Up Almost 2,000% Over the Past 10 Years, This Under-the-Radar Stock Is Still a Buy

If you look at the top 10 stocks of the past decade, there are some well-known companies on that list. But even though it made the top-10 list (shares are up over 2,000% during the past 10 years) equipment rental company United Rentals (URI -0.93%) still isn't a household name. In this video from Motley Fool Live, recorded on Aug. 26, Fool contributor Jon Quast explains to fellow contributor Brian Feroldi all the reasons he added this long-term winner to his portfolio and why he thinks other investors should consider doing the same.

Jon Quast: I love companies that have good free cash flow. That is why I own United Rentals and why I think that you should too. That's the next company that we're talking about. United Rentals also trades on the New York Stock Exchange under the symbol URI.

Now, how did I find this stock? This isn't a consumer-facing company that rolls off the tongue. But when I was looking at the best stocks over the 2010s, this made the list as the 10th best large-cap stock of the 10-year period starting in 2010, ending in 2019. It was a 17-bagger over those 10 years. As I looked into the company, it was still around a $12 billion market cap when I saw it and I couldn't believe after that phenomenal growth. I looked into it, really liked it, wound up buying in January 2020.

What does United Rentals do? They are the market share leader in North America for equipment rentals. Whether that is a backhoe or you need a machine for HVAC, you want a welder, they are the market share leader in North America for those things with about 13% market share.

Now, their biggest application is non-residential construction. You think office space or just anything that isn't a house where you're going to live, that kind of construction. That is their bread and butter. Their second biggest part of the business, though, is equipment rentals for infrastructure. That is one of the things that makes it interesting right now with the big investments that we have in the U.S. toward our infrastructure. United Rentals really stands to be one of the beneficiaries of that.

They also generate revenue by selling some of their equipment from time-to-time. They'll buy a brand new piece of equipment and a backhoe can cost a $100,000. This is why a company might rent from United Rentals besides buying it themselves. It's a very high cost to get started. But if you're renting, you can really manage that cost from a manager perspective, from a construction site. But from time-to-time, United Rentals, will look at the cost of maintaining that piece of equipment versus selling it right now at going market rates and they will also generate revenue from the sale of that. Basically, they will make some money off the rental until it's no longer really profitable for them, and then they'll go ahead and sell it for decent profit as well.

One of the things I like about this is, it's a boring business, but it's very profitable. It's very predictable. Management has really good finger on the pulse when it comes to what's going on in non-residential construction and infrastructure, those sorts of things. They really have a good sense of what demand is going to be year in and year out.

Because of that, this is a free cash flow machine as well. In 2020, they generated 2.5 billion in free cash flow. That is a little bit high for them. They did pause some capital expenditures when they weren't quite sure what was going to go on in the early days of the pandemic. If you go back to 2019, it's a little bit of a better baseline for what they're capable of from a free cash flow perspective. They generated 1.6 billion in 2019. That's a 17% free cash flow margin. This year, they're projecting around 1.7 billion of free cash flow, also around a 17% margin.

Because of that, this stock trades at a pretty decent value, in my perspective. It's about $25 billion market cap today, which means it trades at about 15 times this year's free cash flow. That is a very rare multiple.

Now, of course, to be a market-beating investment, management has to invest that cash flow in things that is going to create shareholder value. Some of the ways that they do this, I mentioned market share. They're the market share leader, but only 13%. And they nearly doubled their closest competitor. Seventy five percent of the rental market is from players who have less than 2% market share. A lot of small players in the space that United Rentals can use their free cash flow to go out and acquire more market share.

They've done this recently with a company called General Finance Corporation. This company provides modular office buildings to construction sites. It's a little bit different from what United Rentals core business is. It provides a new cross-sell opportunity by acquiring this company. They spent about $1 billion to acquire it only around three times sales, so decent value for a profitable company. It's going to be immediately accretive to their earnings and their cash flow. I think that's a good use of capital.

They also buy back a ton of stock. Over the last five years, they've reduced their outstanding shares by 16%. Right now, their share buyback program is on pause. They paused it in the middle of 2020 because of the pandemic. I expect that they'll resume that any day now because they've really been historically, it's a good track record of buying back shares with their free cash flow.

Brian Feroldi: It looks they've been paying down debt with that capital instead of buying back stock.

Quast: Yes over the last year. They retired a lot of their senior notes, for example, and things like that.

Feroldi: Yes. Is the model buy companies with debt and then use that free cash flow to pay it back because they look pretty levered. Is that correct?

Quast: They're decently levered. I think they're looking for around 2.5 and they want to get that down to about two. But it's just the nature of the business, you pay a lot of capital upfront to get the equipment, and then they use that over the lifetime of the thing. They're looking long term.

Feroldi: Cool. That was United Rentals, URI.