals operates about 832 rental locations in the U.S. and Canada, renting about 3,100 classes of equipment, ranging from tools, aerial work platforms and other construction equipment to lighting and trench safety equipment, among others. This equipment is rented to a diverse group of customers including companies in the construction industry, industrial and manufacturing companies, utilities, municipalities and homeowners. In 2013, equipment rental accounted for 85% of the company's $5.0 billion in revenues, sales of rental equipment 10%, new equipment sales 2% and supplies and services 3%.

After a 20% increase in 2013, we see revenues rising 13% in 2014 and 9% in 2015, on higher equipment utilization and equipment rates. We expect revenue growth to benefit from growth in residential and nonresidential construction and increased industrial activity as the economy seems poised to continue to grow, and we think there is pent up demand for construction projects throughout the U.S. URI is also a beneficiary of the surge in oil and gas production in the U.S., as its equipment is increasingly used in the energy sector.

We cite recent economic statistics as signs that both the economy and commercial construction activity are likely to improve. Industrial production increased 0.4 percent in July for its sixth consecutive monthly gain. Manufacturing output advanced 1.0 percent in July, its largest increase since February. Capacity utilization for the total industry edged up 0.1 percentage point to 79.2 percent in July, a rate 1.7 percentage points above its level a year earlier but still 0.9 percentage point below its long-run (1972-2013) average. The Architectural Billings Index for July hit 55.8, the highest point since mid-2007. Nonresidential construction starts in July were up 1.4% above a year earlier, though they pulled back from a very strong June.

We also think that though the economy is improving, visibility into the recovery remains limited. We think this type of demand in an uncertain environment plays into United Rental's strength, as we expect companies to want to rent, rather than buy expensive construction equipment. This should help keep URI's utilization and rates high. Once visibility improves, we think URI can make a compelling case for renting versus buying, allowing companies to use their cash to grow their own businesses without having to invest in major capital equipment.

We see operating margins benefiting from increased equipment utilization at higher yields as well as cost cutting efforts. We expect good operating cost leverage on incremental volumes. We see EBITDA margins widening to 48.0% in 2014 and 48.9% in 2015 from 46.3% in 2013 and 43% in 2012.

We forecast 2014 EPS of $6.58, up 34% from 2013 operating EPS of $4.91 and comparing favorably to 2012 operating EPS of $3.76. For 2015, we see EPS growing an additional 24% to $8.14.

The stock has been a strong performer, with year-to-date price appreciation through September 10 of 47.7%. However, we think there is still room for further appreciation. Our 12-month target price of $145 values the shares at 18X our 2015 EPS estimate, near the middle of the company's ten year historic P/E range. Given our view that we are still in the early stages of a long term cyclical recovery in nonresidential construction, which should allow for strong demand for rental equipment for some time, we think the current valuation near the lower end of URI's historic range (based on our 2015 estimate) is attractive.

Risks to our recommendation and target price include weaker commercial construction activity than we are expecting, an economic downturn, increased competitive pressures and weaker customer spending. Higher interest expenses could curtail economic growth, but it would also make renting versus buying equipment more compelling.

S&P Capital IQ's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.


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