Herc Holdings Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

Herc Holdings Inc. is a leading North American equipment rental supplier, offering a wide range of construction, industrial, and other equipment, along with various value-added services.

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.

Business Overview

Herc Holdings (HRI) operates in the equipment rental industry, providing a diverse array of equipment, from aerial work platforms and material handling equipment to heavy earthmoving and power generation machinery. HRI’s business is broadly split into several segments:

  • Equipment Rental: This is the core of HRI’s operations, providing rental equipment, primarily to construction, industrial, and infrastructure end-markets. It is comprised of rental revenues for both new and used equipment.
  • Sales of Equipment, Parts, and Supplies: In this segment, HRI generates revenue from selling new and used equipment, parts, and supplies for construction projects.
  • Services and Other Revenue: This segment includes transport, fleet management, maintenance, and other ancillary services, as well as the sale of ancillary products such as safety equipment and small tools.

HRI primarily operates in North America, with some operations in other locations. However, these are small.

Revenue Distribution:

HRI’s revenue is primarily driven by rental income, with most of the revenue coming from the core rental operations, and a large focus on large, well-capitalized customers. The remainder of the revenue is comprised of revenue from selling equipment, parts and supplies, and services. Here’s how its revenue was split in the first 9 months of 2023:

  • Equipment rental: 70%
  • Sales of new and used equipment: 18%
  • Service and other revenue: 12%

The equipment rental industry is generally tied to macroeconomic conditions, construction activity, and infrastructure spending. The industry is highly competitive, fragmented, and price-sensitive. There has been a consistent trend of increasing customer demand for rented equipment due to its flexibility and cost-effectiveness compared to outright purchases, with companies also placing greater emphasis on sustainability and cost efficiencies. Consolidation in the industry has also been occurring, with larger players acquiring smaller ones to gain scale and market share. Also, there’s an accelerating trend of technology integration into the equipment rental business, as companies are using data and software to improve their operations.

HRI noted a major increase in rental and supply sales in 2022 and the trend appears to continue into 2023. However, HRI also stated there may be a softening of demand by customers for equipment in a recent report.

Margins:

HRI’s operating margins vary based on the equipment being rented, utilization rates, and geographic locations. Here is a summary of 2022 margins in all parts of their business:

  • Equipment Rental Margin: 37.5%
  • New Equipment Sales Margin: 6.5%
  • Used Equipment Sales Margin: 10.5%
  • Service Revenue Margin: 27.7%

Competitive Landscape:

HRI operates in a highly competitive industry that includes national, regional, and local players, and is very competitive on pricing. Competitors include United Rentals, Sunbelt Rentals, and various regional and local providers. Competition is fierce on:

  • Price: given that equipment is often a commoditized item.
  • Service Quality: providing prompt service and maintenance.
  • Availability: providing the right equipment at the right location at the right time.
  • Geographic Reach: ability to serve customers across a wide geography.

What Makes HRI Different:

HRI’s competitive edge comes from:

  • Scale: A massive fleet of equipment spanning a huge variety of offerings, as well as a nationwide footprint, enables it to serve customers across the country.
  • One-Stop Shop: A complete offering of rental equipment combined with services and parts and supplies.
  • Technology: A push into leveraging data and software analytics to improve operations. HRI has mentioned that they are building their own platform to reduce complexity.
  • Customer-Oriented Strategy: A strong focus on building close, and long term relationships with large customers.
  • Fleet Quality: the company is focused on having younger and more efficient equipment.

Financials

  • Revenue Growth: HRI has shown positive revenue growth in recent years. There has been a lot of success in the rental business, and a slight uptick in the sale of new and used equipment. For example, total sales in 2022 came in at $2.27B which was a 26.7% increase from $1.79B in 2021. The trend appears to be continuing into 2023.

  • Profitability: HRI’s profits have also grown recently. For example, in the first nine months of 2023, HRI had a profit of $225.6 million compared with $133.5 million a year prior. This highlights that both revenue and profit margins are going in the right direction.

  • Debt: HRI relies heavily on debt, as is quite common in a capital-intensive business like equipment rentals. The company has a little over 5 Billion in total debt, according to their latest fillings.
  • Capital Expenditures: This is another important expense for a business that relies on equipment rentals. However, given the positive outlook on the business, capital expenditures are expected to slow down for the next couple of years to normalize the business.
  • Cash Flow: Overall, HRI has consistently increased their cash flow over the past couple of years.

The growth and profitability in HRI’s business is strong and is trending in the right direction.

Moat Analysis

Moat Rating: 2 / 5 HRI has a very limited, narrow moat based on the following:

  • Scale: Its enormous fleet and nationwide network provides it with an edge in the equipment rental industry.
  • Switching Costs: Customers can choose to use a rental equipment provider because it has existing relationships with other companies. It’s unlikely a construction company is going to change all of its equipment rentals to different firms if they are satisfied with the incumbent supplier.
  • Regulation: To gain access to the market and be a rental company does have regulation barriers that take a decent amount of time.

However, it is unlikely to have a wide moat for several key reasons.

  • Commoditized Products: The nature of its products makes HRI inherently prone to competition on price. They don’t manufacture a specialized and hard to copy equipment, rather rent generic equipment.
  • High CapEx: High CapEx requirements make it difficult for HRI to generate superior returns. While the scale allows for some benefit, it also increases the amount of capital it needs to operate the business.
  • Local competition: Given that most construction and industrial projects are completed on a local level, it leaves room for smaller competitors to thrive and take part in the industry.

Risks to the Moat

  • Technological Obsolescence: As equipment manufacturers develop more efficient technology, HRI could face challenges in upgrading its fleet and losing ground to competitors that adapt more quickly.

  • Economic Downturns: The company’s performance is tied to economic cycles, which implies that a downturn would cause decreased levels of business.

  • Increased Competition: New entrants or existing competitors might invest heavily in their network or fleet, which can erode HRI’s competitive advantage.

  • Inability to Improve Efficiencies: If HRI is not able to properly use technology to cut costs and improve business efficiency, then competitors may gain a competitive edge.

Business Resilience

HRI’s business has both defensive and cyclical aspects. On one hand, construction projects are a continuous and ongoing part of most economies, and this provides stability. On the other, demand for equipment and construction is tied to overall economic conditions, so an economic downturn can affect HRI. As such, HRI is unlikely to be as resilient as a bond, but likely more resilient than an individual tech company.

Understandability

Understandability Rating: 2/5 HRI operates in a somewhat complex industry, particularly for a layperson, but the basic concept of renting equipment is easy to understand. However, the complexities come in how you analyze and understand the company’s financial statements given their level of debt, equipment and leases. The business isn’t incredibly easy to understand, and hence I am rating this at 2/5.

Balance Sheet Health

Balance Sheet Health Rating: 4 / 5 HRI is relatively healthy from a balance sheet perspective. As previously mentioned, HRI has high amounts of debt given its capital-intensive business. However, they have had no problems in the past and it seems like they can handle the high debt load as they have shown strong revenue and profit growth in the past year. Overall, it is a relatively healthy and improving balance sheet, so I will assign it a rating of 4/5.

Additional Points

  • Share Repurchases: HRI has a repurchase program which has continued over the last year, a positive sign for investors.
  • Guidance: They have reaffirmed their 2023 guidance in their latest report.
  • Acquisitions: They have acquired many smaller businesses to try and grow their business.
  • Stock Offering: HRI plans to have a public stock offering for around 1.1 Billion of its shares to help lower its debt.

Final Remarks

HRI is a company in a competitive and fragmented industry. While it has an edge from its size and geographic reach, it’s questionable whether this is enough to earn it a great moat rating, so it has a narrow economic moat. The business, however, has shown some solid revenue and profit growth recently. The company has a manageable level of debt. Overall, it has a decent balance sheet, with positive momentum, so I will assign it a 4/5. The business isn’t easy to fully understand and I would not describe it as a super-simple business.