WillScot Mobile Mini: Upgrading To Buy On Depressed Valuation (NASDAQ:WSC)

Overview

My recommendation for WillScot Mobile Mini (NASDAQ:WSC) is a buy rating, as I expect valuation to revert back to its 3-year average and WSC to continue tracking against management’s long-term guidance. Note that I previously gave a hold rating to WSC, as I thought it was important to keep an eye on WSC for the next quarter or two to make sure the company stays on track to meet its guidance and maintains the momentum seen in 1Q23.

Recent results & updates

I believe the key area of disappointment was the weak modular units on rent performance (19,200 in 2Q23 from 20,235 in 1Q23), which led to the market punishing the stock as they see this as a sign of weakness for FY24. Indeed, there was a 5% decrease observed in the number of units rented. However, it is important to note that 3.6% of this decline can be attributed to the deliberate postponement of retailer remodels, a factor that was already anticipated. When accounting for this adjustment, the observed decline of 5% in the headline figure is effectively reduced to a more modest 1.4%, indicating a relatively less severe outcome. Following a period of peak COVID recovery backlog in 2022, it is not unexpected to observe a decrease in underlying volumes due to a combination of weak macro climate and a weak Architectural Billings Index (ABI). However, if we look at the ABI data so far, the contraction has been decreasing and the index is seeing more periods of growth (above 50) in recent quarters. This suggests that things are gradually getting better, and as we approach FY24, end-market demand should start to increase. Significantly, it is noteworthy that the influx of Federal funding that is anticipated to commence and gain momentum throughout FY24. Consequently, it can be reasonably anticipated that there will be a boost in volumes in the upcoming year.

What is particularly intriguing is that despite an environment that has lesser demand (relatively to a strong macro backdrop), WSC is not experiencing any significant impact on pricing. The modular AMR and spot rates continue to exhibit a spread of over 30%. Although there has been a decrease in the spread in storage, this can be attributed primarily to timing and the robust performance of AMR. However, spot prices have not shown any signs of decline. It is also crucial to note that management’s objective for long-term value-added products (VAPS) in storage is based on a pricing assumption of $70 per unit delivered. It is already tracking at approximately $20 per unit delivered within the first year of initiation. This momentum is clearly strong and exhibits management ability to replicate the success seen in VAPS launch in modular. Looking ahead, I expect this figure to continue tracking towards $70, driving pricing growth. I would also note that PRORACK is a high-quality product, and it should be a meaningful contributor to driving pricing towards $70 in FY24.

Spreads between modular delivered spot rates in the last 12 months have average — over the last 12 months in the average of the portfolio continue to remain above 30%.

As a point of reference, our last 12-month delivered rate in storage is already over $20 per unit, and that’s with only one year since the rollout of our basic offering and before any contribution from PRORACK. From: 2Q2023 earnings call

Therefore, I anticipate an increase in EBITDA margin in the coming quarters as volume improves and pricing faces no pressure. In fact, the expansion in 2Q23 (WCS expanded EBITDA margin by 500 bps) deserves more attention than the weakness in volume. Looking forward, the management is also optimistic about the continued expansion of EBITDA. In terms of costs, it is anticipated that the expansion of the EBITDA margin will be facilitated by the reduction in variable costs resulting from decreased work orders and the diminishing impact of inflation. Additionally, efficiencies gained from logistics and the operating leverage of selling, general, and administrative expenses (SG&A) are expected to contribute to this margin expansion. Furthermore, the WCS is expected to experience advantages resulting from increased effectiveness in the allocation of resources towards modular refurbishment. Additionally, there is potential for enhanced procurement practices in terms of drivers and trucks, which could lead to a greater ability to internally manage transportation within the modular segment. Objectively speaking, management has honestly done really well in driving EBITDA margin towards the target set in the 2021 investor day, as EBITDA margin has increased from 39.1% in 4Q23 to 43.9% in 2Q23.

When viewed together, I believe the market has overly punished the stock by focusing too much on the weak volume this quarter and is missing out on the big picture that: volumes should improve in FY24; pricing remains healthy; and EBITDA margin is well on track.

Valuation and risk

According to my model, WSC is valued at $54.5 using consensus FY24 estimates, representing a 28% increase. My variant perception vs. the market is that I expect multiples to re-rate back to the WSC 3-year average of 12x forward EBITDA as the market starts to realize that the situation is not as bad as it seems. Especially that management is tracking their guidance well. As there is a lack of public peers, I compared WSC to the SPX index. Historically, the ratio between WSC and SPX forward EBITDA has trended up to as high as 1.1 (before the recent 18% drop). It is currently at 0.8x, which I don’t think is fair given that WSC is still growing much faster than the market and has runway for EBITDA margin to continue expanding. Assuming this ratio tracks back to the 3-year average of 0.9x, it implies a forward EBITDA multiple of 12x (which is my assumption).

However, the risk is that volume (units on rent) will deteriorate further from here as the macro situation worsens. If this turns out to be true, I believe the market will put more focus on the near-term execution and results, which will further detract the stock price from its medium-term intrinsic value.

Summary

I upgrade my rating to a buy for WSC based on several factors. While the recent decline in modular unit rentals raised concerns, a deeper analysis reveals that much of this decline is due to the anticipated postponement of retailer remodels. Moreover, the improving ABI and the influx of Federal funding in FY24 suggest potential growth in end-market demand. What’s particularly encouraging is that despite lower demand, WSC is not experiencing significant pricing pressure, with strong pricing growth expected in the coming quarters, driven by VAPS and PRORACK. The expansion of EBITDA margin in 2Q23, cost efficiencies, and management’s successful execution are also positive indicators for the company.