A year ago, under the hammer of the Covid-19 stock market crash, who’d have had the courage to pile into Ashtead Group (LSE: AHT)? Those who did have been amply rewarded, as the Ashtead share price has more than doubled over the past 12 months.
Shares in the construction rental firm fell in the early days. But unlike the wider market, they recovered quickly and resumed their upwards pre-pandemic trajectory. Over the past two years, Ashtead has gained a whopping 150%. So why is the venerable Ashtead looking like a hot new growth stock?
Ashtead is based in the UK, but it carries out most of its business in the US. And what’s the big thing on President Joe Biden’s agenda? It’s massive infrastructure renewal. The US government plans to invest more than a trillion dollars in projects over the next decade. And Ashtead, trading under the name Sunbelt Rentals, is America’s second-biggest rentals firm. So the big driver behind the Ashtead share price seems clear enough.
The thing is, much of the heavy plant machinery needed by the industry is simply too expensive for construction firms themselves to buy. They just can’t afford to tie up big capital in equipment that’s not getting daily use. That’s where the rental firms come in, and they can generate some nice margins for their shareholders. As an example, Ashtead’s return on investment in the US last year came in at 20%.
Cyclical business
The downside is that when the construction business slows, companies like Ashtead can be stuck with expensive equipment standing idle. And it is a cyclical industry, so a future down spell could put pressure on Ashtead.
Now, I reckon we’re probably at the start of a bullish spell for global infrastructure development. And it could well last for more than the next 10 years. But I have one big question. Does Ashtead’s current valuation allow any safety margin to cover possible future weakness?
Based on results for the year ended 30 April, the current Ashtead share price gives us a trailing price-to-earnings multiple of nearly 34. And this is the company that ended the prior year on a P/E of just 12.5. Over the long term, I’d expect a company like this to operate on a similar valuation to the overall FTSE 100. So maybe around 14-ish. And I think we’re very likely to see a reversion close to the long-term average. But that could happen several ways.
Ashtead share price valuation
The optimistic outcome would be for earnings to grow sufficiently over the next few years to bring the P/E down without damaging the share price. If the hoped-for earnings growth doesn’t come off, I’d expect a share price fall. Or we could see something in between. So is the potential growth really there, and is Ashtead still a buy at today’s valuation? My Motley Fool colleague Harshil Patel believes so, and I think he could be right.
I’m just a bit nervous about today’s high valuation, and how the next industry cycle could turn out. But I definitely have Ashtead on my watchlist for further investigation.