Custom Truck One Source, Inc. (CTOS) Earnings Call Transcript

I'm James Kayler, the Homebuilding, Building products and Rental analyst here at BofA. Very happy to have Custom Truck One Source, Ryan McMonagle, Chief Operating Officer; and Chris -- I'm going to mess up your last name, Chris Eperjesy, CFO. Thank you guys so much for coming. I appreciate it. And we're going to do this just as a fireside chat. But even though you guys aren't going to do a full overview presentation, I think it would be helpful just kind of like go over kind of sort of how the company is structured and a little bit of a history, sort of like how you got to where you're at today as a public company.

Why don't I start? And if there's any questions, we're obviously happy to go deeper. But I think -- and I'll start with the history, and then I'll kind of get to the company. But if you think about the history of what is Custom Truck One source today, it really was formed in April of last year. So in April of 2021. And the way I describe it is there were 2 legacy businesses. So there was what was Custom Truck, which was privately owned by Blackstone, which was put together back in 2015 with the vision of being a one-stop shop for specialty trucks. And then there was Nesco, which was -- originally, it was a privately-owned company. Actually originally Platinum owned the company. Many years ago, they sold it to Energy Capital Partners in 2014. And then Energy Capital Partners, through a De-SPAC process in 2019, took it public through a De-SPAC process. And then in 2021, Platinum Equity bought control of Legacy Custom Truck from Blackstone and then also merged us with Nesco at the same time. And so that became what is today Custom Truck One Source. So we've been public since April of 2021. And I described the business as we're a one-stop shop for vocational trucks. And so to us, that means that we'll take care of our fleet customers any way they want to consume equipment, whether they want to rent equipment, whether they want to purchase equipment or they just want us to help service their equipment. We believe that being a true one-stop shop for the customers is the best way to grow, is the best way to capture market share. It has been -- and there are numerous kind of advantages of having that business. That model is largely what Legacy Custom Truck was. Nesco was a rental first model. And so Legacy Nesco and Legacy Custom Truck at the time of putting the 2 companies together, each had a rental fleet that was about the same size. So each had about $650 million of OEC, original equipment cost, in the rental fleet. So we put those 2 businesses together and then also through the model of selling new and used trucks that Custom Truck had and then offering parts and service as well. Today, those are the 3 segments that we report in. We report our ERS segment or Equipment Rental Solutions, our TES, Truck and Equipment Sales, and our APS Aftermarket Parts and Service. Those 3 segments are what make up Custom Truck today.

Super helpful background. And it's interesting how all the connections over the years is kind of all brought back together with Platinum and now in the public market. From a end market perspective, can you talk a little bit about who your ultimate customers are and sort of the sectors that are sort of the most important drivers of the business today?

Yes, sure. And so we kind of identified 4 key markets that we have. Our largest is going to be in the utility space, transmission and distribution. It's roughly 60% of our business. The next biggest segment is broadly defined as infrastructure. It's a little over 20%. And then telecom and rail are just under 5% each. And then the rest is a group of other industries and end markets.

And I guess -- I mean you hit on this a little bit, but maybe you can talk about -- and you guys both came from the truck side. And so obviously, you saw a lot of value in sort of the integrated product offering. Nesco obviously had a different business model. Maybe you can tell us sort of like strategically how that sort of interplay works especially like as it relates to your customer relationships?

Sure. I think there's a couple of things that make the one-stop shop model valuable. And there's really 2 groups that I'll refer to. The first is what makes the rental fleet perform even better. So when we think about the rental fleet in particular, we've got a lower setup cost. We know that we have a 7% to 10% cost advantage in terms of what it takes to add an asset into our rental fleet by putting those units together ourselves versus if we were to buy completed units from a different equipment provider. And so I think that's certainly significant. Because of the model that we carry inventory on our balance sheet and then as there is customer demand for equipment, we're able to either sell it or to rent it. I think it drives some of the rental performance as well because we keep that inventory as inventory and we don't consume it and put it into the rental fleet until it's ready to go to a customer. And then because we have 100 sales reps across the country who -- about 30 of them are focused on renting equipment, about 70 are primarily focused on selling equipment. As we think about selling assets out of the rental fleet at the end of its useful life, we're able to sell the majority of our equipment direct to the customer. And so we're seeing higher residual value. So we think there's a lot of benefit in terms of running the rental business because of how it relates to what we call our integrated production business as well. And then we think when you think about the customer, the advantages that the customer never has to leave Custom Truck, right? So there are very few of our customers who only buy or who only rent equipment, the majority of our customers -- and Chris hit on it -- but the majority of our customers are contractors. So utility contractors, or telecom contractors, or rail contractors. The majority of our customers own a portion of their fleet and rent a portion of their fleet. There's shades of gray in there in terms of how much of their fleet is owned and how much of it is rented. But by being able to take care of everything they need for their fleet, we found that we're able to capture a greater share of wallet, and we're also able to react as the market moves if rental is more in demand for a period of time or if purchasing equipment is more in demand. So we think there's a significant rental advantage and a significant cost advantage. And then in terms of taking care of the customer, we know that we have some real competitive advantage there as well.

Very good. So you sort of you touched on this with the fact that a lot of your customers own some fleet, rent some fleet. I guess I wanted to dig in on that a little bit more to understand. I mean if you have a -- my guess is that it's hard to sort of have a view on sort of like what percentage they're owning versus renting. If you do or directionally, I would be curious, but even more so, maybe sort of walk through their decision to own a certain piece of equipment over renting it. Is it certain types of equipment? Is it with big project surges? Sort of what is driving their decision to rent from you guys?

It's a little different by end market, and it's certainly different kind of depending on where demand sits. But we would say in general, and this is a broad generalization, but the contractors typically rent about 50% of their fleet. That seems to be the average. There's a lot of dispersion around that. And so there are contractors who only rent, right? And they're doing that for balance sheet reasons or if they're primarily chasing contracts, right? They may choose to only rent for the duration of that contract. And then there are other contractors who prefer to own their fleet. And so they've made a decision that they think they're efficient allocators of capital and prefer to own their fleet. We will see that they come to us to rent in addition to their own fleet because of increases in demand, which is what's going on right now with a lot of our contractors -- or because of a lack of availability of supply, which is also what's happening right now, where we're seeing backlog continue to increase. And so because it's increasing, we're not able to meet their demand and so they are renting also. So I think there's a couple of dynamics in there that are in play.

Before getting to maybe the outlook and sort of like the growth levers, in terms of the industry like structure -- I was stuck in traffic I guess you on my way to Miami to visit this cruise company, we were stuck at [ Altec Truck ] or 2 of them the entire way. So I know that CTOS and Altec are sort of the 2 largest players. But in terms of scale, like how big are you guys as part of the market? And then what is the rest of the landscape look like across the country?

Sure. I'll start by talking about the utility end market, in particular. And there's not publicly available data. So this is just kind of our perspective of what the market looks like. But we think that Altec Manufacturers, just over half of kind of all of the buckets and digger derricks that are put into the utility end market, and then there's 2 other large players there. There's Terex, which we sell. We do the installation of Terex equipment as it goes to contractors. And then there's Versalift who are the 3 largest players in that segment. And then there's a handful of other small manufacturers in the utility space. So it's consolidated from a manufacturing standpoint in the utility space. We know that we're the largest buyer of Terex buckets and diggers. And so we will buy their bucket and digger, we will turn it into a completed truck, and then we will rent it or sell it to customers. And so from a manufacturing standpoint, that's what it looks like. And then you've got a lot of fragmentation from other providers who will offer rental equipment or who will build a completed truck for a customer. And that's what the landscape looks like on the utility side. When you get into telecom, slightly different but similar players in the telecom segment. There, it's Altec and Versalift are the 2 largest players in the telecom segment. And then you've got names like Posi+ and you've got names like Dur-A-Lift and ETI who play in those segments as well. And then when you get into some of the other specialty vocational segments, you've got a different lineup of attachment manufacturers there, and that's where the custom truck model is unique. Altec has decided to focus primarily on utility and telecom. And we've taken a view of there's a lot of additional products that those customers are looking to purchase, whether it's tractors or trailers or dump trucks or water trucks or vacuum trucks, that we think it's important to have those products in our product offering as well.

It sounds like on the, certainly, for the utility on the manufacturing side, it's pretty consolidated. How about on the rental side? I assume the rental market is more fragmented.

It is. We think now consolidated Custom Truck and Altec have the 2 largest rental fleets that are out there. There are some large regional players. And then there are a lot of fragmented smaller local mom-and-pop players who rent the same type of equipment as well.

I guess maybe just as a lead in to sort of like the outlook for those various end marks. But like what in terms of what is the composition of your fleet look like? Meaning, I mean, I probably won't -- I don't know a lot of the very specialized equipment, but where is like sort of the main focus on the rental fleet? And I know you guys have done some great slides. We're kind of laying out the sort of financial model, meaning like the sort of returns and how to think about that on a various pieces of equipment.

Sure. I'll start. The makeup of the fleet, Chris, mentioned that about 60% of our total revenue comes from utility. When we look at the rental fleet, about 70% of the rental fleet revenue comes from our utility customers. And so there is a bit more concentration on the utility when it comes to our rental fleet in particular. And I think just over half of the rental fleet is made up of what are called buckets and digger derricks. So buckets are what are used to go up in the air 40 feet. We have some that go up 190 feet and then digger derricks are what are used to drill holes in the ground. So that makes up about half of the rental fleet and then there's an additional 20% to 30% of additional utility equipment in the rental fleet as well. And I think -- so that's the makeup of the fleet. It's just under 10,000 pieces today, about $1.4 billion of OEC now on a consolidated basis is what's in the rental fleet. It's about 3.7 years old in terms of age of equipment. And I think that's one of the things that makes the fleet unique and certainly from a credit perspective is important. 3.7 years old, the useful life of the equipment is really kind of 15 to 20 years when you think about the total useful life of the types of equipment that make up the fleet. And then I think, James, to think about your question, we've gotten comfortable with the economics of both renting a piece of equipment and selling a piece of equipment. And so we disclose a metric that we call on-rent yield, which is just under 40% a year. And so that's kind of the revenue generated by one piece of equipment over a year. So you've got about a 2.5-year payback, if you think about a piece of equipment that way. We've also discussed in the past our unlevered ROIC. So we generate about a 20% unlevered ROIC when we track an asset from the time we put it into the rental fleet to the time that we sell a piece out of the rental fleet. So we're very comfortable from a capital deployment side there. And then when you think about the sales side of the business, we're generating -- we report kind of low teens gross margin when you think about the gross margin that we're making on selling a piece of equipment. Obviously, very different from a capital intensity on the rental side and very little capital exposure on the sales side of the business, but we've gotten comfortable that the returns over a period of time are similar and are acceptable for both sides of that business, each side of the business.

Very good. And I know a big part of the sort of Platinum and the de-SPAC thesis was that Nesco had been very much underinvested in, just given its levered balance sheet. So I guess, what were the areas that you guys saw as an opportunity for investment? And sort of where do you stand in that investment cycle?

A couple of things. So yes, we talked about how their fleet at the time of putting the 2 fleets together was about 1 year, 1.5 years older than the CTOS fleet. And so we've -- in our early calls, we talked about some of the R&M expense that needed to occur to get the fleet up to our rental standards. And then we've also talked about -- we mentioned it on our last call that we've been replacing some of that fleet as well. And so I think we're working through that process. Obviously, as supply chain continues to improve, we can replace more rental fleet. But we've been -- but as it has improved over the last couple of quarters, I think we mentioned on the Q3 call, we put about $97 million of new CapEx into the rental fleet. And a meaningful portion of that was replacement CapEx. So able to take out some of the older fleet that was some of the legacy Nesco fleet and then some of the older us Custom Truck fleet as it just continued to age.

Great. Well, just making sure that we stay on -- I want to come back to some more detailed stuff, but to make sure we stay on time. I do want to comment -- because I think the -- I think people looking at the company don't necessarily have like the perspective in to your end markets. And so I'm curious if you can talk through sort of like your outlook for end markets. And I know that some segments is a little more visibility. I know like there are like publicly stated CapEx budgets. And then I guess as part of that, if there are any sort of major, whether it's regulatory or project-driven things that are driving the CapEx cycle on the utility side.

Sure. I'll start with T&D and we'll talk about some of the other end markets. But there's really 3 things that I would highlight as you think about the T&D end market in particular, and this first one will apply to most of our end markets. But because there's been a constraint on the supply of equipment, there's a large replacement cycle coming of fleets needing to replace kind of the equipment that's in our fleet. So we see that as a very good driver of demand. Specific to T&D, we are very bullish on the outlook for both transmission projects and distribution projects that need to get done. So there's plenty of new transmission lines that have been announced that are being built. There's a lot of maintenance happening kind of on existing transmission lines. And then the same is true on distribution. So we think that just as you think about the aging of infrastructure, we think that's a significant demand driver for us. If you think about electrification, we think electrification of everything, of passenger vehicles in particular, means that there's a significant upgrade that's needed on the grid as it sits today. So that's a great demand driver for us. So to me, we had a bullish call on transmission and distribution even before the third, which is the infrastructure bill. So the infrastructure bill has about $70 billion that's been allocated for T&D spend. And we don't believe that any very little, if any, of that is really shovel-ready projects today. And so we think that the amount of capital that will be spent on those projects is just a third great driver of demand for the T&D space, in particular, and ultimately for Custom Truck.