Herc Reports Solid Fourth-Quarter Results, Showing Rental Demand Remains Intact

Herc reported solid numbers to end 2022, but investors sent the company’s shares down approximately 6% intraday. We think the negative sentiment was brought on by the company slightly missing consensus fourth-quarter EPS estimates (by roughly 3%). However, in our view, the company continued to show strength across the board, thanks to strong rental demand. The same factors we’ve discussed in recent quarters were at play, for example, constrained new equipment supply. This dynamic has led many construction contractors to rent equipment while supply chains correct.

All in all, we elected to increase our fair value estimate to $140 per share from $137 previously. The key catalyst was our bullish stance on the company’s near-term sales opportunity. We continue to believe that contractors will increasingly opt to rent equipment as opposed to buying new, especially in cases where equipment is used intermittently. We forecast Herc’s top line to grow by 19% in 2023, which is notable given sales increased by 32% in 2022. On the margin front, we’re expecting operating margins to expand roughly 130 basis points to 21.7% in 2023 compared with 2022. In our view, strong pricing will be a key lever the company will pull to grow profitability in 2023. Herc exited 2022 with 6.6% pricing growth. To start the year, we think Herc can expand pricing by a mid-single-digit rate, thanks to the strong demand environment.

On valuation, we think Herc’s shares are currently fairly valued, trading roughly 4% above our $140 fair value estimate. Note, our forecast bakes in our view that increased U.S. infrastructure spending will start flowing through at the end of 2023, with the majority of spending occurring between 2024-25. This dynamic gives us confidence to project healthy free cash flow generation in our forecast. We believe free cash flow will improve incrementally over the next five years, before landing above $500 million in our midcycle year, 2027.