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

All right. Good morning. This is Tami Zakaria, Head of U.S. Machinery, Engineering and Construction sector equity research at JPMorgan. It is my pleasure to welcome Chris Eperjesy, Chief Financial Officer of Custom Truck One Source. For those that need an introduction, Custom Truck One Source provides truck and heavy equipment rental and sales services and serves customers in the United States, Canada and Mexico. So with that, I'll turn it over to Chris for his presentation.

Good morning, everyone. I'll take about 10 minutes, just to give you kind of a brief overview of the company. Just in case you don't know. At the first slide, you saw those photos. Those are photos of products that we manufacture. The way we position ourselves is a one-stop shop platform. So we focus on both rental of specialty equipment as well as sales and then aftermarket parts and service. On an LTM basis, we're $1.87 billion of revenue, $427 million of EBITDA, we have about 2,500 employees. And in our rental fleet, we have just under $1.5 billion of assets, original equipment cost and 10,300 units. You'll see in the charts on the lower right, just some information about our end market, our revenue distribution and our rental fleet, I'll go through that because I do think it is important. If you look at our end markets, roughly 60% of our revenue comes from the utility space, so transmission and distribution. And that's pretty consistent with where it was last year. I think last year, it was 60%. Infrastructure has actually grown. Last year, it was roughly 20%. This past year, it was 24%. So we have seen pretty significant growth there and then rail and telecom are both about 5%. In terms of our revenue distribution, about 2/3 of our revenue comes from the sale of new and used equipment. And then just under 1/3 comes from rental and then under 10% comes from aftermarket parts, service and sales. In terms of our rental fleet, so as I mentioned, we have just under $1.5 billion in our rental fleet. That rental fleet is distributed amongst these products. So buckets are roughly 31%, digger 17% and other T&D is 22%. So you'll see the majority of our rental fleet is geared towards the utility space. Then we also have cranes, rail and telecom, all between 5% and 10%. In terms of the year that just finished, it was another record year for us. So I'll just hit on some of the highlights. Revenue was up 20% versus 2022. Adjusted gross profit was up 13%. And then our adjusted EBITDA was up just under 10%. While our margins in all of our segments held flat, what you'll see there in terms of why the EBITDA flow-through was lower than revenue is there is a mix impact. Our new sales equipment business is on an adjusted profit basis in the mid-teens, high teens, and our rental business tends to be closer to 75%. And so you're seeing a little bit of a mix impact there. In terms of the business segments, we have 3 ERS, which is our rental and used sales business. Our TES business, which is new equipment sales and then APS, which is aftermarket parts and service, you'll see the ERS business was up roughly 10% that was largely driven by the used equipment sales that's coming out of the rental fleet. I think that was up just over 20%. Our TES business had another very strong year, every quarter, we had double-digit growth, and we're just under 30% for the year versus when the deal was -- the combination occurred in April of '21. We've continued to delever. Although this year, we were flat year-over-year. But at the time of the deal, we were 4.6x and we finished the year at 3.5x and I'll talk a little bit more about that in a slide later. And we did open 3 new branches, one of the, I think, opportunities for us is as we look at some of the white space in the country is to get some new locations, service sales in rental locations. And so we've been able to open 3, which I'll also talk about in a moment. In terms of end markets, very favorable end markets in the utility space, infrastructure, rail and telecom, and we've laid out here just the impact of the IAJA impact. And you can see it's hundreds of billions of dollars as well as just the overall capital expenditure that's occurred in the industry, and you can see it's a high single-digit to low double-digit kind of CAGRs over the past 3 or 4 years. So just great end markets, and we're seeing that in terms of our backlog and our overall demand. I'm not going to go through all of these, obviously, but we have a very diverse and highly loyal customer base. You'll see not very concentrated. We have 8,000 customers. Our top 15 customers represent about 16% of our overall revenue. No single customer represents more than 3. And you can see here just a representative list across the utility space, infrastructure, telecom and rail. And again, we have a long tenure, 15-plus year tenure, with most of our top customers. We have a pretty broad industry equipments as well as geographic distribution. So pretty resilient business as we look forward. I talked a little bit about the differentiated one-stop shop model. We think it's unique. So we have great relationships with our suppliers, which are largely OEM suppliers, attachment suppliers as well as we offer our customers an opportunity to either buy equipment, new equipment, used equipment and also rent from our rental fleet. And so we think having that end-to-end customer solution is a real benefit for us and creates a competitive moat when you think about the $1.5 billion and 10,300 units that we have in our fleet. In terms of our branch network, we're up to 38 locations now. We just recently announced 3 new locations, Casa Grande, Arizona, which has some production capabilities, Sacramento and Salt Lake City, which are similar to our other locations in terms of service, rental and new sales capabilities. The areas that we're continuing to focus on, if you were here last year, there were 5 regions. We've checked Southwest off now, but the specific Northwest Northern California, the New Jersey, New York metro area and then the Carolinas are the areas that we're really focused on as we look at future growth. This is just a summary of our performance year-over-year. As I mentioned, we had pretty significant growth year-over-year, 19% revenue, just under $1.6 billion to just under $1.9 billion. We saw similar growth in our adjusted gross profit. And EBITDA, again, was up from $393 million to $427 million, saw good growth across all of our markets. One headwind that we have had is we do have floor plan interest costs which is actually a reduction to EBITDA. So we don't add it back as an interest cost. And we have seen as a result of higher interest rates and a strategic decision to kind of mitigate some of the impacts of supply chain. We've carried probably higher levels of inventory than we typically would. And so we are seeing a little bit of that impact. But in spite of that, we were still able to show pretty significant growth year-over-year. Similar story here, just trying to show you kind of what's happened since the deal closed in April of '21. And so we've added about $500 million of revenue. And you can see $135 million, $140 million of EBITDA, unfortunately, and I'm sure this will come up in the Q&A. We have not seen a similar appreciation in our share price and our share price is close to the level at which platinum equity executed the deal back in April of '21. So definitely, I think there's some opportunity there. Our 3 segments. I'll just touch on this a little bit. I talked about it. We have 3 segments: equipment rental solutions, which we call ERS; track and equipment sales, which we call TES and then our aftermarket parts and service. Our aftermarket parts and services, I said on an earlier slide, is roughly 6%, 7% of overall revenue, so relatively small. Our ERS segment really is focused on the sale of the rental assets when they come off as well as the rental of the assets that are in our fleet. Typically, the key metrics that we look at are utilization on the fleet OEC on rent or original equipment cost on rent and then on rent yield. And then in our truck and equipment sales business, obviously, it's our backlog, which I'll talk about in a second is continues to be at relatively elevated levels. And then, of course, our aftermarket parts and service business, where we focus on selling tools, kits and providing other services for the vehicles that we rent and sell. In terms of our overall balance sheet and liquidity, you'll see here at the time of the deal closed, we had 4.6x leverage. We got that as low as 3.3x and then saw it come up in the fourth quarter as a result largely of the investment in inventory I talked about as well as our share buyback program. On the top right, you'll see we have significant availability under our existing ABL facility. So we have a $750 million facility, where we have about $325 million the suppressed availability on that and then existing ABL availability of about $200 million. We have said, and I'll talk about it in our guidance in a second, a leverage target of getting below 3x by the end of this fiscal year. We had set a similar goal for the year that just ended, but we made the decision to invest in some of that inventory just given the growth that we are seeing that effectively pushed that goal out for about a year. In terms of the guidance, so we announced this guidance, was it last week? Last week or the week before. In terms of our expectations for 2024, we think it's going to be another growth year for us. We think it's going to be mid-single digit to double digits, so 7% to 17% growth there. So we finished, as I mentioned, at 1.9. We're projecting between $2 billion and $2.180 billion. You can see the different segments there, ERS, 1% to 5% growth, TES, 13% to 27% growth and then EPS 4% to 11%. Overall EBITDA growth, we're expecting somewhere in the range of 3% to 10%. One of the things we'll probably talk about in the Q&A, we have seen a little bit of softness in our transmission business on the rental side. And really, we do think it's temporary. It's not any indication of long-term demand and getting some projects started and some funding. And hence, that is what's driving the lower ERS growth. But we continue to see really strong demand on the TES side. And so we expect that to continue this year and have another year of double-digit growth. Additionally, we set a couple of additional targets. We're going to generate more than $100 million of levered free cash flow. We do expect to get below the 3x leverage by the end of the year and it will be another year of an approximate $400 million gross CapEx in our rental fleet. And the way to think about our CapEx is typically about $100 million is what we think of as net maintenance CapEx. And so when I say that of that $400 million, roughly $300 million would be maintenance CapEx. We have another roughly $200 million of proceeds on sales of used equipment. And so we think of that kind of as the net investment in the maintenance CapEx. And so the delta between the $300 million and the $400 million would be growth CapEx, which will largely be focused on specialty rental in vocational space. So things like refuse trucks, roll-off trucks, water trucks and then things like hydro-excavators and hydrovacs. And so with that, I think we can open it up to Q&A.

Perfect. I'll start off with some questions and then open it up to the audience towards the end. So you had a strong 2023 despite supply chain remaining a gating factor. So let's start there. Where in terms of supply chain normalcy, are you at now, what areas remain bottlenecks versus pre-COVID levels or pre-COVID times?

Yes. I mean, you've seen we've been able to expand our inventory levels back to historical levels or even higher. So we've definitely seen an improvement across the board, so much better than it was. It's not wide open, so we would not call it back to normal. Our chassis -- our, what do you call it, our Class 8 chassis, which had been an issue now are much more available. So we're not experiencing a lot of difficulty with our Class 8 chassis. But we are -- continue to experience some around our Class 5. Our attachment is much better than it was. So we're in a much better position than we were even a year ago and certainly much better than we were 2 years ago. And so I would really describe it as more one-offs now than any across the board issues with any 1 supplier, whether it's a chassis OEM or an attachment OEM.

Got it. So lots of comments today from several companies around U.S. infrastructure spending in mega projects. Remind us, how does your product portfolio fit into that narrative? And what are your competitive advantages for, let's say, an infrastructure project.

Yes. And so I -- in one of the early slides I talked about the end markets that we serve. We serve utilities for transmission, distribution, infrastructure, which are the roll-offs, the refuse trucks, the water trucks, hydro-excavators would all be in that category and then rail and telecom. And so all of those end markets are extremely well positioned. I think our competitive advantage is obviously the size of our fleet. So we have 10,300 units, and we're continuing to invest there and just our overall capability on the new equipment side and that the investments we've made will allow us to continue to expand. And that is one thing to note. While the margins in the TES business tend to be lower than the rental margins. It's also a much lower asset business in terms of the invested capital that's required. If you think about the rental fleet, we have $1.5 billion of original equipment cost there. So it's a much heavier investment in terms of assets, in terms of invested capital.

So to dig a little deeper on that, in a typical infrastructure or utility project, when does your products -- when do your products see the most engagement in demand? Is it toward the front end when you break the ground or towards the tail end or pretty consistent throughout the life of the project?

It's pretty consistent throughout. If you think about a utility project as an example, when they're digging to do the poles, they would be using our digger derricks to dig. When they're now working on the poles, they would be using our bucket trucks to go up and work on them and they could also be using our pole trailers as they're bringing the trailers to it. So it's typically once construction begins is when our -- typically, our products get used and they typically get used through the duration of the project.

Got it. And then last earnings call, you spoke about some softness in utilities. Can you recap for us what happened and whether you think this can reverse in the near term? I think you mentioned you don't see it as a structural weakness in demand. So what's really driving this? When do you see this inflecting?

Yes, it's definitely not structural. We definitely see good long-term demand across all of our end markets, but specifically in utility and specifically in transmission. What we have seen is just the timing of some of the funding, the timing of some of the projects getting ready to go. So we have a long list of ones that are getting ready to go. They're just not there yet. There can be some regulatory issues at times, and certainly, there's some funding issues. But everything we hear from our customers, everything we see, this is really temporary. And we would expect by the second half of the year that these projects are going to be picking back up and we'll get back to normal utilization. If you think about our utilization, we've historically guided mid-70s used to be really good and 80 was great. We had a period where demand was just so strong that we got up into the high -- the mid- to high 80s for a brief period of time at the end of 2022. We still have across most of our products and most of our end markets, utilization that's at that 80% range. It's really what's happening in transmission that's bringing it down. I think we finished the year at 75-ish percent in terms of overall weighted utilization, but we would expect that to rebound by the second half of the year.

So 2 follow-up questions on that. The first one, if the Fed were to slash rates this year, historically, is that a positive for rental demand?

Yes, you would think as rates were rising, that, that might push customers from buying new equipment to renting new equipment. We actually didn't see any correlation. And so we saw continued strong demand in both. And so I think the answer is we're not seeing that strong correlation at all.

Got it. And the second follow-up is on the utilization rate. You mentioned it ticked down to, I think, 77.6% or call it, 78% and so -- but it's still quite strong compared to other rental companies out there. But is this high 70% sort of the new normal? Or what is your expectation of utilization rate as you look into the next 4 quarters?

Yes. Our historical guidance, I think, still holds, which is mid-70s to low 80s is a good -- a really good range, and it will -- there is some seasonality throughout the year. There is -- we could encounter issues like we've had in the most recent 2 quarters with transmission business. But as a general rule, the specialty rental business, especially our end markets is a lot different than GenRent. And so we typically are pretty resilient in maintaining those utilization rates and same thing on the residual value side. We hold residual value 60% to 70%, 5, 6 years, 7 years after the asset's been in the fleet. And so that's very unique versus what you see in the GenRent space.

So we know that specialty rental penetration remains notably lower than general rental. What do you think is the reason behind this? And what needs to happen for these to reach parity? Or is parity at all possible between rental versus specialty?

We definitely think there will be a closing of that gap. I think GenRent rent is 50, mid-50s, high 50 kind of penetration. Specialty rentals low to mid-20s. And so there's obviously a lot of room to move there. What we see in our business, there is a lot of rental and new equipment sales in the utility space. In the specialty and vocational, it tends to be more sales. And so that's roll-off trucks, refuse, water trucks, hydrovac. And so we do think, longer term, there's probably an opportunity there for -- as that market matures and that is where we saw a lot of our growth in 2023 as that market matures, there's going to be a bigger market for rental. And so we do see that gap closing. I would not put in the near-term horizon at getting up to that 50%, but certainly, we should see movement.

Got it. And so could you share your views on the specialty rental pricing market with inflation moderating, and we've seen relatively strong pricing over the last 2 years or so. Do you believe rental contract pricing for the specialty channel can see some downward pressure going on from here?

Our general guidance has been and continues to be, we think we can maintain margins and so in adjusted gross profit basis for our rental business, it's in the mid-70s. Our used equipment sales from the rental business bounces around a little bit more because it depends on whether it's an RPO, which is a rental purchase order or if it's a used -- truly a used piece of equipment or if it's a direct sale to a customer, and so that can be anywhere in the 30% to 40% kind of range. And then our TES new equipment sales has been kind of in the mid- to high teens. Our goal is to continue to maintain those margins. We think there's opportunity long term to expand them all. But as we look at 2024, I would think more of maintaining those margins and covering any potential inflationary costs.

Got it. So just to build on that point of used equipment market, you've seen strong profitability in recent years from the sale of equipment, both used and new. What do you -- do you expect a normalization ahead?

I do think that is one of the things, as I was talking about the difference between GenRent and Specialty Rental. We think that, that's sustainable and will be there for the long term. And so as I mentioned, 60%, 70% kind of residual values we're getting 30%, 40% margins on those sales when we sell those. And we expect that from everything that we've seen that that's going to continue to be kind of what we're going to experience going forward.

Got it. Okay. So let's talk about your one-stop shop business model. I think that's pretty unique. Does that have an impact on customer acquisition? Or does this more -- does this drive retention more than acquisition? And more broadly, what do your customers care most about the business model and why they keep coming back to CTOS?

I think the answer is both. And so customers like the flexibility of being able to -- and many customers do rent and purchase. So they have that flexibility of perhaps they have a certain base of business so they buy equipment, but then they can use Flex with renting. And so we certainly see that a lot. There are customers that only buy and there are customers that only rent as I mentioned, specialty and vocational tend to be buyers versus renters. But as we look forward, we think having that flexibility for our customers, which we do, we can easily because we're both the truck upfitter or manufacturer as well as the renter, we can allocate assets where the demand is. And so as we look forward, we would expect that to continue. I think in terms of what they view most important, certainly availability and flexibility, but also having that broad network that we have across the country for parts and service is also something, I think, that distinguishes us versus largely a lot of regional and local competitors. And so that's certainly one of the moats that we have.

Great. And are you looking to expand your rental fleet into any new product lines or adjacent markets?

So as I talked about, one area that we think there's a lot of opportunities in specialty and vocational which we've probably just scratched the surface here, but we have seen significant growth in things, in refuse, in water trucks, in hydrovac and so certainly, that's an area as we look at -- I mentioned we have about $100 million of growth CapEx. More than half of that is going to be going to growth in those markets. And so we definitely see an opportunity there.

Got it. So on your business model, you have the ERS segment, the Rental Solutions segment, and then you have equipment sales segment. Is there a preference to grow one or the other? The rental business is clearly more profitable from a margin perspective. So is your goal to sort of keep it at the mix there currently at or change it over time?