Stock to Watch: Ashtead Group

A seemingly bizarre development is forecasts for FTSE 250-listed plant-hire group Ashtead Group being guided aggressively upwards - despite a lacklustre US construction industry, to which it is principally exposed, and growing fears of a double-dip recession.

Yet there are genuine reasons, backed by directors' share buying. The situation shows how you must never become complacent towards equities: even and perhaps especially during times of fear. When shares are depressed and a company can show it is a "special situation" then bang, you see a re-rating.

Ashtead jumped over 20% to about 140p after first-quarter results (to end-July) on Monday 6 September, although the key question is more for the medium term: analysts at UBS reckon the shares could be worth 300p if the US manages to avoid a recession. A double-dip is pretty much the consensus view but remember the adage, "the stockmarket has predicted nine of the last five recessions." Cheer up, it might not happen.

In which case, it is worth putting Ashtead on the watch list. A range of 30p over 200p since March 2009 shows how volatile the firm can be; this is because it will always be seen as a cyclical share, the possibility of plant hire being a "feast or famine" industry. Mind also, that tangible net assets per share are only about 20p and the prospective yield under 3%, hence valuation is driven by expectations of earning power.

Yet the US plant hire industry, where Ashtead earns over 80% of its revenue, has become a lot more "oligopolistic" - i.e. fewer, stronger operators with relative freedom to price. Plant hire firms tend also to be operationally geared, meaning that changes in revenue can affect or even magnify profit quite quickly.

These two factors explain the 21% revenue growth and 67% profit growth at Sunbelt, a key US subsidiary, with management saying: "we are clearly benefiting from the ongoing structural change in the US rental market. Sunbelt has also now delivered 15 consecutive months of year-on-year rental revenue growth. These structural trends are likely to continue with further increases in rental penetration and Sunbelt's market share expected."

The aspect of industry structure benefiting recent performance is shown by US construction spending being about 20% below the last two peaks, and falling, yet superior growth emerging at Ashtead.

So the crux for sentiment is whether this aspect of restricted supply - which contrasts with over-supply in 2007-08 - can continue to boost the company's financials into 2012 despite evident risks for the US economy.

Management believes so, hence is already guiding for its year to end-April 2012 to be substantially ahead of expectations. UBS has upgraded this year's profit forecast by 31% "although this remains conservative in our view. We leave the 2012/13 forecast unchanged given the macro situation but we think risk is heavily on the upside."

While I would take a 300p share price target with a pinch of salt, Ashtead's financial dynamics do indeed offer very useful upside with the shares fallen from over 200p earlier this year on macroeconomic worries. Investors tend to have a strong gut instinct to dump cyclical shares at the early stages of a downturn, but this has been contradicted by special industry factors.

Management has no doubts on necessary capital expenditure to meet demand, with capex rising from £63 million to £225 million and with £325 million planned for the 2011/12 year. Net debt has increased seasonally to £848 million although its ratio to operating profit is within targets. The group's two debt facilities are committed until mid-2016.

Mind the aspect of currency translation, where the 21% reported revenue growth rate is at constant exchange rates, compared with a 12% actual rate, however in "actual" terms even the statutory (not normalised) results show barnstorming progress, with pre-tax profit up 136% to £33.1 million and earnings per share up 127% to 4.2p.

With the US representing over 80% of group revenue, the trend in the dollar remains a significant factor and some investors are cynical enough to believe in the dollar's demise amid US indebtedness and weak economic performance. The bear argument on the dollar assumes a loss of hegemony (imperial dominance for the currency) as the US falls steadily from grace.

Yet the extent of international trade in dollars and Chinese vested interest in their massive holdings of US Treasury bonds are factors in support. Note how the dollar is still prone to rally on crisis days in financial markets, as investors resort to US Treasury bonds. Even Nouriel Roubini, "Dr Doom" among economists, keeps his predominantly cash holdings in dollars.

Straight after the first-quarter results, one of Ashtead's non-executive directors bought 7,467 shares at 133p, to hold 13,822 shares. While a modest holding, this increase backs the board's expressed confidence and follows purchases of 50,000 and 25,000 shares at 139.5p in early August, by the chief executive and finance director who own 411,357 and 1,577,034 shares respectively. Although they did not catch the late summer low, this is now revealed as a stockmarket event rather than reflecting the industry. The chief executive was also buying modest amounts of shares at 158p to 167p, then gifting them to children.

It would be wise never to forget how volatile plant hire shares can be; and I am not being complacent in this piece, towards very real risks in the global economy. Yet Ashtead's resilience is a marker how this share could indeed rebound a lot further if a double-dip recession is avoided.

You can learn more via www.ashtead-group.com, which includes a webcast of the results' analysts meeting.

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