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After a Nice Run, Does H&E Equipment Have More Upside?

By Robert Hanley - Dec 7, 2013 at 9:00AM

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H&E Equipment has had a nice run in 2013, leveraging strength in the domestic construction sector. Should new investors take a position?

Like the rest of the equipment-rental industry, H&E Equipment Services (HEES 0.72%) has been riding a rebound in demand from the construction sector, delivering a strong double-digit stock price gain over the past year. It has also benefited from a reduced number of competitors at the top, courtesy of last year's merger between mega industry players United Rentals (URI -2.46%) and RSC. 

H&E is also shareholder-friendly, returning significant capital to shareholders through a large special dividend in 2012. So, should new investors bet on this small cap?

What's the value?
H&E's combination with fellow regional player ICM Equipment in 2002 provided the company with a solid foundation and national footprint, including strong positions in the Gulf Coast and Intermountain regions. From that base, H&E has been gradually filling out its market exposures, owning 68 facilities as of September. 

Unlike its larger competitors, though, the company's business mix includes a relatively large new-equipment-sales operation that it uses to create downstream sales opportunities in the parts and services areas.

In fiscal year 2013, H&E reported solid top-line growth, up 24%, aided by a positive pricing environment and selective additions to its store network. Despite a double-digit year-over-year increase in the size of its rental fleet, the company's overall fleet time utilization remained above 65%, indicating strong end-user demand from its primarily construction-related customer base. 

The net result has been rising profitability and operating cash flow generation, capable of funding future increases in both its network and rental fleet.

Going head to head
Of course, H&E's growth ambitions will increasingly put it in head-to-head competition with United Rentals, the country's largest equipment-rental company. United nearly doubled its size with last year's acquisition of leading competitor RSC, offering rental services through more than 800 locations across the U.S. and Canada as of September. 

It uses its large size to its advantage in its continuous quest for operating efficiencies, generating an adjusted operating margin above 20% versus roughly 11% for its smaller competitor.

In fiscal year 2013, United similarly posted a top-line increase, up 26.1%, boosted by both its acquisition of RSC and a solid gain in average product pricing. Unlike H&E, though, United generates the vast majority of its revenue from rental services, utilizing sales operations mainly as a conduit for end-of-life disposal of its used fleet. 

The company's focus on the rental market as well as its strategy of pursuing large national accounts has produced a strong and improving profitability level, providing ample funds for the management of its acquisition debt and further increases in its rental fleet.

Also on the competitive-threat list is rental giant Hertz Global (HTZG.Q), which has been participating in the equipment-rental segment since 1965. While the company's network of roughly 340 locations pales in comparison to industry leader United's operating base, Hertz's global scale allows it to operate in a greater variety of key international markets, like China and Australia.

Not surprisingly, Hertz's equipment-rental unit has also posted a solid operating performance in fiscal year 2013, with a 13.7% increase in revenue and a strong pickup in profitability. While the unit has only been marginally increasing its domestic network lately, it has found better opportunities internationally and through diversification initiatives, including a recent purchase of Cinelease, a major provider of lighting and grip rentals to the entertainment industry. 

In addition, the unit has benefited from its parent company's improving financial results, which have been bolstered by a strong car-rental business and the effects of the 2012 blockbuster purchase of the Dollar Thrifty car-rental chain.

The bottom line
Domestic construction activity has enjoyed solid growth in 2013, with the American Institute of Architects forecasting a 5% increase in commercial construction activity for the full year and further increases in 2014.  Assuming the forecasts bear out, H&E appears well positioned as a primary beneficiary of the higher activity level, and it should be able to generate further profit growth over the next year. 

While United Rentals and Hertz's rental units are formidable competitive threats, given their size and scale advantage, the current favorable industry pricing seems to indicate that end-user demand is strong enough to lift all boats. As such, H&E is an intriguing play for investors in the rental space.

Fool contributor Robert Hanley owns shares of H&E Equipment Services. The Motley Fool owns shares of Hertz Global Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

H&E Equipment Services, Inc. Stock Quote
H&E Equipment Services, Inc.
HEES
$35.18 (0.72%) $0.25
United Rentals, Inc. Stock Quote
United Rentals, Inc.
URI
$323.23 (-2.46%) $-8.15
Hertz Global Holdings, Inc. Stock Quote
Hertz Global Holdings, Inc.
HTZG.Q

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