Ashtead – a building equipment rental firm on solid foundations

In the immediate aftermath of the first wave of the pandemic there was much talk about the need to “build back better” by spending more on infrastructure. The idea was that this would not only jumpstart the major economies by putting people to work, but also make up for decades of underinvestment that had led to severe deficiencies, something that was increasingly acknowledged as a problem even before 2020.

Throw in a housing boom, and it’s no surprise that the shares of firms involved in the manufacture and rental of construction and industrial equipment surged for most of last year.

However, over the last nine months this boom has started to unravel. There are several reasons for this. Firstly, central banks have started to raise interest rates in order to temper inflation, making it more expensive to finance infrastructure projects and raising fears that house prices may decline.

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The rising price of energy and food are also starting to squeeze people’s incomes, raising fears of recession. Finally, governments are also looking at ways to cut spending in order to tackle the huge fiscal costs imposed by the pandemic.

Benefiting from diversification

One company that has been caught up in this downturn is equipment-rental specialist Ashtead Group (LSE: AHT). The stock has fallen by over 40% since last November. The fall looks overdone. Firstly, there is little sign that the slowdown in demand is affecting its core construction business, now mainly focused on the US.

The company recently reported that it continues to benefit from supply-chain problems with manufacturers that have resulted in an overall shortage of equipment. It also believes that there is a longer-term shift to companies renting equipment rather than buying it outright.

Another reason why a construction downturn won’t affect Ashtead as much as some experts think is that it has been putting a lot of effort over the past fifteen years into diversifying its business. As a result, it now receives a rising proportion of its money from other sectors, such as the film industry and “mega projects”. These projects, such as carmakers building new facilities to manufacture electric cars, are particularly important, as they not only bring in large amounts of revenue, but are also relatively immune to economic downturns.

Ashtead has a strong growth record: sales rose by 60% between 2017 and 2021, while profits increased by a similar amount. At the same time it continues to earn a very strong return on capital expenditure (a key gauge of profitability) of between 12%-15% a year, allowing it to keep increasing the dividend. Yet it trades at only 12.5 times 2023 earnings, a very modest valuation compared with both the US and UK markets.

In addition to the group’s strong fundamentals, there is evidence that the shares may have bottomed out over the past few weeks. They are now trading above their 50-day moving average. I recommend going long at the current price of 3,785p at 50p per £1. With a stop-loss of 2,005p, this would give you a total downside of £890.