Ashtead Group Stock: Long Growth Runway At 18-21% EPS (ASHTF)

The following segment was excerpted from this fund letter.

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Ashtead Group plc (OTCPK:ASHTF): Public LBOs

Our broadcast TV franchises, leasing, building products distributors, plastic packaging, and roll-on/rolloff (RORO) shipping fall into this category. One trend I’ve noted in these firms is growth creation through acquisitions which provides synergies and operational leverage associated with vertical and horizontal consolidation and the subsequent repurchasing of shares with debt.

The increased cash flow from acquisitions and subsequent synergies are used to pay the debt and the process is repeated. The effectiveness of this strategy is dependent upon a spread between borrowing interest rates and the cash returns from the core business and acquisitions. Recently, interest rates have been increasing, and this has reduced the economics of this strategy; but a large spread still exists if assets can be purchased at the right price.

One example of public LBO firms we have in the portfolio is Ashtead Group plc (OTCPK:ASHTF). Ashtead is an equipment rental/leasing firm that operates in the United States, Canada, and the United Kingdom. Ashtead’s growth model is achieved through overall market growth, including the continued increase of leasing over ownership of equipment (5-6% per year), opening new stores in clustered footprints, and synergistic M&A (8-10% per year).

These are enhanced by opportunistic operational leverage from scale and share repurchases (5% annual growth). The current penetration for general tool equipment rental (70% of sales) is 55%, but for specialty equipment it is on average only 10% (30% of sales). Thus, the runway for growth through penetration is long. Ashtead’s operational leverage is illustrated by their net income margins being up 120%, with a 5x increase in revenues over the past 10 years. These factors should lead to 18-21% EPS growth going forward. Ashtead has had 19% and 31% EPS growth over the past five and 10 years, respectively.

The cluster strategy creates a local infrastructure where new products can be supplied/leased for high incremental margins. Part of Ashtead’s strategy is to lever up to purchase:

1. new locations to geographically expand, and,
2. complementary equipment leasing firms and then pay the debt down with cash flows post acquisition, similar to private equity funds.

Ashtead has done this many times over the past 10 years. This strategy is similar to that of Asbury’s, described in previous letters. In comparison to other equipment firms, Ashtead has amongst the highest asset turns and margins. This has resulted in 21% to 43% returns on equity over the past five years. Below is an estimate of the fair value of Ashtead based upon future cash flows utilizing this model.

Ashtead						EPS Growth	26%					£ 50.60	9.48	5-yr fwd PE		10% growth PE
												6.3%	15.80	Earnings/FCF Yield		28.5
		2021	2022	2023	2024	2025	2026	2027	2028	2029
Revs		£ 5,232	£ 6,548	£ 7,943	£ 9,134	£ 10,505	£ 12,080	£ 13,288	£ 14,219	£ 15,214			Revenue Drivers
Growth			25%	21%	15%	15%	15%	10%	7%	7%			7-10% Organic (mkt growth (3%), share & penetration (3%))
													3-4% M&A & share buybacks
ATCF		£ 743	£ 1,125	£ 1,373	£ 1,579	£ 1,816	£ 2,088	£ 2,297	£ 2,458	£ 2,630			Historical op leverage
Margin		14.2%	17.2%	17.3%	17.3%	17.3%	17.3%	17.3%	17.3%	17.3%
															Target Price	$152.09
Cash FCF		£1.68	£2.55	£3.20	£3.80	£4.50	£5.34	£6.05	£6.68	£7.36		Shares	442	$22,365.20	IRR	24.6%
Growth			51%	26%	19%	19%	19%	13%	10%	10%
	Repurchase Rate
Shares		3%	442	428.74	415.88	403.40	391.30	379.56	368.17	357.13

Click to enlarge

Ashtead currently trades for an EPS multiple of about 15.8x and an earnings yield of 6.3%, with low 20% EPS growth. Ashtead’s BBB-rated debt (with an EBITA coverage ratio of 7.6x) is currently yielding 6.2%. Given a conservative projected EPS growth of 10% per year, Ashtead should trade at 29x earnings using Graham’s formula of 8.5 + 2 * growth rate. Applying this multiple results in about a 2x return today and a 3x return in five years.

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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.