Ashtead Group PLC

LSE:AHT

Earnings Call Transcript 2023-Q1

[Operator]

Good day, and welcome to Ashtead Group Q1 Results Conference Call. Today's call is being recorded. I would now like to turn the conference over to Brendan Horgan, CEO. Please go ahead, sir.

[Brendan Horgan, executive]

Thank you, operator, and good morning, everyone, and welcome to the Ashtead Group Q1 Results Call. I'm speaking from our field support office in South Carolina, and joining on the line from our London office are Michael Pratt and Will Shaw.

Before getting into the results slides, I'd like to take this opportunity to speak to our Sunbelt team across the group to congratulate and thank them for their incredible contributions.

This is primarily in recognition of 2 things. First is their dedication to the leadership and engagement of the people across our branch network, which now exceeds 1,250 locations, who in turn bring a similar dedication and even pride in servicing our customers. And second, for their ongoing resolve and continuous improvement mindset embedded in our safety culture. This culture extends from our branches to our team members' homes and, indeed, to our customers at their sites, projects or events. Without these cultural elements, we would not be in a position to cover the ongoing growth and success of the business as we will today.

So as I usually say when signing off on company calls and communications, thank you. Keep leading positively and safely out there and stay focused on people, people, people, customer, customer, customer.

With that, we'll move to the highlights on Slide 3. The business continues to perform very well, delivering another quarter of strong revenue and earnings growth in end markets which I will characterize as high demand and structurally supportive. In the quarter, rental revenues in North America increased 28% over last year. The principal driver to PBT and EPS growth of 29% and 33%, respectively.

During this quarter of strong revenue growth, we continued to advance our strategic growth plan, Sunbelt 3.0, now in the second year of a 3-year plan. We did so in part by executing on all our capital allocation priorities, beginning with nearly $700 million in CapEx, which fueled our existing locations and greenfield additions with new rental fleet and delivery vehicles; expanding our North American footprint by 33 locations, 20 by way of greenfield openings and 13 via bolt-on acquisition; investing $337 million in bolt-ons in the period; and returning $116 million to shareholders through buybacks.

Despite these levels of growth, capital investment acquisitions and returns to shareholders, we remain near the bottom of our net debt-to-EBITDA leverage range. These results demonstrate the ongoing strength in our end markets and the fundamental strength in our cash-generating growth model. The business is performing better than our previous expectations in revenues and operating profit. However, on a PBT basis, this is offset by the now, not surprising, increased interest cost. We, therefore, expect PBT to be in line with our expectations for the full year.

Let's move on to our outlook on Slide 4. Recognizing the momentum in the business from Q4 and throughout Q1 in demand levels, better-than-targeted rental rate progress, pace of greenfield openings and bolt-on activities, we are increasing our full year revenue guidance. We now anticipate the U.S. to be in the 17% to 20% growth range, Canada increases to growth of 19% to 22% and the U.K. improves to flat to minus 4%.

From a CapEx standpoint and consistent with previous updates, we maintain a range of $3.3 billion to $3.6 billion, of which $2.7 billion to $3 billion is new rental fleet. These activities and anticipated business performance lead to expect free cash flow of circa $300 million.

On that note, I'll now hand it over to Michael to cover the financials in more detail. Michael?

[Michael Pratt, executive]

Thanks, Brendan, and good morning. The group's results for the first quarter is shown on Slide 6. As Brendan said, we had a strong quarter, with the momentum we experienced last year continuing through the first quarter and into the second. As a result, group rental revenue increased 26% on a constant currency basis. This growth was delivered with strong margins and EBITDA margin of 46% and an operating profit margin of 28%. As a result, adjusted pretax profit increased 29% to $555 million and adjusted earnings per share were $0.944 for the quarter.

Turning now to the businesses. Slide 7 shows the performance in the U.S. Rental and related revenue for the quarter grew by a strong 29% against last year which, in turn, was up 7% on pre-pandemic levels. This is driven by a combination of volume and rate improvement in what continues to be a favorable demand and supply environment. The strong activity and favorable rate environment have enabled us to pass through the inflation we've seen in our cost base, both in general as well as in the direct costs related to ancillary revenues such as fuel, transportation and erection and dismantling, which are growing at a higher rate than pure rental.

This ability to pass through inflation could be seen in the EBITDA margins of our same stores, which continue to progress. However, while we have passed through the inflationary impact, these ancillary revenues generate a lower margin than the pure rental business and represent a greater proportion of revenue this year.

In addition, we continue to open greenfields, adding 18 in the quarter, and complement our footprint through bolt-on acquisitions. Inherently, in the early phase of their development, greenfields and bolt-ons are lower margin than our more mature stores. The locations added through greenfield openings and bolt-ons since the beginning of last year have an average EBITDA margin about 10% lower than our same stores and it takes around 3 years for them to achieve average margins.

These effects, coupled with the well-trailed increase in investment in the infrastructure of the business in support of Sunbelt 3.0 throughout last year, particularly in relation to technology, lowered the EBITDA margin by around 1%. Given these dynamics, we expect drop-through to improve as we move through the year, although it will be affected by the level of bolt-ons in the rest of the year. All these factors contributed to drop-through for the quarter of 43% and an EBITDA margin of 48%, while operating profit was $567 million at an improved 30% margin, while ROI improved to 26%.

Turning now to Canada on Slide 8. Rental and related revenue was 20% higher than a year ago at CAD 159 million. The original Canadian business goes from strength to strength as it takes advantage of its increasing scale and breadth of product offering as we expand our specialty businesses and look to build out our clusters in that market.

Our lighting, grip and lens business continues to encounter a degree of market disruption, with the threat earlier this year of strike action in the Vancouver market resulting in productions being delayed or transferred elsewhere. As a result, Canada delivered an EBITDA margin of 43% and generated an operating profit of CAD 38 million at a 22% margin, while ROI is 20%.

Turning now to Slide 9. U.K. rental and related revenue was 11% higher than a year ago at GBP 149 million. This growth is despite the significant reduction in work for the Department of Health as we completed the demobilization of the testing sites during the first quarter. As a result, the Department of Health accounted for approximately 16% of revenue for the quarter compared with 34% a year ago.

The core business continues to perform well, with rental revenue 23% higher than a year ago. However, the inflationary environment, combined with the scale of the logistical challenge in completing the testing site demobilization over 3 months and the significant increase in demand over that period, particularly in returning events market, contributed to some operational inefficiencies. The principal driver of the reduction in operating costs is the reduction in the work for the Department of Health. These factors resulted in an EBITDA margin of 31% and an operating profit margin of 14%. As a result, U.K. operating profit was GBP 26 million for the quarter and ROI was 12%.

Slide 10 updates our debt and leverage position at the end of July. As expected, debt and leverage increased in the quarter as we actioned all components of our capital allocation policy, resulting in leverage of 1.6x net debt to EBITDA, excluding the impact of IFRS 16. Our expectation continues to be that we will operate within our target leverage range of 1.5 to 2x net debt to EBITDA, but most likely in the lower half of that range.

As we've said on many occasions, a strong balance sheet gives us a competitive advantage and positions us well to optimize the structural growth opportunities available in our markets. Therefore, as shown on Slide 11, we recently accessed the debt markets in order to strengthen our balance sheet position further and ensure we have appropriate financial flexibility to take advantage of these opportunities.

We issued $750 million of 10-year investment-grade debt of 5.5%. Following the notes issue, our debt facilities are committed for an average of 6 years at a weighted average cost of 4%.

And with that, I'll hand back to Brendan.

[Brendan Horgan, executive]

Thanks, Michael. We'll now move on to some operational and end market detail on Slide 13. Beginning with the U.S. business, our revenue gains continued. General Tool improved upon last year's strength with 23% growth in the quarter. Specialty continued its remarkable performance, growing 39% in Q1 on top of last year's 22% in the same quarter. The strength of this performance was broad, extending through all geographic regions and specialty business lines.

One year ago, when presenting our Q1, I stated that the then current supply and demand equation was as tight as I had experienced in my 25-year career, an effect that was contributing to market share gains and record levels of time utilization throughout the business. Well, here we are in my 26th year and it's even more pronounced than 1 year ago.

Becoming clear in this environment is the step change in structural change, driving deeper rental penetration and favoring larger, more capable rental companies as it relates to share of what is becoming an ever larger pie.

Further, and has been the case, our industry, like any other, is experiencing inflation, ranging from equipment to goods to services to wages. As I've said consistently for more than a year now, when you combine the supply and demand circumstances, inflation realities and a relentless focus on customers, you should be able to increase rental rates. We continue to do just that. Our sequential and year-on-year rate improvement has been very good, once again outpacing our ambitious internal targets.

Let's take a closer look at our specialty business performance on Slide 14. The year-on-year rental revenue movement illustrated herein demonstrates the ongoing and compounding growth across all the specialty business lines. Total U.S. Specialty rental revenues increased 39% in the quarter. Consistent with statements made in previous results, this ongoing progress highlights a few items. First, this lineup of complementary products and services creates powerful cross-selling opportunities, which customers increasingly subscribe to.

Second, we're in the very early stages of rental penetration which is being accelerated by today's market dynamics, our scale and expertise, producing a reliable and often better alternative to ownership. Finally, this level of activity in our specialty business serves as a proxy for the strength of our nonconstruction end markets, which generates the lion's share of our specialty revenues and is an important part of our General Tool business.

Let's move on to the U.S. construction outlook on Slide 15. Consistent with what we've shared for some time now, this slide summarizes the collection of relevant construction and rental industry forecasts. We are continuously on the lookout for any changes in current or forecasted construction activity levels or customer behavior. Thus far, the macroeconomic circumstances have led dodge to only downgrade their forecast for residential starts and, by extension, the corresponding residential put-in-place construction values. The most notable movement adjusted down single-family home starts to near pre-pandemic levels.

However, the best available information is still not pointing to a lowering of nonresidential construction. Rather, as indicated by the graph on the top left of the slide, we continue to see robust starts and, shown within the bottom left, ongoing momentum, indicating its highest levels since 2008. These activities are validated every day within our business as customers continue to work on existing sites and begin new projects.

Further, recent legislative activities in Congress have funded the CHIPS and Inflation Reduction Acts. Together, these bills will fund new projects that will cost hundreds of billions, ranging from new semiconductor factories to solar to EV to battery plants. This funding, which to be clear has not been included in the starts or put-in-place forecast on this slide, will surely and considerably add to the mega project landscape, which we detailed in June. And for further clarity, these new Acts are in addition to the federal infrastructure package signed into law last year.

Let's put all this together. As these forecasts stand, it is simply the case that with the ongoing strength in starts, current activity levels, presence of mega projects and if these forecasts are directionally correct, it will result in a strong demand market for years to come, which we are incredibly well positioned to benefit from.

However, as we've said consistently, we would be foolish in this macroeconomic climate to take these forecasts as absolute. As we've always done and gotten far better at over time, we're keeping a watchful eye on any movement in these forecasts. As things update in the months and quarters to come, we will continue to share with you the best available information as we use it to calibrate our own investment plans.

Turning now to our business units outside of the U.S., we'll begin with Sunbelt Canada on Slide 16. Our business continues to expand and perform well in Canada as our brand increases and customers recognize the growing breadth of products and services offered. As the conditions are not dissimilar to the U.S. in activity, demand and supply environment, we're experiencing equally strong performance from a utilization and rate improvement standpoint. This growth and performance continued to deliver strong year-on-year revenue gains and margin improvement within the legacy Canadian business.

As Michael explained, the Canada margins are temporarily muted as a result of the lighting, grip and lens business' market in Vancouver being impacted by labor union challenges. We're well underway executing on our Sunbelt 3.0 plans in Canada and our runway for growth remains long.

Turning to Sunbelt U.K. on Slide 17. As we covered in June and Michael updated today, this year is a transitionary one as the business finalizes the demobilization of the Department of Health testing sites. Thus far, we've seen the business perform well by completing the demob ahead of schedule and, importantly, redeploying the fleet in a rapid manner to other parts of the business. Much of the fleet utilized by the testing sites was power, accommodation units, lighting and barriers.

As the graph on the top right of the slide indicates, our fleet on rent is higher than a year ago despite the absence of the testing sites. This is an incredibly successful transition. These results demonstrate the underlying performance of the business as current end market demands remain strong. Further, it should provide evidence to the fact that Sunbelt is increasing its market share by better leveraging our unique range of general and specialty products and services through our best yet cross-selling efforts.

Also worth noting is our ongoing rental rate progress. Although we've not delivered increases consistent with what we are achieving in North America, we've demonstrated the ability to advance rental rates. This is something that has long been absent in the U.K. rental industry, and we're happy to be leading this effort. Our plan is not to relent in this important area.

Turning now to Slide 18. As we've done with every set of results since the launch of our Sunbelt 3.0 strategic growth plan, I'm pleased to update you again on the progress across all actionable components. Illustrated herein, you'll pick up some of the specifics related to each.

To highlight a couple, first is the addition of 33 locations in the quarter through a combination of 20 greenfields and 13 locations by way of acquisition. Second, these additions contribute to achieving cluster status in 43 of the top 100 U.S. markets. I'll remind you, our 3.0 plan was designed to grow our top 100 market cluster achievement. From 31 to 49, we are well ahead of our planned pace.

The other actual components of technology, ESG and capital allocation are all active in delivering according to plan, and we'll give a more comprehensive update on one of the actionable components in conjunction with our half year results in December.

Moving on to Slide 19. Our CapEx guidance is identical to what we presented in June. The supply-constrained environment is still very present. However, we are working well with our primary equipment manufacturers and the landings throughout the quarter and into August have been strong. We continue to balance new fleet landings with disposals based on demand and actual timings of deliveries. This gives us a degree of flex capacity, which in today's environment is a very powerful lever.

So we anticipate rental fleet CapEx in the U.S. to be between $2.4 billion and $2.6 billion. And after our non-rental CapEx across the group and ongoing rental fleet investment in Canada and the U.K., we guide to $3.3 billion to $3.6 billion for the group in the full year.

We maintain flexibility in these CapEx levels, particularly in the roughly $1 billion scheduled to land between January and April of 2023. However, at this stage, we find it unlikely we would elect to make any deferrals or cancellations.

This leads to capital allocation on Slide 20. In the quarter, we invested $699 million in existing location and greenfield fleet additions and a further $337 million in bolt-ons. It's also worth noting that since the period end, we've invested a further $183 million on 7 bolt-ons and have a healthy pipeline going forward. We completed $116 million of share buybacks in the quarter. And despite these ongoing investment activities and returns to shareholders, we are at 1.6x net debt to EBITDA, again, near the bottom of our leverage range.

So to conclude, let's turn to Slide 21. This has been another good quarter of growth and ongoing momentum. Our end markets remain strong and the forecasts support a continuation of strength well into the future. The nonresidential construction outlook has been enhanced by the recent legislative passing of the CHIPS and Inflation Reduction Acts. These additions, in conjunction with the already flush current and forecasted mega project landscape, point to strength in demand for years to come.

This trifecta of market dynamics, supply constraints, inflation and skilled trade scarcity remain very real. The ongoing presence of these, coupled with operational challenges, however, are outweighed by the secular benefits to our business, resulting in increased rental penetration rates and considerable market share gains for businesses in our industry who possess the scale, experience, equipment purchasing influence and financial strength. Rest assured that our business is positioned to win in this reality.

This update should demonstrate again the strength of our financial performance as well as execution of our strategic growth plan Sunbelt 3.0. Our greenfield plan for the year will deliver in excess of 100 openings, and the bolt-on pipeline remains very active with potential, giving us great optionality to further supplement our organic growth.

So for these reasons and coming from a position of ongoing strength, improved trading and positive outlook, we look to the future with confidence in executing on our well-known and understood strategic growth plan which will strengthen our business for years to come.

And with that, we'll be happy to take any questions. So operator, back over to you for instructions.

[Operator]

[Operator Instructions] We will take our first question from Neil Tyler, Redburn.

[Neil Tyler, analyst]

I'd like to ask two questions, please. First on rate. In your upgraded revenue outlook, I think part of that is an increased expectation for the average rate increase. Can you please sort of split out how much of that rate increase will stem from a catch-up in pricing across the national contracts and accounts current commercial terms? And then perhaps if you were able to split out what the figure includes for any assumptions around sequential momentum in rate from the current levels in spot or local markets? And that's the first question.

And then secondly, more broadly and conceptually, as you think about the U.S. rental industry fleet, compared to 2019, if I think about it in broad supply/demand terms, if we use 2019 as a starting point, can you give us your perspective of where the industry stands in perhaps sort of percentage point terms on the supply-demand balance versus 2019 if December '19 is, say, 100? Are you above or below that level in terms of supply/demand?

[Brendan Horgan, executive]

Sure, Neil. Let's start with your rate question. When we look at rate between national strategic key, whatever one may refer to, and let's just put all the rest in sort of that transactional bucket, we've seen incredibly similar progress in both. So our larger strategic customers, we've been successful in passing through rate increases not terribly different than transactional.

Of course, when it comes to sequential, which is that second part of your question, you have to wait for certain windows. And as you would expect, we have some more clustered endings to pricing agreements around the calendar year-end and then also interestingly enough at the fiscal year-end. So we've already had that latter piece, but the majority of that will be -- or the largest tranche will be at the end of the calendar year.

In terms of what you've seen from our increased guidance from a revenue standpoint, if you just take the U.S., that midpoint of 4%, 2% of that is coming from rate. So we would have anticipated in our plan or budget, if you will, a 5% rate. Now we expect 7% for the year. And if we just go ahead and finish out, because this could be a question from someone else, the rest of that 4% would be made up just under 1.5% by way of bolt-on and just a bit more than 0.5% from underlying activity around utilization.

Your second question around fleet, which is a really good one. I think part of what you're asking, and you can correct me if I'm wrong here is, are we at an imbalance? Or is there any risk of imbalance of overfleeting the industry? And let's remember the supply-constrained environment that we've been in throughout this entire pandemic and this continues to be the case. So certainly, our view would be most rental companies would take considerably more fleet than they've been landing. And therefore, the fleet balance would be less than that 2019 baseline. So if 2019 was 100, I would say this is -- so this is grabbing numbers from the air here, it's 90 today.

I would have preferred to have landed an extra $1 billion in fleet through August and I have every confidence that, that $1 billion in fleet would be on rent servicing customers at a rate higher than it was a year ago. I think it's a good position to be in and as an industry where even if one would want to, it would be very difficult to overfleet right now. So I hope that answered your questions there, Neil.

[Operator]

We'll take our next question from Rob Wertheimer from Melius.

[Robert Wertheimer, analyst]

I have two, if I may. So the first is just your characterization or could you please characterize the bolt-on market? Your activity remains very high there. I don't know whether the desire to own or to manage the inflationary pressures has kicked up the opportunities in bolt-on. That's my first.

And then the second is just your impression of inflation, whether you're reaching a cresting point in labor or other things, or whether this is something that's not yet crested and visible into the future so far.

[Brendan Horgan, executive]

Sure. From bolt-ons, as you've seen now for all through last year and thus far through -- we just closed our last deal the 1st of September, it remains strong. I've sat across from many business owners, and there are a variety of different reasons and rationale that they go through, but certainly the pressures of today. Inflation in general, some struggling to understand perhaps or decide what to do when it comes to things like wages, it's certainly part of that. The other is just getting that skilled trade as the skilled trade in our world, i.e., professionally, commercially licensed drivers, trained mechanics, et cetera, are rare and seem to be going to companies like Sunbelt.

But certainly, one element is fleet. I'm literally thinking of one specific owner for a business that will close on before the end of the month. Not a big deal, but like so many of these, if you look at the average size of these deals, it's just under $30 million that we're doing. But they simply just -- this owner just cannot get the fleet. He's been told by many manufacturers, "Hey, literally, you'll get it after Sunbelt gets theirs." So those are challenges.

And I think when you look at -- keep in mind, too, as you may know, Rob, the majority of the deals we do are not in a process engaged with a broker. Something like 2/3, even a bit higher of our deals, are shorter tap deals that we've built relationships with over the years. And part of them come on because they know our expansion plans. We're going to open a greenfield in any town, North America, if you will. And when we do, they kind of have to decide, are they going to stick in and compete? Or are they going to take that as an opportunity to sell? So I hope that answered that piece for you.

Inflation, boy, if I had a crystal ball and could look at that one, we would all be in a different position, so to speak. I think when it comes to wages, let's begin there with your more, shall I say, kind of white-collar positions. It seems as though I think we could expect that to ease a bit year-over-year.

When it comes to skilled trade, I think the question is still out there, just given some of the cost of living. But as we see things like fuel pricing come down, this is down now for many days in a row. I think we might see that abate a bit. So I think I feel a bit less pressure, so to speak, when it comes to that step change year-over-year as we go into that season ahead of us. And certainly, much of the inflation that we've seen in the business, it's not going to step change the way that it had in previous periods. So broadly, that's the way I would view that.

[Operator]

[Operator Instructions] We'll take our next question from James Rose, Barclays.

[James Rosenthal, analyst]

I've got three, if I may. First is on drop-through in the U.S.. Could you talk us through how that drop-through moves higher in the second half? And what are the sort of main moving parts underpin that?

Secondly, could you talk through organic growth by customer size? There's lots of headlines about big mega projects coming through and going on. Is the environment in the smaller SME more transactional client base still strong and the outlook looking resilient there?

And then lastly, on cash flow. I've noted sort of elevated receivables balance this year. Anything to point out in terms of average credit risk or anything we should think of in terms of free cash flow for the full year there?

[Brendan Horgan, executive]

Sure. Sure, James. I'll take -- Michael will do AR. And Michael, do you want to take a stab at fall-through?

[Michael Pratt, executive]

Yes. On fall-through, yes, we expect it to progress as we go through the year. And as part of the thing about what we said last year, we were investing in the infrastructure of the business. And so if you think of -- that investment was that -- the run rate of that cost was higher by the time you got to Q4 than it was when you got to Q1. So you've sort of got that headwind. Once you then level out effectively, then that headwind gradually decreases quarter-over-quarter.

So it will also get influenced by bolt-ons, as we've talked about. Bolt-ons, we don't -- very rarely do we buy businesses that have margins the same as our own. They're usually much lower. So that will have an impact as well. But it really is that, as you get -- it's a comparative period more than the current period that will influence how drop-through improves as we go through the year.

On receivables, it's a couple of things. It's increased. It's a level of ramp-up in the volume that we've done. Our aging -- certainly, our older debt is still not dissimilar to what it was a year ago and actually at the April 2021 year-end. So there's nothing really to call out. It's really just a function of the business. And we'd expect to -- the debt -- the receivable days to sort of decline as we go through towards the end of the year-end. But there's nothing that causes concern in those figures.

[Brendan Horgan, executive]

And James, in terms of your question between your small to midsized SMEs, if you will, versus the larger strategic customers, the answer is not dissimilar to what I would have mentioned when it came to rental rate. So certainly, there is an abundance of very large projects and we're seeing growth in those accounts, both new and existing, mostly the latter. Because on those big, big mega projects, there are only so many contractors out in the marketplace that can handle those larger, more sophisticated projects. But we're seeing great growth in those. And we're also seeing on those sort of projects longer duration. So the term gets even longer.

And when it comes to the SMEs, they're really just about keeping up. They're not growing quite as fast. So when we look at our pie, our vernacular, we call those strategic customers, that would be -- others would call national key, et cetera. So our strategic customers are taking up a bit more of the pie, but you're talking about 35 to 37 sort of variety, which tells you that there's SMEs, albeit not growing quite as fast, are still growing rather robustly.

[Operator]

We will take our next question from Rory McKenzie, UBS.

[Rory Mckenzie, analyst]

It's Rory here, three please. Firstly, just to unpick the assumptions in that 17% to 20% U.S. rental rate -- rental revenue growth outlook. So you said 7% comes from rising rental rates. Can we assume 6%-ish from bolt-ons this year? And does that therefore leave 4% to 7% organic volume growth?

And then secondly, just a follow-up on that. The $200 million to $400 million of new rental revenue that comes from the new organically adding new fleets, that's only about a 10% to 15% incremental dollar utilization on the $2.5 billion of U.S. fleet CapEx you planned for this year. I appreciate there's always timing differences, but the same math in previous years gets to more like a kind of 40% to 60% incremental dollar utilization. So just wondering, given your comments on how busy the industry is, does this say that the cost of fleet you're acquiring has gone up hugely over the past year or so? Or are there something else that maybe I'm missing in that? Maybe just those two first, please.

[Michael Pratt, executive]

Well, I'll take the latter of that -- I'll take the fleet one. I think -- I'm not sure, [ I quite forgot ]. I think the piece you're missing is that $1.3 billion, $1.4 billion of that will be replacement CapEx. So although we're spending $2.6 billion or the budget for the -- or the upper end of guidance for the U.S. market is $2.6 billion, about half of that goes on replacement fleet. So I haven't -- and back of that through the workings. But it sounds to me what -- in terms of math you were doing, that would be a key factor in it.

And then the rate piece, yes, bolt-on, that sort of order, without breaking it down, certainly, if you -- as we've said in our growth in Q1, about 6% of that was bolt-ons. So now clearly, what we -- it will be at a similar sort of level as we go through the year. Obviously, you're lapping increasing contribution from prior year bolt-ons. I suppose it dribbles down a bit if you think about it because we don't forecast bolt-ons. So I'm just thinking here mathematically, if I'm comparing Q1 this year with Q1 last year and 6% comes from bolt-ons, the fact we added more bolt-ons in the last 9 months of last year, we're not repeating them this year in our forecast. So as a percentage, I would expect the contribution probably to moderate a little bit is at that order.

[Rory Mckenzie, analyst]

That's very helpful on the replacement point. And then just lastly, Brendan, on your comments on the deepening rental penetration, do you think any of that might prove a bit kind of artificial or short term given your customers, I presume, are also really struggling to buy in any fleet they would otherwise have purchased outright? I know that rental penetration tends to be quite sticky, but what's the risk around behavior reversing should -- well, if ever, supply chains normalize?

[Brendan Horgan, executive]

Yes. Well, look, I think it would be your point about sticky. Our experience is when you get these step changes, they tend to stay. This is a dramatic step change, I would say, and all you have to really do is study the OEM dealer network. So whether you're talking about, let's just say, yellow iron manufacturers or you're talking about the Bobcats of the world. Plain and simply, their dealers don't have new stock. So of course, customers are turning more and more to rental.

What we've experienced in the past, and I anticipate we will continue to do so, as customers recognize how reliable rental is as that alternative to ownership, they will fractionally make a step change themselves. So if they would have owned 6 and rented 4 in the past of certain products, they may be -- they may only have 3 of those 6 that they own left and, therefore, are renting the rest. And do they settle out the other way, 4 and 6, 4 own, 6 rented. I think that's the more likely bet.

And there are so many other things involved. You've got inflation of new equipment, which certainly we're experiencing some of and we will continue to do. But nowhere near, from a comparison standpoint, of what an owner of a product, let's just say, that's 8, 9, 10 years old, and they're going to attempt to buy a new one today, first things first, they have to wait 12 to 18 months to get it. And secondly, it's going to be significantly more expensive than that 10-year-old asset and what they're replacing.

And then when you get into things, we saw this, Rory, you'll remember, when we went through the engine tiering change, when we went to Tier 4 engine, that was much more rental leaning than was the predecessor engines because of the complexity of working on them. And now you introduce things like electric or things that are hybrid in our environment, and again it adds that complexity. So it's a fair point you raise. And at some point, it will level out, so to speak. But I think it's more leveling out rather than a tide going out.

[Operator]

We'll take our next question from Allen Wells, Jefferies.

[Allen Wells, analyst]

Three for me, if it's okay as well. Firstly, just a quick follow-up on the drop-through comments. Can I just say, I think we've talked about kind of 50% drop-through was averaging for the year is achievable. I think you've talked about that at the full year results. Do you still see that, that level is achievable for the full year given what you've delivered in Q1 in inflationary environment? And maybe just any comments on the key variables around that.

Second question, just on the interest cost charge -- change that impacts guidance today. Obviously, it feels like a pretty sizable move given we only spoke about this, I guess, back in June. $340 million of interest on a 4% average yield, it implies about $8.5 billion of average net debt versus the $7.7 billion now. So could you maybe just talk about the assumptions that have exactly changed from June until now? Is it just really around that 5.5% note that you issued in August? So just keen to see assumptions.

And then the very final point, obviously, post quarter close, just any general trends around kind of rate environment utilization accelerating further obviously as we move through that kind of summer busy period. Any post-quarter comments would be really appreciated.

[Brendan Horgan, executive]

Sure, Allen. Let me take the drop-through. We are sticking with our target of 50%, and we think it will be circa 50% as we move through the year as we get into our half year results in December. If we think otherwise, we'll let you know then.

It's just very important to understand the mechanics and the levers behind it. If we take, for instance, so we talked about bolt-ons, which -- that should be blatantly obvious, and that's been the case forever as we've deployed this bolt-on strategy. Furthermore, of course, there's the greenfield program as we've made the step change. But that part was part of the plan. Bolt-ons, as you know, we don't budget for those. But if you look at what's happening from an ancillary revenue standpoint where we are absolutely passing on the costs to our customers and, therefore, generating growth in profits surrounding that.

But let's take the quarter and let's just speak to the U.S. So pure rental revenue is up circa 26%. So the pure rental, if we rent a skid loader, we rent it for x and that was up 26%. when you look at things that have these commodity cost increases with them on the ancillary lines, trans, fuel, E&D, as for instance, transportation was up 40% in the quarter. Revenue, fuel was up 52% for the quarter. Revenue, 37% increase in revenue in E&D. All of those we made more absolute profit with. However, they just are at a lower margin. So that's always been the case in our business, and we have had ebbs and flows in the past.

However, in prior periods when we went through this, our margins were just much lower overall and, therefore, just that incremental gain sort of hit that. What's going to happen a couple of quarters from now? Those are going to be lower than pure rental revenue growth and it's going to make our fall-through look better. And no one will ask a question about why fall-through is better and we probably won't say anything. But my point is, that's what the material drivers are in that, that you just have to understand, nothing's changed about the business other than that environment overall.

Michael will answer, too, but before I'll just touch on your post-quarter ending. August was an incredibly strong month, plus 25% and a bit percent pure rental on a billings per day basis. And obviously, when we get sequentially through the year, those comps get harder as they did in August. So that just demonstrates the strength, and the same would be said for the time utilization that drove that and rental rate. We had rental rate progressed 1% sequentially from July into August. So things remain robust.

Michael, do you want to take the interest question?

[Michael Pratt, executive]

Yes. On the interest, it's a couple of things, one of which is, obviously, since we -- the bolt-on M&A that we've done, so we will have higher average debt than we first thought of when we were guiding last time.

And also, if you can go back to when we're sort of in that early June time period is when rates were really starting to move and just starting to move. So actually, we think -- our assumption is based on U.S. LIBOR rates getting into the high 3s by the end of our financial year. Now that's an assumption and people have their own views on it. I'm not an expert in where rates will end up. The consequence of that is that we're assuming on that floating rate piece of the debt, then our average interest rates are about probably 1.5% more than we would have assumed in the first instance. And you're right, we also then did a bond as well, which ensures we've got the financial capacity to go forward. But in the current environment and whether it's a new normal or not, only time will tell, but obviously it was slightly more expensive than the debt we had when we were giving guidance back in June.

[Operator]

We'll take our next question from Madeleine Jobber, Morgan Stanley.

[Madeleine Jobber, analyst]

I just have two, please. So firstly, fuel prices will obviously be a quite key driver of your drop-through for the full year. But I was just wondering exactly how sensitive will be your drop-through be to fuel prices? How should we think about that going forward? And do you have any hedging for fuel prices in place currently?

And then secondly, we've seen a lot of data points which have suggested continued strong and resilient demand within your non-resi markets, so things like data center and warehousing. But of course, given the supply constraints that you've highlighted yourselves, are you seeing any lag in that demand actually being converted into breaking ground and construction? Or have you seen any data points that suggest some delaying or postponement of any project in this area?

[Brendan Horgan, executive]

Sure. Let me take that second one first, the large projects. You are right, I mean, when we win these large projects, whether it be a data center, as you mentioned, or more recently, we will be involved in activity surrounding this CHIPS Act. I'm surprised there's been no questions about that. But these are 2 very, very large bills that have passed and will be lots of spending.

And if you take these semiconductors, to put it in perspective, of 3-building data centers, about $1.5 billion in cost to construct. And we would get our flow-through of that as it relates to rental and those are big projects. A semiconductor plant, those are going to range from about $5 billion to $10 billion, more of them being $10 billion, $10 billion for one project. We anticipate or expect one of those projects would take somewhere in order of magnitude, $90 million, $95 million worth of rental fleet in the product ranges that we carry to accommodate a win of that magnitude.

So I'll use that to answer your question. What will we see happen? I think we will continue to see projects start as planned. They'll just simply take longer. And it's going to be working with companies like ourselves, when we're working with our manufacturers, and that's just adding to our confidence in our order levels, not just in 2022, but in 2023 and beyond. And we're using that as part of our construct.

So I think what you'll see happen is we will perpetuate the supply-constrained challenges that the rest of the rental market is experiencing as well as businesses that were owners previously. So as we and a couple of others that are out there have that foresight are placing orders to accommodate these big projects, that's what's going to happen.

So we have seen definitely some projects start just a bit later than planned, and it's not just all around equipment. It could be steel, it could be any number of things. But more often than not, they just take longer to finish than they would have prior.

When it comes to your question on fuel, and just let me know if that was answered clear enough for you, if we look at our just fuel sales, so what we sell for fuel to fill up a piece of equipment as it's returned, you're only -- you're talking about 3% or 3.5% of our revenue. So that piece of it, as fuel prices come down, as we said before, it becomes less of a margin drag to the total rental, but fuel more than anything. It has got to do with the fuel that, of course, we're burning in our own vehicles to conduct our operations.

And if you think about that from a delivery cost recovery standpoint, if we were to look at that DCR that we always measure in the U.S., again, to make the point on fall-through, our numerator in that regard is up 40% year-on-year and the denominator is up 30%. So again, we're covering it, but DCR by default is actually a sort of lost leader, so to speak. Our DCR now, our recovery, is up to 84%, which is 7.5% better than a year ago. So as fuel does come down, that will get better. But we do not, we never have deployed any hedging of fuel.

[Operator]

[Operator Instructions] We'll take our next question from Karl Green, RBC.

[Karl Green, analyst]

Just a couple of follow-up questions from me. Firstly, just in terms of the major packages, which are being pushed through infrastructure, CHIPS Act and the Inflation Reduction Act, some of that spending is going to be federal, some of it is going to be effectively public-private partnership type work. Would you expect to see any kind of improvement over the medium term on returns on invested capital as a result of the skew towards those kind of projects? That's my first question.

And then the second question, a little bit more drily, just in terms of the launching for the issuance of those 10-year notes at a 5.5% coupon. Just wondered if you could sort of present, compare and contrast versus how that steps up versus the effective rate on your variable senior secured bank debt at the moment. So I'm just sort of wondering around whether there could be an element of issue is regret as and when the Fed pivots down the line.

[Brendan Horgan, executive]

Sure. So if we look at these Acts, let me just be clear because it seems as though they're not understandably maybe followed quite closely abroad as they are here. But if you look at these CHIPS and Science Act, it's called, this is basically in certifying modern semiconductor plant capacity to be built in the U.S. It was something like 40% of the global production back in 1990. And today, it's 12%, for instance.

So what that Act has done is that it's several hundred billion overall, but one very specific line is a $52 billion in direct tax credit subsidies at 25% of the cost of construction. So this is going to equal no less than $200 billion in semiconductor worked out. That -- yes, that is federally funded, so to speak, by way of tax credits, but it's very much going to be the private sector deploying that capital.

And when it comes to Inflation Reduction Act, this is another Act, it's almost $500 billion total bill, if you will, or Act, but $370 billion of that is pointed to energy production and manufacturing. So funding things like wind, solar, EV, batteries, et cetera. Again, that's going to be really largely deployed through the private sector based on various channels in which they will pursue. So that will amount to a lot of opportunity from a rental revenue standpoint.

And your question about, okay, what does that all mean for ROI? We get bigger. Our cost base isn't as big, proportionally speaking. And we grow our revenues and our ROI will nudge forward as is customary. These projects will be incredibly profitable when one is on site and has a large amount of fleet deployed with a relatively low sort of cost of operations there.

[Michael Pratt, executive]

And then picking up on the interest rate point. At the moment, our ABL facility is priced at LIBOR plus at the moment, paying 150 basis points of the margin. So all in all, it's around about 4% at the moment. And as I sort of indicated earlier, the expectation would be that interest rates will continue to rise.

Is fixed rate long-term debt is slightly more expensive? Yes, but I think it's more a question of having financial flexibility for the business. We have a trade-off in a way because clearly we wouldn't have needed that debt if we weren't growing at the rate we're growing and looking to do bolt-ons, et cetera. And when you sort of have a choice in a way, you can do bolt-ons and get an ROI in the teens, which you then look to improve and you can pay 5.5% to be able to fund that. So I think either way, it is a positive delta and you end up accessing debt markets when you believe it's appropriate.

So no, I don't think there's any regret about it at all. I think it was the right thing to do for the business at the time and it puts us in a good position to take advantage of what's coming ahead of us.

[Operator]

There are no further questions on the line. Speakers, please proceed.

[Brendan Horgan, executive]

Great. Well, thank you for taking the time this morning to join us, and we will look forward to catching up at our half year results in December.

[Operator]

This concludes today's call. Thank you for your participation. You may now disconnect.