H&E Equipment Services, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

H&E Equipment Services, Inc. is an integrated equipment services company that rents, sells and provides parts and services for construction, industrial and other equipment.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

H&E Equipment Services (HEES) operates in the fragmented equipment services market. While they strive to create moats through various strategies, they are ultimately susceptible to cyclicality and intense competition.

Business Overview

H&E Equipment Services, Inc. (HEES) is a company that rents, sells, and provides parts and services for heavy construction and industrial equipment. Their operations are primarily located in the United States, spread across numerous locations. They serve a diverse customer base, including construction companies, industrial firms, and government agencies.

  • Revenue Streams: HEES generates revenue from three main areas:
    • Equipment Rentals: Renting heavy equipment like cranes, excavators, loaders, and other specialized machinery. The rental market contributes the most to HEES revenues, often approximately half of total revenues.
    • New and Used Equipment Sales: Selling new and used equipment from various manufacturers.
    • Parts and Services: Selling equipment parts, performing repairs, and offering maintenance and service contracts.
  • Industry Trends:
    • Infrastructure Investment: Government spending in infrastructure projects has the potential to increase demand for HEES services and equipment.
    • Construction Growth: Increased commercial, residential, and government construction drives demand for equipment rentals and sales, creating opportunities for growth. However, in times of economic uncertainty or contraction, this demand can fall rapidly as companies put projects on hold.
    • Technological Advancements: New technologies in equipment are creating higher ROIC, but also require constant investment to keep its equipment updated.
    • Equipment Leasing vs Purchase: A rising trend of businesses preferring to lease equipment to avoid the high up-front capital costs of buying.
    • Industry Consolidation: An industry trend towards consolidation to gain economies of scale and better margins that have been occurring for a few years.
    • Competitive Landscape: The equipment services industry is highly fragmented, with numerous national and regional players vying for market share. HEES competes with national rental companies, regional rental houses, and equipment dealers. In particular, competitors with a large network of branch locations have advantages in service and delivery time. Price competition tends to be intense, especially when demand cools and utilization rates drop.
  • What Makes HEES Different?
    • Integrated Service Model: HEES offers a full suite of products and services, which provides an all in one option for their customers. This has the potential to lead to strong customer loyalty, better cross-selling, and higher customer spend per deal.
    • Geographic Reach: HEES has a significant number of branches throughout the U.S. and it is continuing to increase their footprint through both acquisitions and newly created locations. The number of branch locations is a strength because it increases their market share and makes them more convenient to their customers.
    • Customer Relationships: HEES has a strong focus on building relationships with their customer base, which creates strong long-term value for their shareholders. They aim to be a one-stop shop for their customers and that creates value for both sides.
    • Data Driven: The company has also increased their utilization of data, which is meant to help reduce costs and improve customer relationships.

Financial Analysis

While HEES reported strong revenue growth in the past few years, the high debt combined with cyclical business means there are areas where the company can struggle.

  • Revenue Growth: The company’s revenues have increased greatly in the past few years. The total revenues for the 9 months ended September 30, 2023 increased 20.5% compared to the prior year. They also had revenue increases of 33.2%, and 20.6% in 2022 and 2021 respectively. However, in the past, they have suffered major drops during the recession of 2007-2009, so their numbers are heavily affected by the broader economy. This high increase is due to increased demand for equipment, higher rental rates, and acquisitions of other businesses.

  • Profitability:
    • Gross profit margins: These have been improving in the last few years. The gross profit margin for the 9 months ended September 30, 2023, was 42.8%, compared to 39.5% in the prior year. This is due in part to higher rental rates and lower cost of sales.
    • Operating margin: In line with improvements in gross margins, operating margins are also improving. They were 15.5% for the 9 months ended September 30, 2023, compared to 13.6% in the prior year.
    • ROIC: It has been increasing in the past few years as the business improved. In 2022, they reported an ROIC of 14.7%, however that was before the large increase in interest rates that occurred in 2023. In 2021, the number was 10.2% and in 2020, it was 7.5%. However, this metric can fluctuate wildly based on acquisitions.
  • Capital Structure:
    • High debt: The company utilizes leverage to finance its assets. At the end of the 3rd quarter of 2023, the company reported $2,289 million in total debt, compared to $1,765 million at the end of 2022. The higher interest rate has been a challenge for the company because of their reliance on debt. The interest rate has also eaten into profits. Interest payments were $113 million in the most recent quarter, compared to $19.3 million in the same quarter the year before. Because of the interest rate hikes, and their high debt, the company can suffer a huge loss of revenue if interest rates continue to go up.
    • Equity Growth: The company has also significantly increased equity by 116.2% in 2022 due to a series of stock offerings.

Moat Analysis

HEES does not have a wide moat. It mostly relies on strong customer relationships, their scale and brand recognition, and a diverse network of branches throughout the United States to differentiate themselves from the competition. While these factors are positive, they do not lead to a long-lasting, defensible competitive advantage.

Moat Rating: 2 / 5

  • Intangible Assets: The company has a strong brand, which provides some pricing power, but is not impossible to replicate. They lack strong patents or regulatory approvals that would lead to a true competitive moat.
  • Switching Costs: Although the company serves some companies who have a high cost to switching to another provider, they also offer products for small one-off use cases and have a low percentage of repeat customers. Thus, customers are not highly locked in, and switching is fairly easy.
  • Network Effects: The business is not driven by network effects.
  • Cost Advantages: Because equipment is a large portion of their expenses and also a similar product among different companies, they do not have significant cost advantages. They are also highly influenced by changes in the cost of labor, gasoline, and materials.

Risk Assessment

  • Cyclicality: HEES operates in a cyclical industry, and their performance is directly tied to economic activity. They have had periods with big revenue gains, and periods with massive revenue losses. A large part of their business is driven by rental revenue. If a recession were to start, the revenue, utilization rates, and price of their equipment may all significantly fall.
  • Debt Levels: Given their high debt, a rising interest rate can significantly erode margins and profitability of the company. The high debt payments also reduce the amount of flexibility the company has.
  • Intense Competition: The fragmented nature of the equipment services market means high price pressure, and an erosion of profitability can occur quickly if competitors act irrationally.
  • Acquisition Risk: They depend partially on making acquisitions to grow their business, and those can easily fail to generate the expected returns.
  • Labor Costs: They have high labor costs, which are also vulnerable to economic fluctuations. It is very hard to create sustainable cost advantages without a process advantage over peers.
  • Technological Innovation: The company must continuously update its equipment to keep it new and valuable, but this requires consistent capital investment.

Business Resilience: While HEES may be resilient during an economic upturn, it appears to be vulnerable during a recession or economic uncertainty given their high debt, cyclical business, and intense competition. However, the company is in the process of expanding its business into new and growing areas, so that may reduce the level of impact for a downturn.

Understandability Rating: 3 / 5

The business model of HEES is relatively easy to grasp: a company rents, sells, and services equipment. It involves three main revenue streams of equipment rental, sale and service. But to truly understand the business, an investor must have knowledge of financial statements, how they interact, as well as an understanding of the market they exist in. They also rely on more complicated metrics like ROIC and WACC. However, their model is fairly straightforward, hence the rating.

Balance Sheet Health: 4 / 5

Their balance sheet health would be in the middle of the scale. This would be because they have a substantial amount of assets, and a manageable level of current liabilities. However, their long-term debt is significantly higher than is ideal, creating issues when interest rates rise. They have also been relying more and more on debt to finance operations, which if continued, can become a serious problem.

Recent Concerns / Controversies / Management Responses

  • Supply Chain Issues: Supply chain issues that have impacted the industry have begun to resolve, as supply chains started to return to normal following the COVID-19 pandemic. They are seeing increased lead times and higher costs.
  • Rising Interest Rates: Interest rates have made their existing long-term debt much more expensive. The increasing interest rate environment was talked about several times by their CEO in the latest earnings call.
  • Acquisition Costs: They expect a large amount of revenue growth to come from acquisitions, but the cost of these acquisitions might not result in value creation.