Legacy Diesel Fleets Will Struggle Under Tightening Emissions Rules

Key Takeaways

• The shift to electric and autonomous vehicles and stricter environmental regulations risk making current assets obsolete, raising costs and compressing margins.
  
• Heavy investments in fleet expansion and high customer concentration increase financial vulnerability and revenue volatility amid evolving industry and competitive pressures.
  
• Robust demand, strong cash flow, and supportive policy are driving sustained growth, improved margins, healthy backlogs, and increased financial flexibility for the company.

Catalysts

Provides specialty equipment rental and sale services to electric utility transmission and distribution, telecommunications, rail, forestry, waste management, and other infrastructure-related industries in the United States and Canada.

• The ongoing transition toward electric and autonomous vehicles risks making Custom Truck One Source's existing portfolio of diesel-powered and legacy platforms obsolete, requiring heavy new investment to maintain competitiveness and potentially rendering existing fleet assets less valuable, which could result in lower return on assets and margin compression over time.
  
• Escalation of strict environmental regulations and emissions standards exposes the company to rising compliance costs, reduced demand for non-compliant equipment, and disruptive shifts in customer purchasing behavior, threatening both top line revenue and long-term profitability.
  
• The company's aggressive fleet expansion strategy, evidenced by record Q2 OEC and ongoing high CapEx commitments, increases exposure to financial risk if end-market rental demand slows or if technological disruption accelerates, which could drive down utilization rates, depress asset values, and heighten leverage-ultimately putting future earnings and balance sheet stability under pressure.
  
• High customer concentration in core infrastructure and utility segments leaves CTOS vulnerable to sector-specific policy changes or spending cuts; should infrastructure investment growth stall, CTOS could face sharp declines in order volume and revenue volatility, as illustrated by recent declines in backlog despite strong quarterly sales.
  
• Industry trends toward direct-to-customer strategies by OEMs and accelerated consolidation are likely to intensify competitive pressures and lower pricing power, which could further erode net margins and limit Custom Truck's ability to differentiate through traditional distribution and upfitting services.

Custom Truck One Source Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Custom Truck One Source compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Custom Truck One Source's revenue will grow by 6.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -1.9% today to 0.9% in 3 years time.
• The bearish analysts expect earnings to reach $20.9 million (and earnings per share of $0.1) by about September 2028, up from $-36.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 77.1x on those 2028 earnings, up from -38.3x today. This future PE is greater than the current PE for the US Trade Distributors industry at 24.0x.
• Analysts expect the number of shares outstanding to decline by 2.94% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 12.32%, as per the Simply Wall St company report.

Custom Truck One Source Future Earnings Per Share Growth

Risks

• Sustained high demand in core utility and transmission markets, driven by secular electricity growth and substantial grid maintenance spending, is supporting strong rental activity and double-digit revenue growth, which may lead to continued revenue and earnings expansion.
  
• Record-high utilization rates for the rental fleet and strategic fleet investments indicate robust end market demand and effective capital allocation, which could drive higher recurring rental revenue and improved net margins over the long term.
  
• Legislative clarity, such as the inclusion of accelerated depreciation in recent federal spending bills, is creating favorable conditions for small
• and medium-sized customers to invest in equipment, potentially supporting Custom Truck One Source's sales growth and positively impacting revenues.
  
• Order flow, especially among local and regional customers, showed significant year-over-year growth, with signed orders up nearly 35 percent and overall backlog normalizing at healthy levels, suggesting sustained future revenue streams and supporting healthy earnings.
  
• Management's reaffirmation of full-year guidance, strong levered free cash flow generation, targeted reduction of net leverage, and improved key financial metrics point to greater financial flexibility and improved profit outlook, which may underpin share price resilience.

Valuation

• The assumed bearish price target for Custom Truck One Source is $5.5, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Custom Truck One Source's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $9.0, and the most bearish reporting a price target of just $5.5.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $2.3 billion, earnings will come to $20.9 million, and it would be trading on a PE ratio of 77.1x, assuming you use a discount rate of 12.3%.
  
• Given the current share price of $6.09, the bearish analyst price target of $5.5 is 10.7% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.