Fitch Initiates Coverage on United Rentals NA with ‘BB’ Senior Secured Rating
NEW YORK — Fitch Ratings initiates coverage on United Rentals, Inc. (UR) and its principal operating subsidiary United Rentals, Inc. (North America) (URNA). The ratings are assigned as follows:
United Rentals, Inc.
— Subordinated debt ‘B’.
United Rentals, Inc. (North America) (Guaranteed by United Rentals, Inc.)
— Senior secured debt ‘BB’;
— Senior unsecured debt ‘BB-‘;
— Subordinated debt ‘B’.
The Rating Outlook is Stable. Approximately $3.1 billion of securities are covered by Fitch’s actions.
Fitch’s ratings for UR (and URNA) reflect the company’s strong market position in the North American equipment rental sector, its successful navigation through the 2001-2003 recession, and significant core cash flow. Rating concerns center on UR’s weak balance sheet, low core profitability, and meaningful reliance on secured borrowings to fund the business. Intermediate-term liquidity is acceptable as the company had over $500 million of availability under its committed bank credit facility, which expires in 2009, at Sept. 30, 2004 and only moderate loan and lease annual amortization requirements through 2009.
The Stable Rating Outlook recognizes that UR is the subject of a nonpublic fact-finding investigation conducted by the Securities and Exchange Commission (SEC). While the scope of the inquiry appears to be significant, the specific target areas are unknown to management. At this point the ratings and outlook reflect the inquiry will be resolved satisfactorily.
While Fitch has noted significant goodwill write-downs that UR reported in 2003 and 2004, Fitch is comfortable with management’s explanation for these charges and believes that the likelihood that UR could report similar charges in 2005 and beyond is remote. Nonetheless, this is an area in which Fitch is closely monitoring and could have an influence on the company’s ratings in the future
The double-notch difference between URNA’s senior unsecured rating and the subordinated rating reflects the collateral shortfall of revenue-earning equipment-supporting debt. Revenue-earning equipment collateral coverage of senior debt has been in the range of 1.07 times (x) to 1.34x since year-end 1999. The insufficient hard asset coverage for the subordinated debt suggests that repayment in a liquidation scenario would be based on UR’s enterprise value. Consequently, Fitch views UR’s and URNA’s subordinated debt as highly speculative.
UR and URNA are each SEC registrants. While URNA is the principal debt issuer, it accounts for approximately 99% of UR’s assets. As such, Fitch uses UR’s financials for its analysis of both companies.
Founded in 1997, UR was one of a handful of public companies formed to help consolidate the equipment rental industry. To management’s credit, the company has remained viable during a period of unprecedented volatility in the sector as other consolidators, such as NationsRent and National Equipment Services, filed for bankruptcy protection, or, in the case of Rental Services Corp., were acquired by larger companies. Since its founding, UR acquired 250 equipment rental companies. At Sept. 30, 2004, UR had more than 730 locations in the U.S., Canada, and Mexico.
While UR’s acquisition strategy positioned the company as the industry leader in equipment rental, it had an adverse impact on its balance sheet. Goodwill created as a result of UR’s acquisitions peaked at more than $2.2 billion, or about 44% of assets, at Dec. 31, 2000. More importantly, book equity has not exceeded goodwill at any point over the past five years. As such, the company’s risk-adjusted capitalization compares unfavorably to companies engaged in short- and longer term leasing in Fitch’s rating universe. While writedowns of $1,032 million since 2001 may call into question the valuation of the remaining $1.3 billion of goodwill remaining on UR’s balance sheet at Sept. 30, 2004, the drivers of these charges – the combination of a limited operating history, reclassification of business segments, and unprecedented volatility in the equipment rental sector – are not viewed as recurring events.
Reflecting the cyclicality of the equipment rental business, UR’s earnings before interest, taxes, depreciation, and amortization expenses (EBITDA) have fluctuated sharply since 1999. Equipment rental demand is directly related to nonresidential construction expenditures. Given the weakness in nonresidential construction expenditures since 2001, UR’s EBITDA declined in spite of an increase in its equipment fleet. The company’s EBITDA showed some improvement in 2004 as nonresidential construction experienced a monthly year-over-year uptick according to the U.S. Department of Commerce since February. This improvement was reflected in UR’s operating results, as well as the results of other large equipment rental companies.
Operationally, UR reported significant losses in 2002, 2003, and is likely to report a large loss in 2004. These losses were triggered by large special expenses, principally goodwill writedowns, debt refinancing costs, and business restructuring. Absent these charges, UR remained modestly profitable with 2003 appearing to be the cyclical trough. To management’s credit, in spite of the declines in gross domestic product for nonresidential construction in 2002 and 2003, revenues remained fairly constant.
The improvement in UR’s EBITDA, excluding special charges in 2004, has had a favorable impact on the company’s financial leverage ratio, defined as total debt, including convertible securities, divided by EBITDA. This ratio has ranged between 3.10x and 4.10x since 1999 and stood at 3.90x (annualized) at Sept. 30, 2004. With UR’s equipment reinvestment requirements, this level of leverage is particularly high and a meaningful decline in the near-term is not likely, although improvement in this metric is a key focus for management over the intermediate term. Fitch is also cognizant of the impact the company’s off-balance sheet operating leases and adjustments for real estate rents have when considering adjusted debt totals.
Based in Greenwich, CT, UR is the largest equipment rental company in North America as measured by equipment fleet, revenue, and store locations. For the nine-month period ended Sept. 30, 2004, the company reported total revenue of $2.3 billion and EBITDA excluding special charges of $604 million.
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