Ashtead shares point higher as it gets balance right

It would be easy to keep saying Ashtead shares are defying reality, after the latest ‘pop’ of the machinery leaser’s stock.

Perhaps though its 9% jump on Wednesday, taking the five-year advance above 600%, is instructive, not bewildering.

Keeps lifting

The latest surge came after Ashtead lengthened its string of profit upgrades even further.

It said full-year results should exceed previous forecasts.

But despite several similar forecast hikes over the last 18 months, Ashtead shares have struggled since rising to a record close of 1176p late in 2014.

Persistent investor concerns over its credit-fuelled business model have taken their toll.

Look, no cash!

In theory, Ashtead looks dangerously exposed to an increasingly imminent upswing in interest rates.

It is easily the most indebted of the biggest UK companies that make money the way it does: hiring and occasionally selling everything from small tools to massive machines, primarily to builders.

Ashtead’s total debt was more than one and half times the size of its total equity at the end of April.

Speedy Hire, whose market cap clocks in below £200m vs. Ashtead’s £5.2bn, has a debt/equity ratio of 45%.

More comparably-sized Aggreko, which rents large power generators, is on 49%.

Ashtead’s cash balance always seems to be in the red whenever I look=it spends all of its income, and more.

That suggests the company’s outsized leverage—up by a quarter over the past year—is primarily deployed to keep investors sweet, even if the stock yields a below-FTSE average 1.6%.

Throw in sensible depreciation/amortisation of £212m on average per annum during 2010-15 (remember, this company is all about capital goods), and we can see how rising credit costs could wreak havoc on Ashtead.

Sunbelt powers US sales

In practice however, the doom scenario falls down at management’s door.

The track record of Ashtead’s C-Suite, led by Chairman Christopher Cole and CEO Geoff Drabble, for almost a decade, can speak for itself.

AHT 5-year total return: 50.4% annualised, FTSE 100 average: 4.8%.

Still, the board’s best skill might simply be good timing.

Ashtead makes most of its revenues in the US, where its Sunbelt Rentals generates 84% of group sales each year from a buoyant building market.

There’s little sign that construction there will slow materially next year.

But if and when it does, plant (AKA big machines) can be sold much more quickly for cash when the rental market turns—than say, oil production equipment can be liquidated.

Ask petroleum industry focused cousins like Weir, Rotork and even Smiths Group.

Sensible depreciation (see above) lowers the risk of balance sheet shocks in the event of weaker-than-expected disposal values.

This backstop offers some protection for Ashtead’s growth story.

Then if we knock out the weakest from our comparison, AHT’s 13.15 times prospective price/EPS, close to peer average, could be way too low.

Balance of risk

More conservatively, the balance of probabilities currently favours a continuation of the stock’s current outperformance for the medium-term, at least.

On a technical basis, AHT continues to recoup from the 24th August levels that brought lows for a majority of global markets.

Ashtead’s uptrend has been orderly too.

Even if the stock fails to clear the rising channel established after the year’s weakest prices, it cleared the 200-day moving average last month and has also been supported by a steeper trend since October.

The latter does raise the risk that a rising wedge could be completed next month, heralding a tough reckoning for the stock.

Still, current momentum (Slow Stochastic sub-chart) looks supportive.

And the stock closed on Wednesday above glaring resistance from July c. 1080p.

That’s pretty much bang on the important 61.8% retracement of the May/August slide.

DAILY CHART

Please click image to enlarge