Edmond Jackson's Stockwatch: Ashtead Group

Does a consensus for double-digit earnings growth over the next three years still make the FTSE 250-listed shares in US/UK plant-hire firm Ashtead Group a 'buy' despite their impressive rise to a recent peak of 730p?

I drew attention at 140p in September 2011 amid directors' share buying and structural changes in the US rental market benefiting stronger players, hence allowing them more freedom to set prices. Management was also guiding results for the year to end-April 2012 substantially higher.

These aspects of strong competitive position and operational gearing (changes in revenue being magnified in profits) remain the key to Ashtead's future in a macroeconomic environment dicey to judge, hence the recent volatility in the shares.

Despite fears over US debt management these last two years, Congressmen have "succeeded" at kicking the can down the road and the central bank has sustained vigorous quantitative easing - such that an economic recovery now appears to be gaining traction, for example stronger-than-expected manufacturing and construction data on 3 September. Recovery also seems to be picking up in the UK.

In its last financial year to 30 April 2013, Ashtead derived 85% of turnover from North America and is reaping the benefit of massively expanding capacity. In August 2006 there was the $1 billion (£640 million) acquisition of Nationsrent, which then led to fears that Ashtead was exposed to a US recession, hence a 30p share price in 2009.

Despite falling profitability (see table), management ramped up spending on new equipment from £30 million in 2009 to £200 million in 2010 - this is projected to grow to £560 million this year. Through whatever combination of luck and masterstroke, this explains the dramatic profits turnaround when the US downturn actually encouraged more firms to rent equipment than own it.

The trading view on Ashtead shares therefore reduces to whether the US construction industry (also the UK) is now in the early stages of a long-term cyclical upturn - in which case Ashtead rates as a 'momentum buy' - or imminent action in Syria drags the US into another extended war (is a 60-day deadline realistic?) that risks debt issues and worries hurting the economy again.

Bigger capacity may also make Ashtead sensitive to a downturn, if it happens, this time around. This is probably why the stock plunged 50p to about 625p in intra-day trading on 4 September despite impressive first-quarter results to end-July,

with pre-tax profit up 59% to £99.5 million on revenue up 24% to £410.5 million. Return on investment for the Sunbelt US subsidiary has improved from 21.1% to 25.3%, well ahead of the group's pre-tax weighted average cost of capital, while the A-Plant in the UK has risen from 3.4% to 6.8%. Both firms are the second largest in their markets. Management was again able to indicate "a full-year result ahead of our previous expectations", hence underlying momentum continues.

A recent jagged share-price chart suggests the market is aware of risks, despite broker targets of 670p to 830p and no-one daring to publish 'sell' advice. At about 650p the shares trade on 16.5 times the recent consensus earnings per share forecast for the current financial year, dropping to 14.3 times for 2014/15 - although with management guiding forecasts higher, the price/earnings multiple could be lower. It is still most likely in a fair value range.

Although the five-year table shows cash flow per share recently lagging earnings per share, like-for-like first-quarter operational cash flow rose from £100.1 million to £117.9 million; the dent to net cash flow results from payments for rental property, plant and equipment, up from £162.2 million to £179.1 million - helping explain net debt up from £988 million to £1.19 billion amid the seasonal rise in working capital, also smaller acquisitions. The latest results show interest expenses only 10% of operating profit and with a new $2 billion debt facility the situation looks manageable.

Ashtead has moved on from its chequered history of rapid acquisitions, unstable debt and aggressive accounting that took the shares as low as 2p in 2003. Its 53 year-old chief executive joined in 2006 and has transformed the group, perhaps enjoying some luck with the benefit of "cheaper to rent than buy", which did not apply to plant hirers in the early 1990s recession. But in fairness he has made his luck with a radical strategy.

For share trading, consider an odds-setting approach. On a two- to three-year view it may be 70% likely a cyclical upturn will prevail, making Ashtead a useful means of exposure; but there is also, say, a 30% chance it is priced in and should Syria prove another example of the US being drawn into an extended conflict then this is a share that could suffer.

The share therefore merits attention in weeks ahead as the uncertainties of outcome for likely US air strikes on Syria imply pressure on sentiment, in which case another buying opportunity may arise. But if any military campaign hits trouble (including terrorist reprisals) which ultimately affects the US economy, Ashtead's expansion and operational gearing may make it look exposed. So holders need to take care and short sellers may also see opportunity.

For more information see ashtead-group.com.