Stockwatch: Time to exploit this share's momentum

Sweet spot, or portending a cyclical peak? First-quarter results from US-oriented industrial equipment renter Ashtead show pre-tax profit up 23% to £160.4 million on revenue up 20% to £539.6 million. That's a very strong top line performance for a FTSE 100-listed group with revenue just over £2 billion in its last financial year to end-April.

The consensus expectation is for over 40% earnings growth in Ashtead's 2015/16 year, moderating to a mid-teens rate, although the stock had de-rated since June from 1,217p below 900p, partly amid the wider sell-off. It has jumped over 100p in response to the figures, but its forward price/earnings (PE) multiple is still modest at 13 times, reducing to 11 times.

Low PEG and robust earnings outlook

Dividing the PE ratio by the earnings growth rate results in values well below 1.0 - the classic test of earnings value according to the price/earnings-to-growth, or PEG factor. It's modest partly because the market has tried to price in risks of a cyclical downturn, yet Ashtead has scotched that fear for now, citing strong momentum.

The stockmarket hasn't been irrational though, it correctly anticipated the upcycle in pricing Ashtead on an average 57 times historic earnings in 2011, moderating to the mid-twenties in recent years. Now it is trying to look a year and more ahead after one of the longest upturns in history, boosted by exceptionally loose monetary policy in the US and UK.

Capacity has built up in plant hire, which would leave operators more exposed in a downturn. By recently de-rating Ashtead, the market was also likely reacting to expectations that central banks would soon begin raising interest rates - a fear now reduced by international financial turmoil. But unless the Chinese economy hits genuine trouble, central banks still appear resolved to normalise monetary policy to some degree.

Good scope for long/short traders

Ashtead is therefore attractive for traders to exploit its ongoing momentum, bearing in mind the reasons why the stock fell will reassert later to create a shorting opportunity. The PEG is attractive currently, but can be explained by enough investors avoiding Ashtead because they fear the cycle turning down eventually. To trade the stock capably you therefore need to be attuned to dynamics of the bull/bear case and also how sentiment interacts.

Analysts at Barclays have maintained their forecasts in response to the update - while Ashtead's current rating is in line with the industry long-term average, "we believe at this stage of the cycle, and growing significantly ahead of the market, a premium to the long-term average is merited". Who knows if that will prove correct, but it's certainly an up-tick in sentiment.

After springtime bad weather, Ashtead has seen an especially strong improvement in demand - meaning record levels of utilisation in July, on a fleet 26% enlarged. Management has confidently invested £349 million in the first quarter alone, opening 19 greenfield locations and making a smaller acquisition. They are on track to achieve mid-to high teens fleet growth in the US, and open 50 new locations in the full year. All good for the short term and how long the cycle extends, but mind it implies growing capacity risk.

US/UK industry cycles are influential

Ashtead remains a classic cyclical in the wider context. The US economy surprised most people with its 2012 rebound, helped by QE and ultra-low interest rates, and the UK has achieved GDP at the high end of international growth rates, its construction industry benefiting from "help to buy" mortgage subsidies.

With 84% of group revenue derived from the US in the last financial year, a key question is what extent the US economy can remain relatively strong against risks such as China and a strong dollar crimping exports. It's a significant but not altogether macro call: e.g. when I initially drew attention to Ashtead at 140p in September 2011 a chief reason was structural change in the US hire market with fewer operators - hence more freedom to price. The 2009 recession also meant firms were switching to renting than ownership of equipment to improve returns on capital employed.

Warnings from Speedy Hire and HSS Group hint at UK rental weakness and likely contributed also to Ashtead's drop, but these firms do not have majority US exposure like Ashtead. At the June prelims, management said US growth was "across a range of market sectors" hence it was investing accordingly and more widely. Same-store growth of 17% against 7% market growth last year and 8% projected this year, reflects market share gains. While Ashtead has avoided sensitivity to the oil & gas industry, its stock represents a play significantly on the US economy and dollar - a virtue for now. The US stockmarket is rebounding due to healthy domestic data.

Mind the debt, cash flow and low yield

Other reasons why Ashtead is more a long/short play than tuckaway, include £1.8 billion net debt - rising admittedly for sound reasons of investment supporting growth. This compares with net assets of £1.1 billion at end-July, i.e. gearing in the order of 164%, recently up from 152%. And it's manageable - Q1 net finance costs were only £19.5 million against £180.2 million operating profit, although this extent of debt tags the stock as "geared cyclical". A sub-2% yield is no prop and further focuses attention on earnings. Moreover, the table shows the cash flow trend isn't great, often substantially lagging earnings and set against significant capital spending - hence the rise in debt and earnings cover for the dividend being kept high. The market barely cares about all this while the going is good, but likely will when the cycle turns down.

It all makes Ashtead great material for long/short traders, with risk presently on the upside.

For more information see: ashtead-group.com.