SWOT Analysis
        For those of you new to the SWOT analysis this is a tool to help
review a company’s internal Strengths and Weaknesses as well as the
external Opportunities and Threats to gauge how competitive URI truly
is versus the rest of the industry.

Strengths: While researching URI I have uncovered quite a few
strengths that help give them an edge in a highly competitive market
place.  Since URI is the world’s largest equipment rental provider,
they create a size advantage that gives it economies of scale that
smaller mom and pop shops do not have.  URI has $4.0B of rental
equipment, which means they are buying in bulk (i.e. they get a volume
discount).  It has also leveraged the use of IT wisely and networked
their 700+ branch locations so it can act like one large rental
outlet. If a customer is at location A and needs to rent a piece of
equipment in location B, then URI will move the equipment around to
improve utilization and delight their customers.  URI has been
continuously improving their dollar equipment utilization (average
rental revenue/average equipment fleet cost) over the past few years
from 55% to 62% thru ’06.  These utilization improvements have
translated into record margin improvements (net income as % of revenue
was 6.8% in ’06 versus negative 2.7% in ’04).  Management has added
new services like training certification for equipment to help tie
their customers closer to URI in order to become less of a commodity
and more of a specialized service provider.  These services should
help differentiate URI from their competition and allow for superior
pricing and margins.

Weakness: In my mind there is one large concern that warrants the most
amount of scrutiny by investors, which is the large amount of leverage
(i.e. debt) that URI uses.  The good news is that URI has been paying
down debt over the past few years as shown in graph 1 below.  The debt
to capitalization ratio is also lower, but still sits north of 50%,
which creates more risk than the average company (especially moving
into a slower economy).  This massive amount of debt is what has
allowed it to be successful and expand so rapidly over the course of
ten years and I’m glad to see URI is reducing these ratios to lower
their risk exposure a bit. As debt has dropped and EBITDA has risen
URI has reduced their chances in breaking their covenants with the
banks (i.e. URI has to abide by certain rules set by the lenders like
net income versus interest rate expense and if broken could cause a
liquidity issue if the banks call their loans).

Opportunities: Equipment rental is a positive trend as more companies
prefer to rent versus buy equipment to reduce capital costs, use
equipment only when needed, remove the costly storage and maintenance
requirements and have an inventory of equipment around the world at
any given time.  URI has been heavily investing in new and replacement
equipment to expand their business (i.e. Capital investments of $800M-
$1000M/yr). About 20% of their capital spent is for expanding the
equipment versus the 80% to replace retired equipment. URI has been
acquiring small companies ($10-$30M) to add to their existing base as
they are in a highly fragmented business that is ripe for
consolidation.  It can bring in a smaller business to it’s network and
get better utilization and strategically source supplies and equipment
at a lower cost realizing higher margins.  URI recently was offered
$34.50/share by a private equity firm (Cerberus Capital), but due to
the collapse of the credit market the deal fell thru.  I believe
Cerberus Capital is a well run company and only made this bid after
getting a rare insiders look at the books.  A bid for $34.50 would
have meant Cerberus felt this price was under valued and worth much
more since Cerberus Capital focuses on buying under valued companies
for a strategic investment.   URI is likely still taking bids if any
are out there so there may be an opportunity for a second bid (likely
at a lower price) once the market decides to settle down (hopefully in
the 2nd half ’08).  Lastly, I believe since URI only has a 7% market
share in the North American they have plenty of room to grow in their
current market plus have ample opportunity to pursue Europe, Asia, and
South America.

Threats: The largest threat in the near-term is if the US enters into
a recession and construction gets weaker than it already has. This
will not bode well for URI’s utilization rates and result in much
lower revenue and margin in the short-term.   Fortunately 90% of URI’s
business comes from commercial and industrial segments, which has held
up very well compared to residential.  Competition is everywhere and
there are some large players in the field like Hertz and Home Depot,
but I believe URI has positioned itself to compete based on much
broader product offering and specialization such as training and heavy
customer support to offer complete solutions for their end customers.

Financials
        URI has worked diligently to improve their financials over the past
few years and their score card reflects it below:
o       Net margins have improved significantly from negative 8% to positive
7%
o       CFO (Cash Flow from Operations) growth of 43% per year  (5 year
avg.)
o       FCF (Free Cash Flow) is -6% driven by CapEx in new equipment to grow
the business (I think CFO is the better indicator here because of
their growth)
o       ROE (Return on Equity) at 17-18% the last two year
o       ROIC (Return on Invested Capital) increased 300 basis points in the
past three years to 15%

URI Valuation

        The valuation portion of the newsletter is the best part as it
indicates what the potential rates of return one might achieve
assuming company fundamentals stay in tact for the long-term.
        The eighteen variables Stock Black Book used to score URI generated a
score of 75 out of 100, which is a bit lower than last months pick
AEO, but I feel this is a great opportunity with a higher potential
risk and reward.  The variables that I believe are most compelling for
this stock idea are the fact that the financials have showed
remarkable improvements over the past few years (CFO growth and
expanding net margin as % of revenue). Management has put a large
emphasis on increasing ROIC, which has paid off with the current rate
of ~15%.  URI has the largest market share and margins in a
competitive industry that is ripe for consolidation. URI has proven
they can acquire and successfully integrate businesses and are not
afraid to sell under performing businesses like their traffic control
business.  I am also very attracted to the fact that Cerberus Capital
offered $34.50 per share after getting an up close look at their
financials.  Now admittedly they pulled the plug on this deal, which
is likely driven by the collapse of the credit markets (this is what
Cerberus claimed). I assume that URI is worth at least 80% of what
Cerberus offered, which would mean $28 per share.
        As far as intrinsic value is concerned I believe this stock should be
valued at $32 per share today (1.7X the current price) and in five
years could be as high as $65 per share (3.4X the current price). This
would create an average return over the next 5 years of ~28% based on
today’s $18.84 price reaching $65 in 5 years. I am assuming a cash
flow growth rate of 8% over the next 5 years and a slight net margin
erosion (back to ~6%) as the economy is likely to slow and URI’s
utilization rates will likely decline. I may be too pessimistic as URI
recently came out and increased 2008 guidance to my surprise (11%
higher EPS than the street expected and 280 basis points higher PM%
than 2007). I believe the risks in URI are related primarily to a
slowing economy and completely built into the stock. If commercial
building and roadway projects have a continued decline this will hurt
URI in the short-term. Most experts are calling for a construction
bottom in mid ’08 in residential. Commercial building has not been
impacted like residential, but if this were to change this would be a
near-term risk.
        Stock Black Book is convinced this is an opportune time to open a
position in URI driven by it’s very low versus historical valuation. I
like the long-term trend of this industry consolidating and more
customers wanting to rent versus buy.  If URI continues to pay down
debt and maximize margins through better equipment utilization rates I
think this will drive a much higher stock value.  I feel most if not
all the down side risk has been baked into the current price and the
upside opportunity will be exposed once other analysts recognize the
tremendous cash flow URI generates on a yearly basis versus the
current price.  In the interest of fair disclosure the author of this
newsletter currently holds a long position in this security as well as
most investments he recommends.

Now typically because whan a Private Equity (PE) walks on a deal,
theres a reason, that reason typically being deteriorating
fundamentals.  In this case, the company was the same as it was before
the purchase offer (maybe better as they raised guidance), and
Cerberus still walkd the deal.

Now you have a company, the same as it was before, plus 100 mm extra
Free Cash Flow, at a severely discounted price because a bunch of
douchebag investors took the walkout as a sign that the company was
falling.

They also stated that they are reducing CAPEX by around 350 MM which
will increase FCF ....

Long URI

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