Sunbelt Rentals Holdings

Sunbelt Rentals reported robust 12.5% rental revenue growth to $2.9 billion, 60 basis points of operating margin expansion to 24.4%, and 20.4% EPS growth to $1.18 per share driven by better profits but also aided by share repurchases.

Why it matters: Management boosted its fiscal 2027 revenue and EBITDA guidance based on the strong results and improving outlook across most of its verticals. Similar to its peer group, mega projects continue to be the drivers of increased revenue, and the related capital expenditures on fleet to support that growth. Management also struck a more confident tone on local markets with supportive macro indicators and potential for greenshoots. While impressed with the top line, we continue to struggle with margins. Sunbelt had modest improvement in operating margins driven by sales growth meaningfully outpacing depreciation expense. However, EBITDA margins compressed 100 basis points to 42.2% on higher ancillary revenue.

Long view: Investors seem less concerned about operating leverage for the equipment rental companies when growth rates enter double digits. Macro indicators, such as the Dodge Momentum Index, are improving, and Sunbelt pointed to both a better rate environment and tight production from its key suppliers. We acknowledge the company’s improving outlook but would prefer to see ancillary, specialty rental revenue contributing more strongly to margins and returns on capital rather than growth for growth’s sake.

The bottom line: We are maintaining our fair value estimate for narrow-moat Sunbelt Rentals at $80 per share despite the modest revenue guide because our margin expectations were more optimistic. The shares were trading up midsingle digits during Sept. 9 trading on management’s confident outlook.

Our $80 per share fair value estimate equates to about 19 times our fiscal 2027 EPS estimate and an enterprise value/2027 EBITDA multiple of about 6.0. The valuation is not particularly demanding in a historical context. This valuation now reflects the company's primary listing in New York, and Sunbelt had always been reporting financials in US dollars, given how much those assets overwhelmingly contributed to the company's results.

The company continues to see relatively resilient demand across its portfolio, which is admittedly diversified across multiple industries. Sunbelt doesn’t particularly overindex to construction, which has been a comparatively weaker end market. We forecast 8% growth in North America with stable margins in 2027 amid cost uncertainty. This is in line with the higher end of management’s guidance, which strikes us as conservative compared with its competition. For the UK, we forecast 3% growth and stable margins.

For our forecast horizon, we anticipate mid-single-digit growth for general tool with more gradual margin expansion at the EBITDA level to reflect our skepticism that the group retains such strong pricing and the dynamic where rapid specialty rental growth seems to contribute at weaker margins. For the UK, we forecast 5% annual revenue growth with 50 basis points per year of margin expansion, which assumes the business can generally grow in line with its market and management can drive better execution. Overall, Sunbelt’s top line hasn’t been quite as strong as United Rentals’, and we think its profitability in general tool looks comparatively vulnerable compared with the expansion opportunities in specialty.

Our stage II forecast period incorporates an estimated investment rate of 40% and earnings before interest growth rate of 5% with perpetual growth of 3%. An 8.0% weighted average cost of capital derives from a market-average cost of equity and the firm’s current capital structure.

We believe Sunbelt Rentals benefits from a narrow Morningstar Economic Moat Rating due to cost advantage.

Based on our research, Sunbelt Rentals is among the largest customers of all its main equipment suppliers, so it realizes a cost advantage in procurement and generally has the most favorable terms as far as canceling orders during downturns to preserve cash flow and financial flexibility. As the second-largest player in the North American market with 11% market share, Sunbelt maintains a rental fleet and density of stores in the largest markets that are orders of magnitude larger than all peers except market leader United Rentals. This allows Sunbelt to best serve both large scale national but also smaller local accounts. As a result, it can offer customers more products with greater efficiency (lower transportation costs, less need to sub-rent equipment to meet customer needs, and so forth). Similar to United Rentals, we also believe Sunbelt has firmly established economies of scope as demonstrated by its one-stop shop strategy. Not only does Sunbelt offer a very broad array of equipment for general rental, but by growing its specialty business, it layers on additional solutions that relieve customer pain points. General tool engages in the rental of machinery and equipment including aerial platforms, forklifts, excavators, trucks, power generators, HVAC equipment, and various other construction-related equipment and materials. Examples of “specialty” rental include (but are not limited to) providing portable storage/modular spaces (mobile offices, fencing, and so on), plastic bathroom facilities to various job sites, trench safety solutions (digging support equipment and solutions for underground projects), and fluid solutions (equipment to contain, transfer, and treat fluids, often for municipal customers). Overall, we believe the equipment rental space benefits from enduring secular tailwinds because there is a valid outsourcing argument for Sunbelt’s customers. It’s more capital efficient to obtain many of these products and services from third parties like the equipment rental companies.

While this business model is replicable and not particularly unique, we believe there is ample supporting evidence to justify a narrow moat for both Sunbelt and United Rentals. First, returns on investment and EBITDA margins have increased substantially as the businesses have achieved critical mass, and there remains a very wide performance gap versus the third-largest competitor, Herc Holdings.

We believe the biggest debate around the moat concerns pricing power, which is somewhat difficult to analyze given the proprietary nature of that data and how the companies disclose. Per Sunbelt’s presentations, it claims to have/maintain positive pricing in general tool, and it is observing margin expansion in its specialty activities, though the margins of those are ironically lower than general tool. The reverse appears to be the case with United Rentals. We believe the financial data imply 1) at least a degree of stability in general rental, 2) clear growth and margin expansion opportunities in specialty.

To further justify Sunbelt’s narrow moat, we highlight the following factors. Despite serving an extremely fragmented market, the largest players are growing disproportionately and gaining share. We believe this is a strong signal of cost advantage as this would not otherwise be likely to occur. Sunbelt has modified its capital allocation strategy to structurally reduce financial leverage to a range of 1.0-2.0 times net debt/EBITDA and also instituted a progressive dividend. United Rentals has taken similar actions. For businesses often regarded as highly cyclical and quasi-financial engineering plays, management funding growing operations and shareholder remuneration mainly through operating cash flow is a strong signal of confidence.

We think increasing rental penetration can be a key driver for the industry, and this will favor the market leaders. The equipment rental market in North America is approximately $50 billion, and we believe it’s poised to grow by at least midsingle digits over the next five years. This is driven by multiple factors. First, overall investment in large projects such as infrastructure, semiconductor manufacturing, liquid natural gas, and other construction provide durable tailwinds. Specifically, these large, complex projects favor market leaders that can offer a greater breadth of products and solutions to customers. Second, we anticipate growing rental penetration and specialty equipment sales as customers increasingly outsource. Currently, rental penetration rates in North America stand near 55%. We anticipate this will grow for the foreseeable future as more contractors forego buying new equipment in favor of renting because it drives down project costs. By renting, customers can reduce equipment inventory, eliminate maintenance costs, and save on storage and warehousing costs, thus improving profitability.

Sunbelt will continue to gain market share owing to its superior network of locations and robust product offering.

The company will drive further penetration of specialty rentals, driving pricing power and enhancing returns.

The company can get the UK assets to perform like the North American ones or divests them and reallocates capital to better North American assets.

Sunbelt has no pricing power, and returns could deteriorate.

Competitors could capture share via further consolidation and/or price competition.

The company could make poor acquisitions.