Inside Wall Street: As Construction Revives, So Is This Equipment Renter's Stock


Here's a little-noted barometer for gauging the economic recovery: the volume of rental activity for industrial and nonresidential construction equipment. That measure is now showing a rebound that's gaining more traction every day.

That's because gear-rental companies are usually among the early beneficiaries of a recovery, and one company that has proved the maxim to be true is RSC Holdings (RRR), the second-largest equipment-rental company in North America. Its business -- and its stock -- have been gaining smartly.

When the economic downturn got rougher last year, shares of companies related in any way to construction -- including those in commercial or heavy industrial sectors -- got clobbered and driven to their lows. RSC sank to a low of $5.99 a share in early March 2010. That's when I highlighted RSC in this column -- after it fell -- on Mar. 3, 2010, pointing out that the company was surely a turnaround candidate because it would be a big beneficiary when industrial production and construction activity picked up along with the recovery.

"Picking Up Steam"

Like clockwork, as evidence of a renewal started piling up last year, RSC was among the first to reflect that rebound, in its sales and earnings. And in its stock price. RSC shares have more than doubled from the lows, closing around $13.30 on Feb. 22, down some 3.5% for the day as the entire stock market took it on chin, thanks to escalating violence in Libya and other Mideast hotspots. Some analysts say the stock has just started to readjust its worth and could climb more. Investment bank UBS analyst Henry Kirn was one of the analysts who boosted his 12-month price target on the stock, to $20 a share from $15.

"Rental trends are picking up steam, and pricing has come back to life," notes Vance H. Edelson, analyst at Morgan Stanley. He says the company's recent fourth-quarter results were "very strong" and consistent with the outlook provided on Jan. 13. Indeed, the annual growth in rental services was the highest for any fourth quarter since 2005, and year-to-year changes have just recently turned positive, notes the analyst.

RSC rents out a diversified line of heavy equipment -- from backhoes and forklifts to air compressors, aerial platform booms, and generators -- to industrial and nonresidential construction customers. During the recession, RSC took the opportunity of preparing for the down cycle's end and the onset of a recovery by cutting costs and investing in new equipment.

"RSC is a well-run rental company that executed on its business plan through the downturn, generating substantial free cash flow and significantly reducing debt," Edelson points out. The company is now gaining from the rebound in demand and the rise in utilization rates.

"We maintain our overweight rating on this best-in-class equipment rental company that's now benefiting from the cyclical [economic] improvement," says Edelson.

Renting Rather Than Buying

RSC President and CEO Erik Olsson exudes optimism about the company's prospects this year and next. Sales growth suffered in 2009, but it started rebounding in 2010, he notes. "For 2011, we see significant volume growth starting in the second half of the year, as demand continues to pick up and pricing stays firm," forecasts Olsson.

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Part of what's driving up business, he says, is the increasing number of industrial and commercial companies that are switching to renting instead of buying their own equipment. The incentive for doing so is the significant cost-savings. That's basically the reason why the trend toward outsourcing rather than keeping and storing a huge inventory of heavy equipment and supplies has caught on, says Olsson. He estimates that renting equipment results in savings of as much as 22% in the first six months of the rental period.

RSC posted a loss of 71 cents a share in 2010 on revenues of $1.23 billion, but analysts are now upbeat and expect the company to be back in the black starting this year.

"All arrows seem to be pointing in the right direction as RSC enters 2011," says David J. Manthey, analyst at investment firm Robert W. Baird. With volume trends strengthening and its customers increasingly renting rather than buying equipment, the company is well positioned for a multi-year upturn, says the analyst.

So, Manthey expects RSC to start making money in 2011, and he estimates it should earn15 cents a share on revenues of $1.48 billion. For 2012, he forecasts a big leap in earnings and sales, to 57 cents on revenues of $1.61 billion. "RSC remains our top idea, and we believe investors should build positions to benefit from the expected multi-year expansion," Manthey advises.

Early to Invest

Analyst Scott Schneeberger of investment firm Oppenheimer says tangible signs in pricing and leading indicators suggest a turn in the nonresidential construction cycle. He rates RSC as outperform, in part because of implications of double-digit 2011 rental volume growth and incremental margins of 60% to 70% in RSC's earnings before interest, taxes, depreciation and amortization (EBITDA).

Interestingly, RSC is still a less known investment play not only on the upturn in industrial and commercial construction but in the economic recovery, which continues to increasingly gain the confidence of both investors and the business community. One large institutional investor that has been early to buy shares is Fairholme Capital Management, which has accumulated a 14.5% stake.

Investors looking to get in on an overlooked recovery play might want to join the prescient strategists at Fairholme.

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