McGrath RentCorp

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

McGrath RentCorp provides modular buildings, portable storage units, and electronic test equipment for rent and sale.

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

McGrath RentCorp (MGRC) operates across three core segments: Mobile Modular, TRS-RenTelco, and Adler Tank Rentals. Each segment serves distinct customer needs and markets, leading to varying growth rates, risk profiles and competitive landscapes. Let’s take a closer look at each segment:

Mobile Modular (MM): This division offers a wide variety of modular and portable buildings, such as classrooms, offices, and storage facilities for schools and businesses. Their business is structured on providing rentals and related services that can be customized to meet specific client requirements. This segment contributes the majority of MGRC’s revenues and is characterized by relatively stable demand, especially due to long-term contracts and recurring customer needs in sectors like education and government services.
TRS-RenTelco (TRS): This segment is a provider of test and measurement equipment and services. It serves a diverse range of industries, including telecommunications, aerospace, and electronics, and offers both rental and sales options, along with related services such as calibration, repair and technical support. TRS revenue is also directly linked to technological trends, and therefore has had more growth in revenues in 2022 due to high demand in new technology.
Adler Tank Rentals (Adler): This segment specializes in providing tanks and containers for rent to various industries including construction, environmental services, and oil and gas. Adler’s operations are spread across many regions and focus on providing high-quality equipment with specialized services, such as tank cleaning and maintenance. Demand for Adler’s services varies with broader economic conditions and also has high correlations with oil and gas production and environmental regulations.

MGRC’s revenue streams are primarily generated through equipment rentals, but a smaller portion comes from sales of equipment. This implies a mix of recurring and non-recurring revenue, which affects the predictability of earnings and future cash flows. A significant part of revenue also comes from value-added services that provide greater margins than the standalone rentals.
In 2023, the rental business for the three segments accounted for ~83% of total revenues, with service revenues contributing ~10% and sales of equipment bringing in the other ~7%. The combined revenues from rental and services is ~93% of the total revenues.

Industry Trends:

The modular building market is influenced by construction spending, infrastructure projects, economic conditions and government funding in specific sectors.
The electronic test equipment segment is affected by technological advancements, research and development expenditures, and investments in new technology.
The tank and container rental market is heavily tied to industrial production, environmental regulations, and the activities of industries such as oil and gas.

Moat Analysis: 2/5

McGrath RentCorp exhibits some competitive advantages, but these are not very defensible. The business can be said to have a small narrow moat but it is eroding.

Scale Economies: MGRC benefits from some economies of scale in its mobile modular division, in which its extensive depot and branch network leads to efficiency gains and higher utilization of assets. MGRC is one of the leaders in the US market in modular buildings.
- In the other business, its supply capabilities and logistics helps it get the required equipment for the customers on time and in required volumes. However, this aspect is not exclusive to MGRC and is a characteristic in its business.
Customer Lock-In/Switching Costs: In specific instances for the Mobile Modular segment, its long-term contracts with clients (especially with school districts) also provides some switching costs in place because of the costs and efforts involved in finding and hiring a new supplier.
Brand Reputation: The company has been in business for 40 years and has a decent reputation among their customers, especially in the modular division.

However, these advantages are not insurmountable. The company’s moat is relatively narrow because: * Lack of Differentiation: In the rental business and in test equipment business the products are not very differentiated. Competitors can easily replicate the offerings (except for the scale benefits). * Relatively High Competition: There are many competitors in the markets that the company operates in, and none of the competitors is particularly weak. * Lack of Pricing Power: The company’s pricing is largely determined by market demand and competition rather than its intrinsic value or branding. This limits its ability to consistently increase prices and margins. * Limited Geographic Moats: While certain markets benefit from limited local competition, that’s limited to a specific regions only. Moreover, with transportation improvements and globalization, these geographic moats are becoming less sustainable.

Overall, the company has some advantages but faces challenges in sustaining them due to competitive pressures and the nature of its business.

Moat Erosion Risks:

Increased competition in modular and electronic test equipment can erode MGRC’s market share and pricing power.
Technological shifts and new innovations by the competitors may force obsolescence of some of the equipment the company is renting out.
Economic downturns, particularly in capital-intensive industries, can reduce demand in all of MGRC’s segments, putting pressure on revenues and profitability.
High interest rates can impact the real estate segment negatively, and it could also effect credit ratings for the business, which would have an impact on financing.
Increased environmental regulations could require higher investments in more sustainable offerings, increasing the company’s operating costs and hurting profitability.

Business Resilience:

The majority of MGRC revenues are recurring in nature with rentals, which helps in business stability during slowdown.
The company has a long track record in the industry, which can help in getting large contracts, and in gaining repeat customers.
The company is geographically diversified, which allows a cushion if any one particular geography experiences a downturn.
The company also focuses on diversification of products and services in all three segments, which adds diversification advantages.

Financial Analysis

MGRC’s financial performance reflects a mix of stable growth, increased profitability, and the impact of recent economic conditions. Let’s analyze their financial statements over the last few years:

Revenue Trends:

MGRC has shown consistent year-over-year revenue growth for the past few years with rental and services contributing to the majority of growth.
In 2023, MGRC total revenue reached $631 million, with rental revenue at 525 million, services revenue at 66 million and sales revenue at 40 million. 2023 revenues were 8.6% higher than 2022 which were 580 million.
Between 2022 and 2023, the Mobile Modular segment revenue grew by 3.5% to $420 million, TRS revenue increased by 19.5% to $173 million, and Adler Tank’s revenue decreased by 5.6% to $37 million.

Profitability:

MGRC’s gross profit margins are relatively stable at around ~40%, and in the last 3 years they are between 40.2% and 41.6%.
The operating profit margin has risen over time from 18.8% in 2021 to 21% in 2023 due to improving efficiencies.
However, net income declined in 2023 compared to 2022, from 72 million to 67 million.
MGRC’s recent guidance for 2024 implies 9-10% revenue growth, margin around 30%, and adjusted EBITDA margin between 39-40%.

Cash Flow and Debt:

MGRC’s cash flow from operations has been consistent over the years and had a bump in 2021 due to pandemic recovery. However it has fallen off slightly since then.
The company is consistently investing in capex, which has increased to $186 million in 2023 from $111 million in 2022.
The company has been increasing debt in 2022 and 2023. In 2023 it had $709 million in total debt.
Management is actively paying down debt and had a debt-to-EBITDA ratio of 2.2 in 2023 compared to 3.3 in 2022.

Recent Concerns and Problems:

The company has been facing issues related to integration of acquired business which have led to decline in revenue and profits in certain segments.
The company’s margins have been fluctuating and that has put a question mark on how efficiently they are managing their operations. The management is taking steps to improve profitability.
The recent downturn in global economy is putting pressure on some business lines. But as most of these are short-term in nature, management is still optimistic.

Understandability: 3 / 5

MGRC’s business model is reasonably straightforward, but certain complexities exist.

The basic concept of renting and selling specialized equipment is easy to grasp.
However, understanding the nuances of each segment and how they affect overall performance requires some business knowledge.
The company’s financial statements require some analysis to separate out operating and nonoperating activities and to calculate ROIC, debt etc.

Balance Sheet Health: 4 / 5

MGRC’s balance sheet exhibits a healthy position with some points of caution.

The company’s total asset is growing steadily, at 2.2 billion as of 2023.
Total debt at 709 million in 2023, is manageable with the operating cash flows.
The company’s equity position at $1.5 Billion is good and implies the company has more ability to take on debt if required.
The inventory levels have been increasing over the years due to new equipment purchases, and that should be kept under check.
The company is also actively buying back its own shares that indicates it feels undervalued at its current prices and that further strengthens its financial health.

Summary

MGRC is a company that operates through three business segments, Mobile Modular (modular buildings), TRS-RenTelco (test equipment), and Adler Tank Rentals (tanks and containers). The company has a few competitive advantages including scale benefits, customer lock-in and brand recognition, but its overall moat is relatively narrow and eroding. Management is focused on growing and expanding operations with improved efficiency and profitability. The company maintains a financially healthy position but has to keep an eye on debt. The business is somewhat easy to understand, but its financial statements require further analysis to gauge true performance. The risks for the business are primarily from the economy, increasing competition, changing customer preferences and other issues that could impact its long-term growth prospects.

### ##