Ashtead (AHT) - The recovery continues

************KISS OF DEATH (but not in the short term)************
IC TIP.................BUY ASHTEAD

16p - plant hire - It's not easy finding something positive to say about Ashtead. Last year, investors chronicle highlighted apparently irregular accounting practices at the company and there have been corporate governance issues to worry about, too. An accounting problem subsequently emerged at its US unit in March and Ashtead breached its banking covenants. And there are still worries in the City that more problems of this kind could yet emerge.

If that isn't bad enough, there have been some particularly grim market conditions to contend with. General plant hire is an oversupplied market, which is only consolidating slowly, and matters haven't been helped by a decline in commercial construction, par-ticularly in the US, where non-residential construction activity dropped over 30 per cent between March 2001 and September 2002. UK plant hire profits fell 46 per cent last year and US profits slumped 47 per cent.

In a bid to get its kit out on hire, Ashtead has slashed its prices. Rivals accuse it of flooding the market and believe it is one of the companies with most responsibility for the heavy price-cutting that has recently characterised the sector. That has meant that returns on Ashtead's capital employed have dropped from over 10 per cent four years ago to just 4.5 per cent this year - well below its cost of capital (its debt alone cost it 6 per cent last year). This has all fed through to the share price, which tumbled from as much as 240p in 1999 to as little as 3p in March.

So if Ashtead is in such a mess, why would we recommend buying the shares, albeit with a health warning attached, when we judged them to be looking high enough with July's full-year figures? Put simply, the change of heart reflects improved economic prospects and the potential for recovering commercial construction markets - particularly in the US - which accounts for two thirds of Ashtead's business.

The main reason for the collapse in Ashtead's profits reflects the downturn in the construction cycle, critical for a group that has a high fixed-cost-base. As Ashtead's finance director Ian Robson says: "We are a classically operationally-geared business, so our last pound of revenue is a very profitable pound." Equally, the last pound of revenue that drops away inflicts heavy damage. Indeed, in September, Ashtead's chairman Henry Staunton disappointed investors by telling the group's general meeting that he still anticipated "generally flat market conditions" this year. But things are now looking up and Mr Robson reported last month that "for the first time for some time, we are starting to see an improvement in market conditions".

That optimism was been supported by better-than-expected third-quarter results in October from United Rentals, a big US competitor. Although United said that a rebound in non-residential construction remained difficult to forecast, it still posted a 4.7 per cent like-for-like sales growth hike and said that its rental rates were up 3.4 per cent on the year. So when Ashtead reports its half-year figures next month, there's good reason to expect decent news.

Ashtead's financial position - while hardly brimming with health - does at least now look secure. Rentokil, from which Ashtead bought much of its US business, has agreed to defer the interest on a £134m loan and Ashtead renewed its banking facilities at the end of May. It expects to fully refinance by January 2005. The group also generated positive free cash flows last year, an improvement from the previous year's £15m outflow. With the dividend skipped and capital spending being sqeezed, its enormous debts should fall.

Ashtead's shares are undoubtably risky. But the compan is among the most highly geared to a US economic recovery. Taking a punt on Ashtead's shares - which still trade at just half their value at the start of the year - could just be worth that risk. Buy.

BULL POINTS
Plant hire markets are showing signs of recovery

Better market conditions should quickly boost profits

Ashtead's financial position has now stabilised

BEAR POINTS
Suspicions linger over the group's accounting practices

Markets are highly fragmented and oversupplied

No dividend