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Overview -- U.S.-based equipment rental company United Rentals Inc. (URI) has improved operating performance and credit measures. -- We are raising the our ratings on URI, including our corporate credit rating, to 'B+' from 'B'. -- The stable outlook reflects our expectation that the company will maintain credit measures and financial policies consistent with the higher rating. Rating Action On Aug. 30, 2012, Standard & Poor's Ratings Services raised its ratings on Greenwich, Conn.-based United Rentals Inc. to 'B+' from 'B'. We also raised our issue-level ratings on the senior secured notes to 'BB' from 'BB-'; the recovery rating on the notes remains '1', indicating our expectation that lenders would receive very high (90% to 100%) recovery in a payment default scenario. We raised the rating on URI's senior unsecured debt to 'B+' (the same as the corporate credit rating) from 'B' and the recovery rating remains '4', indicating our expectation of average (30% to 50%) recovery in a payment default scenario. The rating on the subordinated debt is now 'B-' (two notches below the corporate credit rating) and the recovery rating remains '6', indicating our expectation for negligible (0% to 10%) recovery in a payment default scenario. We now rate the company's preferred stock 'CCC+'. The outlook is stable. Rationale The upgrade reflects our expectations that URI will likely continue to benefit from improving fundamentals in the equipment rental industry, but that it will generate negative free cash flow in 2012 because of elevated capital expenditures. The company recently acquired the No. 2 player in the equipment rental industry, RSC Holdings Inc. (RSC). Although this transaction increased leverage to about 4.7x, the company should benefit from synergies and strong demand, which could reduce leverage to about 4.1x by the end of 2012. Our forecast assumes: -- Nonresidential construction spending increases about 10% in 2012, and then flattens in 2013. -- The company continues to benefit from good demand from industrial end markets. -- Contractors tend to rent versus buy equipment because of market uncertainty. The company's "fair" business risk profile primarily reflects its leading position in the cyclical, highly competitive, and fragmented equipment rental industry. URI is the biggest player in the market, with a large and diverse rental fleet. The company has good geographic and customer diversification. It also benefits from good economies of scale for purchasing rental equipment and has more flexibility to transfer equipment among branches. We expect improvement in nonresidential commercial construction spending, which spur demand for equipment rentals, to continue to support URI's performance. Nonresidential construction spending has been weak since late 2008, but we expect it to improve in 2012, growing by 10% and then flattening in 2013. Conditions in the equipment rental industry have also improved recently because of contractors' preference for renting versus buying equipment when projects are relatively scarce or uncertain. Additionally, the equipment rental companies are benefiting from good demand from some industrial end markets, such as energy. Over the long term, we expect customers' outsourcing trend to continue. In the quarter ended June 30, 2012, URI reported rental revenues increased by about 15%, partly because of a 7% increase in rental rates and stable time utilization at 67%. URI's 12-month EBITDA margin improved to 39% as of June 30, 2012, from 33% a year ago, reflecting increased pricing power, strong demand, and lower fixed costs as a percentage of revenues. The ratings also reflect URI's "aggressive" financial risk profile. The largely debt-funded acquisition of RSC reflects URI's very aggressive financial policy, in our view. Pro forma for the transaction and $200 million in share repurchases, as of June 30, 2012, URI's total debt to EBITDA was approximately 4.5x. We consider debt to EBITDA of 4x to 5x appropriate for the rating. We believe the combined entity will continue to benefit from strong fundamentals in the equipment rental industry, and earnings growth could result in leverage of about 4.1x by the end of 2012. We assume some benefits from synergies in our forecast. However, execution risk and economic uncertainty could delay an improvement to credit metrics. Liquidity We consider URI's sources of liquidity to be "adequate" under our criteria to cover its needs in the next 12 to 18 months, even if its EBITDA declines unexpectedly. The company has minimal upcoming debt maturities. Our assessment of the company's liquidity profile incorporates the following expectations and assumptions: -- We expect the company's sources of liquidity, including cash and facility availability, to exceed its uses by 1.2x or more over the next 12 to 18 months. -- We expect net sources to remain positive, even if EBITDA drops by 15%; -- We believe the company could absorb low-probability, high-impact shocks. The company has good relationships with its banks and access to the capital markets, as its recent debt issuance to fund the transaction indicated. We expect the company to invest in capital to an extent that is likely to result in negative free cash flow in 2012. We also expect the company to exercise prudent management of its rental fleet, thereby generating positive free cash flow when the growth rate slows and the cycle turns, consistent with the counter-cyclical nature of cash flow in the equipment rental industry. As of June 30, 2012, the company had $41 million in cash and nearly $500 million available under its $1.9 billion asset-based revolving credit facility. Springing financial covenants govern the company's credit facility, and the covenants remained untested as of June 30, 2012. Recovery analysis For the full recovery analysis, see the updated recovery report on United Rentals Inc., to be published this week, on RatingsDirect. Outlook The stable outlook is supported by the current favorable business conditions in the equipment rental industry. We could revise the outlook to negative if the economic recovery falters further, eroding operating performance more than we expect, or if issues related to the integration of RSC appear likely to hinder performance, and leverage rises to greater than 5x. We could raise the ratings if the company appears likely to achieve and maintain improved credit measures and positive free cash flow, and if it adheres to a financial policy that could support a higher rating. For instance, we could raise the ratings if the company sustains total debt to EBITDA of 3x to 4x and the operating environment in the equipment rental industry is likely to remain positive. Related Criteria and Research -- U.S. Economic Forecast: Keeping The Ball In Play, Aug. 17, 2012 -- Industry Economic And Ratings Outlook: Risks Increase For U.S. Capital Goods Companies As The Eurozone Debt Crisis Drags On And China's Growth Slows, June 29, 2012 -- Issuer Ranking: U.S. Capital Goods Companies, Strongest To Weakest, March 28, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Criteria For Rating The Global Capital Goods Industry, April 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Upgraded; Outlook Action To From United Rentals Inc. United Rentals (North America) Inc. Corporate Credit Rating B+/Stable/-- B/Positive/-- Upgraded To From United Rentals (North America) Inc. Senior Secured BB BB- Recovery Rating 1 1 Senior Unsecured B+ B Recovery Rating 4 4 Subordinated B- CCC+ Recovery Rating 6 6 United Rentals Trust I Preferred Stock CCC+ CCC
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