Custom Truck: Infrastructure Bill, Customization Could Be FCF Drivers

Custom Truck One Source, Inc. (NYSE:CTOS) reports a proven business model, which will likely benefit from the infrastructure bill enacted in the United States. In my view, further successful direct contact with customers, customization of offerings, and management of the total debt will likely deliver FCF generation. I also see risks from failed merger integration of Nesco, goodwill impairments, and the dependency on the business interests of Platinum. With that and considering future free cash flow expectations, in my view, the stock appears very undervalued.

Custom Truck

Not every country in the world is characterized by having a fleet of large trucks along with highways and cargo capacities of the magnitude that the United States has. Custom Truck One Source is one of the companies directly linked to this market, its expansion, and its capacity, since they mainly offer products related to truck support as well as tools in the field and sale or rental of both used trucks and trucks.

I want to point out the magnitude of this market, which, due to having the monopoly of land transport of loads of products of all kinds and destined for the most diverse industries, generates a high demand for the services of related and active companies. This, for companies established as Custom Truck, more than 30 years ago and with currently 35 locations throughout the country, means a constant flow of contracts and clients.

Custom Truck not only offers the rental and sale of trucks and fleets for transportation, but also operates within its segment of electric utilities for the telecommunications industry, railway lines, and facilities for different functions throughout the country. According to the company, this market is growing and has had a turn in recent years in which both companies and individuals prefer to rent the equipment before owning it, as it enables the outsourcing of the management of these products.

Besides, in a recent presentation, management noted favorable end-market dynamics with upside thanks to the 2021 infrastructure bill. The infrastructure bill impact is expected to increase the amount of capex in the telecom, infrastructure, and rail industries, which would most likely benefit Custom Truck’s business model.

Healthy Balance Sheet With Some Debt

As of September 30, 2022, Custom Truck reported cash of $26.174 million, together with accounts receivable of $176.969 million in addition to financing receivables worth $32.967 million. Besides, with an inventory of $555.811 million, total current assets stand at close to $801.910 million. Current assets/current liabilities ratio stands at more than 1x, so I would not be worried about the company’s liquidity issues.

Property and equipment stands at $106.721 million, with rental equipment worth $865.569 million and goodwill worth $703.411 million. Intangible assets are equal to $310.888 million, and total assets would stand at $2.85 billion. The total assets/total liabilities ratio is larger than 1x, hence I would say that the balance sheet stands healthy.

The liabilities include accounts payable worth $102.657 million, with accrued expenses around $70.569 million and deferred revenue of about $30.660 million. Finally, total current liabilities stand at close to $562.379 million.

Besides, with long-term debt close to $1.36 billion, operating lease liabilities worth $29.63 million, and deferred income taxes close to $28.1 million, I am not worried about the company’s long-term liabilities. The total long-term debt does not seem small, however, Custom Truck delivers stable EBITDA margins. Hence, in my view, most investors wouldn’t mind financing the operations with a decent amount of debt.

Analysts Appear More Optimistic Than Management

The company’s guidance includes sales growth between 1% and 7% with an adjusted EBITDA margin close to 16%-19%. The figures are significantly lower than what the company reported in 2021 and 2020, so I am a bit more optimistic in my base case scenario.

Market estimates include 2024 sales of $1.768 billion with a net sales growth of 6.83%, 2024 EBITDA of $448 million, and an EBITDA/sales ratio of 25.34%. Operating profit would stand at $201 million, together with an operating margin of 11.40%. Besides, pre-tax profit would be $119 million with net income of $89.1 million. Finally, 2024 FCF would be close to $125 million with an FCF margin of 7.07%.

Further Successful Direct Contact With Clients, Customization, And The Stock Repurchase Program May Bring The Stock Price Up To $13

Custom Truck allows its clients to establish direct contact with the support area 24 hours a day, every day of the year, to solve conflicts with any of its 9,000 facilities circulating throughout the United States. This, within a highly competitive market, especially in the sale and rental of transport trucks, generates a distinction of value over competing companies, favoring the consistency of the company’s business model. Under this case scenario, I assumed that further successful relationships with clients will likely bring revenue growth.

Although Custom Truck has a large number of competitors both regionally and nationally, the company considers that it has certain strengths when it comes to establishing its position in the market, and these have to do mainly with the experience of the company in the field and the great relationship with its customers. In my opinion, these factors, together with the integrated model of the company that offers the one-stop shop and customization for its clients, in addition to a modern fleet whose average age is 3.8 years, generate consistency in the company’s service offerings and a credibility that is very much in favor of its growth and expansion in the market.

Finally, under my base case scenario, I assumed that further stock repurchases will likely bring further stock demand, which may enhance value generation for shareholders. Management offered a certain explanation about its stock repurchase program in a recent quarterly presentation.

My figures include 2033 net sales of $4.520 billion and 2033 net sales growth close to 9.5%. In addition to an EBITDA close to $1.179 billion and an EBITDA/sales ratio of 26.09%, 2033 FCF would be around $226 million.

If we assume a WACC of 6.69%, the sum of discounted free cash flow would stand at $928.1 million. Besides, with an EV/EBITDA of 6.4x, the terminal value would be close to $7.547 billion, and the NPV of terminal value would be $3.7 billion.

Besides, I obtained an enterprise value of $4.630 billion, which, with cash of $26 million and a debt close to $1,370 million, implied equity worth $3.28 billion. Finally, the fair price would stand at $13.3 per share with an IRR close to 5.31%.

Goodwill Impairments, Merger Integration, And Risks Related To The Total Amount Of Debt Could Lead To A Valuation Of $4.7 Per Share

In my view, it is fair to say that there are permanent risks coming from Custom Truck’s business model. First, the acquisition of smaller companies promises the future growth of the company. On the other hand, the inability to integrate these new businesses into its existing segments can negatively affect the operations of the company. Impairment of goodwill or lowering future free cash flow expectations could bring demand for the stock down. In line with these thoughts, let’s note that the acquisitions made by Custom Truck don’t include a small amount of goodwill. In the acquisition of Custom Truck One Source, L.P. management reported a total goodwill of $457 million with total consideration of $1.5 billion.

In addition to its new acquisitions of Nesco and Custom Truck that are still in the integration process, the company is currently heavily dependent on Platinum, which has majority ownership of the shares. The possibility that Platinum’s interests are not aligned with yours can lead to the inability or lack of projection in decision-making. Management discussed these risks in the last annual report.

Platinum owns the majority of our fully diluted shares and, therefore, has the power to control our affairs and policies. Platinum also controls, to a large degree, the election of directors, the appointment of management, the entry into mergers, sales of substantially all of our assets, and other extraordinary transactions. The directors so elected have authority, subject to the terms of our indebtedness, to issue additional stock, implement stock repurchase programs, declare dividends and make other decisions. The interests of Platinum could conflict with your interests. Source: 10-K

Finally, Custom Truck currently finds itself with a considerable debt of more than one billion. For whatever reason, tightening conditions in the debt capital markets may affect the company’s solvency. As a result, I believe that the company’s EV/EBITDA multiple may lower, and the fair price would decline. Management provided an explanation about these risks in the last annual report.

To service our indebtedness, we will require a significant amount of cash. Our ability to pay interest and principal in the future on our indebtedness and to fund our capital expenditures and acquisitions will depend upon our future operating performance and the availability of refinancing options, which will be affected by prevailing economic conditions, the availability of capital, as well as financial, business and other factors, some of which are beyond our control. Source: 10-K

Under the previous conditions, I included 2033 net sales of $3.116 billion together with a net sales growth of 6.5%, 2033 EBITDA of $701 million, and an EBITDA/sales ratio of 22.50%. 2033 FCF would stand at $109.1 million coupled with an FCF margin of 3.5%. I believe that my figures are quite conservative.

Under this case, the sum of discounted free cash flow would stand at $600 million, and with an EV/EBITDA multiple of 5.5x, 2033 terminal value would stand at $3.85 billion with an NPV of $1.8915 billion. Besides, I obtained an enterprise value of close to $2.5 billion and equity of $1.15 million. Finally, the fair price would stand at close to $5 per share with an IRR of -3.5%.

Conclusion

With a business model proven for more than 30 years, the infrastructure bill, and successful client relationship, in my view, Custom Truck will likely experience sales growth and FCF generation. I obviously see risks from the total amount of debt and failed new acquisitions of Nesco and Custom Truck LP, however, I believe that there is certainly upside potential in the stock price.