Equipment Expansion And Electrification Will Drive Recurring Revenue And Support Profitability

Key Takeaways

• Growth in rental revenue is supported by utility infrastructure upgrades and legislative incentives driving equipment purchases, leading to stronger margins and cash flow.
  
• Diversification and inventory optimization efforts reduce risk and leverage, enhancing company resilience and positioning for improved profitability.
  
• Elevated leverage, margin pressures, regulatory uncertainty, and dependence on cyclical sectors pose significant risks to profitability and earnings stability.

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.

• Sustained and growing demand from electricity grid modernization and maintenance, fueled by increasing electricity usage and multi-year utility infrastructure upgrades, is driving recurring rental revenue and supporting long-term top-line growth.
  
• Legislative tailwinds, such as the federal bonus depreciation provision, are incentivizing capital spending by smaller and mid-sized customers, which should accelerate equipment purchases and bolster TES segment revenues and margins.
  
• Strategic and ongoing investments expanding the rental fleet and maintaining high utilization rates (above 75%) are increasing recurring revenue and providing margin stability, supporting consistent adjusted EBITDA growth and improved free cash flow generation.
  
• Broadening order growth, particularly among local and regional customers (signed orders up 45% YoY), and diversification across end markets reduce cyclicality and revenue concentration risk, supporting a higher growth and resilience profile.
  
• Continued focus on inventory optimization and leverage reduction (with a stated net leverage target of below 3x by end of FY 2026), if achieved through strong free cash flow, is likely to decrease interest expense and boost net income, creating potential for valuation rerating.

Custom Truck One Source Future Earnings and Revenue Growth

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Custom Truck One Source's revenue will grow by 6.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from -0.9% today to 4.0% in 3 years time.
• Analysts expect earnings to reach $96.5 million (and earnings per share of $0.43) by about July 2029, up from -$17.4 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $118.3 million in earnings, and the most bearish expecting $85.9 million.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 37.1x on those 2029 earnings, up from -130.5x today. This future PE is greater than the current PE for the US Trade Distributors industry at 24.2x.
• Analysts expect the number of shares outstanding to grow by 0.39% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.66%, as per the Simply Wall St company report.

Risks

• Despite improved leverage ratios and management's goal to reduce net leverage below 3x by fiscal 2026, the company's current net leverage is a relatively high 4.66x, and ongoing capital investments funded by borrowing could materially increase interest expense and pressure net earnings if revenue growth were to stall, particularly amid elevated interest rates.
  
• The TES segment's backlogs have declined quarter-over-quarter and year-over-year, and although management highlights strong intra-quarter order flow, a sustained drop in backlog could indicate normalization or weakening of demand growth; this poses a risk to future revenue visibility and could compress gross margins if demand softens.
  
• Gross margins in the TES and ERS segments are under pressure, with recent gross margin declines and segment mix shifts driven by a higher mix of lower-margin rental asset sales; persistent margin normalization or competitive pricing could negatively impact profitability and overall net margins.
  
• The company acknowledges ongoing uncertainty in environmental regulations, including federal and state emission standards and potential tariff changes; adverse final outcomes or increased compliance costs relating to emissions legislation or tariffs could drive up costs, reduce asset values, or limit product offerings, thereby negatively affecting EBITDA and net earnings.
  
• Custom Truck One Source remains highly exposed to cyclical infrastructure, utility, and industrial markets; any prolonged downturn or slower-than-expected spending in these sectors due to macroeconomic volatility or shifts to alternative technologies (e.g., electrification or automation reducing demand for traditional vocational trucks) could lead to declining sales and EBITDA, especially given the company's significant fixed cost base.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of $11.5 for Custom Truck One Source based on their expectations of its future earnings growth, profit margins and other risk factors.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $13.0, and the most bearish reporting a price target of just $10.0.
• In order for you to agree with the analysts, you'd need to believe that by 2029, revenues will be $2.4 billion, earnings will come to $96.5 million, and it would be trading on a PE ratio of 37.1x, assuming you use a discount rate of 10.7%.
• Given the current share price of $9.96, the analyst price target of $11.5 is 13.4% higher.
• 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.