Custom Truck One Source: A Buying Opportunity in the Wake of Russell Reassessment

The removal of Custom Truck One Source (CTOS) from the Russell 2000 Growth Index on June 30, 2025, has sparked questions about its investment merits. While reclassification often triggers short-term volatility, a closer look at CTOS's fundamentals reveals a compelling case for opportunistic investors. Despite Q1 earnings misses, the company's robust backlog growth, reaffirmed guidance, and undervalued metrics suggest this reclassification could mark a buying opportunity.

The Russell Reassessment: Context and Catalysts

The Russell 2000 Growth Index reconstitutes annually, with changes effective June 30. CTOS's removal likely stems from shifts in its growth profile or market capitalization dynamics. Russell's capping methodology, now enforcing a 22.5/4.5/45 rule to limit concentration risk, may have also played a role. However, the immediate market impact—potentially driven by passive fund rebalancing—could create a buying dip.

Under the Hood: CTOS's Q1 Misses and Hidden Strengths

CTOS reported Q1 revenue of $422.2 million, a 3% miss versus estimates, alongside a wider-than-expected non-GAAP loss. However, the company reaffirmed full-year guidance: $2.02 billion in revenue (2.1% above analyst expectations) and $380 million in adjusted EBITDA (exceeding projections). This resilience hints at underlying momentum:

1. Segment Highlights:
2. ERS (Equipment Rental Solutions): 13% revenue growth, driven by record equipment on rent ($1.2 billion) and 77.8% utilization rates.

3. TES (Truck & Equipment Sales): Backlog surged 14% to $420.1 million, with net orders up 220% YoY, signaling strong demand for utility and infrastructure projects.

4. Strategic Leverage:

5. Inventory levels rose proactively to mitigate tariff risks, but management aims to reduce them by H2 2025 to improve free cash flow.
6. Net leverage (4.8x) is targeted to drop below 3x by 2026, aligning with disciplined capital allocation.

Valuation: Undervalued on an EBITDA Multiple Basis

While CTOS's forward P/E of 63.8x appears elevated, its EV/EBITDA of 9.74x (as of Q1 2025) paints a more favorable picture. This ratio, well below peers like R.R. Donnelley (EV/EBITDA ~14x) and Republic Services (EV/EBITDA ~12x), suggests the market underestimates its long-term growth drivers:
- Infrastructure Tailwinds: Federal spending on electricity grids and utility projects continues to expand CTOS's addressable market.
- One-Stop-Shop Model: Its integrated rental, sales, and aftermarket services create sticky customer relationships, particularly in utility sectors.

Risks to Consider

• Margin Pressures: TES and ATS margins remain strained due to material costs and product mix. Recovery hinges on normalization in H2 2025.
• Tariff Volatility: Proactive inventory builds may strain liquidity until reductions materialize.
• Macro Uncertainties: Economic slowdowns could dampen demand for capital equipment.

Investment Thesis: A Strategic Entry Point

CTOS's reclassification is a short-term headwind, but the company's fundamentals—strong backlog, infrastructure-linked demand, and improving leverage—position it for recovery. The EV/EBITDA multiple offers a margin of safety, while its reaffirmed guidance underscores management's confidence.

Recommendation:
Investors should consider adding CTOS to their portfolios at current levels, particularly if the stock dips further post-reclassification. A 5-10% pullback could create an optimal entry point. Key catalysts to watch include:
- H2 Inventory Reduction: Free cash flow improvement and leverage de-leveraging.
- Margin Expansion: TES gross profit normalization and ERS's scale benefits.
- Backlog Conversion: TES's record net orders translating into revenue growth.

Final Take

CTOS's removal from the Russell 2000 Growth Index is less a verdict on its prospects and more a function of index mechanics. With a compelling valuation, secular demand tailwinds, and a clear path to margin recovery, the reclassification could be a blessing in disguise for long-term investors.

In a market where growth is scarce, CTOS's blend of resilience and undervaluation makes it worth watching—and buying—at these levels.