LZRFY - Localiza Brazil's Car Rental Leader Gears Up For A Bright 2024

2023-12-14 09:29:49 ET

Summary

• Localiza is Brazil's largest car rental company, holding a dominant market position and enjoying favorable terms from car manufacturers.
• Serving individual customers, fleet partners, app drivers, and garage owners, Localiza employs technology for efficient operations.
• Localiza's recent quarter showcased a robust financial performance, with a 57% YoY increase in accounting profit and positive trends in adjusted net income and EBITDA.
• Despite challenges like high interest rates and leverage, Localiza's strategic initiatives, including fleet renewal and productivity focus, position it for positive outcomes.
• Anticipating interest rate cuts, fleet renewal, and synergy gains, Localiza presents an attractive investment opportunity with favorable valuation multiples and international expansion plans.

Localiza (LZRFY) stands out as Brazil's largest car rental company, leveraging its dominant market position to secure favorable terms from car manufacturers due to its status as the country's foremost car purchaser. This advantageous position in acquiring new and used vehicles contributes to a robust asset turnover, a crucial factor in the car rental industry.

The company operates in a cyclical sector, which could be affected by high interest rates, leading to decreased demand for car rentals during periods of economic slowdown. However, the company has successfully tapped into emerging trends, such as the gig economy, through its Zarp platform.

The merger with Unidas has been a positive development, with synergies expected to contribute to enhanced market leadership and increased scale. The company's executive team is focused on improving productivity operational efficiency, and expanding the Used Car division.

The anticipation of interest rate cuts in Brazil, fleet rejuvenation, and synergy gains could potentially elevate ROIC to historic levels by 2024, providing shareholder value. The company's expansion into international markets, particularly Mexico, is viewed favorably, considering the market similarities and potential for consolidation.

Localiza's attractive multiples for 2024, with an EV/EBITDA of 8x, make the stock an appealing long-term investment. I am bullish on Localiza shares and expect improved results in the coming quarters.

Localiza's Business Model and Positioning

The company's business model is structured around four distinct target audiences, each served by specific business lines:

1. Localiza: This segment is dedicated to serving individual customers and encompasses services such as Rent-a-Car (RAC), Meeo (subscription car service), Seminovos (used cars), and Localiza+.

2. Localiza Empresas: Focused on providing fleet solutions to partner companies, catering to both light and heavy vehicles.

3. Zarp: Geared towards app drivers, this segment employs technology initiatives to control delinquency theft and reduce claims remotely. Notably, a facial recognition tool enhances security, preventing the vehicle from starting if the customer is in arrears. Additionally, safe driving is incentivized through a points system, offering discounts on rent or fuel, fostering loyalty. Zarp has become cost-effective for drivers, with its app integration with Uber ( UBER ), creating a significant loyalty link.

4. Eqip: This segment aims to fortify the brand's presence in the heavy-duty vehicle market by offering solutions to garage owners.

Over recent quarters, the company's technology-driven initiatives have garnered positive attention for their role in reducing the costs of Provision for Doubtful Debts ((PDD)). Remote monitoring and controlling delinquency, theft, and claims have enhanced operational efficiency.

In particular, Localiza has strategically invested in the app driver market, tailoring its products and costs to meet their specific needs. Zarp's dedicated agencies cost only a fraction of the average rent-a-car agency, providing a cost advantage.

In a market where only a fraction of drivers use rental cars among a sizable pool, enhancing the customer experience is pivotal for increasing market penetration.

The company has successfully developed the capability to achieve a favorable Return on Invested Capital ((ROIC)) in this segment during a period marked by low-interest rates in Brazil. However, from 2022 onwards, with the escalation of interest rates beyond double digits in the country, naturally, the ROIC was significantly affected, concurrently impacting its share price.

Looking forward, substantial growth opportunities are identified within the individual customer segment, notably with the subscription car service (Meeo). Localiza estimates a considerable market potential, with around 14 million people capable of affording a subscription car. The company also highlights an addressable market of approximately 16.5 million, including 2.4 million vehicles owned by micro and small companies.

Subscription-based maintenance services for car owners, facilitated through partner workshops under Localiza+, are anticipated to generate approximately 100 billion reais annually. This offers a dual benefit of revenue generation and cross-selling opportunities, considering that a significant portion (around 65%) of the company's nearly 2 million customers annually own their vehicles. Currently, 10% of workshops in Brazil are already Localiza partners.

Furthermore, as part of its internationalization strategy, Localiza is focused on operations in Mexico, considering it a long-term project. Acknowledging the market's low penetration, the company anticipates ongoing investments over the next 3 to 5 years before normalization occurs.

Navigating Tough Times: A Challenging Couple of Years

The past two years have presented significant challenges for Localiza as the company navigated efforts to optimize its backlog of orders and its technological and systems integrations.

From a leverage perspective, Localiza's stood at 3.2x (Net Debt/EBITDA) for most of the year. However, promising prospects for a decrease by 2024 are driven by anticipated synergy gains likely reflected in margin expansion.

In 2023, following a shift towards a more positive purchasing mix, Localiza underwent a phase of accelerated fleet renewal, naturally impacting cash generation. As the cycle normalizes, the anticipated effects of gaining scale and greater bargaining power with automakers will contribute to improved margins and Return on Invested Capital.

The current scenario of depreciation and leverage has cast a shadow on Localiza's 2023 performance, exerting pressure on the company's bottom lines.

In addition, it's noteworthy that Localiza conducted a R$4.5 billion follow-on in June of this year, approving a total augmentation in the company's share capital amounting to R$364.5 million through the issuance of ordinary shares. While this move is positive for the company's focus on returns and strengthens its balance sheet, it may hurt its share price due to dilution.

Concerns regarding the thesis primarily revolve around the pricing dynamics of used vehicles for Localiza. However, the company anticipates gradually improving the mix of used cars and a younger fleet by 2024. It has been explicitly stated that in 2024, the company will adopt a strategy prioritizing price overgrowth to sustain a focus on improving return levels.

The competitive advantage gained through the merger with Unidas (since 2022), and the enhanced balance sheet post the follow-on provide management with increased comfort to concentrate on returns, minimizing the risk of market share erosion.

Latest Financial Results

In its latest quarter, Localiza reported an accounting profit of R$664.7 million, reflecting a 57% annual increase. Consolidated adjusted net income in 3Q23 amounted to R$703.3 million, marking a 3.1% increase compared to the same period in 2022.

Localiza attributed the impact on its 3Q23 results to factors such as the negative effect of R$349 million from the increase in depreciation of cars and others. However, there was a compensatory reduction in financial expenses and an increase in EBITDA attributed to growth in volumes, prices, and operational efficiency.

The consolidated adjusted EBITDA for Localiza reached R$2.6 billion between July and September, indicating a 12.5% annual increase. However, the consolidated EBITDA margin experienced a slight decrease, reaching 70.5% compared to 75.2% in the third quarter of 2022.

Localiza's consolidated net revenue grew by 19.3% compared to the previous year, totaling R$7.3 billion. Net rental revenue exhibited a 20.0% increase, with 3.0% in the car rental division and a significant 49.2% rise in the fleet management division.

Used car revenues amounted to R$3.528 billion in the quarter, reflecting an 18.5% year-on-year increase, primarily driven by a significant uptick in used car sales. However, this growth was partially offset by a reduction in the average sales price, influenced by the mix of cars with higher mileage sold wholesale.

The results showcased a 20.6% increase in the Fleet Management division and an 8.8% reduction in the Car Rental division in Brazil. According to the company, this was impacted by the carve-out in the comparison base, with 49.2 thousand cars sold at the beginning of the fourth quarter of 2022.

In Localiza's rental segment, the average daily rate increased by 10.3% year-on-year to R$119.41. While the utilization rate declined by 0.7 percentage points compared to the previous year, it advanced in the sequential comparison, reaching 79.5% versus 77.4% in the third quarter of 2023.

In fleet management, the daily rate rose by 19.3% to R$84.29. The fleet utilization rate of 96.4% was down by 0.5 percentage points year-on-year but up from the previous quarter when the rate was 95.8%.

Regarding depreciation, the average annualized depreciation in the car rental segment was R$6,738 per car. Due to the fleet renewal process, this was mainly attributed to the lower proportion of fully depreciated vehicles. In the same quarter of 2022, the figure was R$4,357 per car.

In Localiza's fleet management, depreciation increased from R$4,194 to R$6,130. This rise reflects the renewal of some fully depreciated cars and the mix of unique and heavy vehicles added throughout 2022. Additionally, Localiza expanded its fleet by 19,000 cars while maintaining a stable net leverage of 2.8x net debt/EBITDA.

Following a 35% decline between July and November, Localiza's shares rebounded after more optimistic Q3 results. However, shares remain up by 31% year-to-date.

The sharp drop in shares between July and November was attributed to Q2, where expectations of a slowdown in the company's earnings growth due to high depreciation and profits pressured by financial expenses were prominent.

In contrast, Localiza's 3Q23 figures eased investors' concerns about a potential growth slowdown. The company managed to sustain daily rental rates at R$119 (a 10% year-on-year increase) in the car segment, indicating the potential for further increases in the upcoming quarters as it navigates a more favorable market without intense competition pressures, in my opinion.

Why Localiza Is Poised to Shine In 2024

Localiza is a potential beneficiary of the Brazilian and global economic scenarios unfolding in 2024. The narrative of low interest rates and global inflation, reminiscent of 2019, maybe returning, offering a potential boost for the stock market.

A peculiar global process of decreasing inflation is underway, with Chinese steel products flooding the market at highly competitive prices. Simultaneously, the United States has allowed historical rivals like Russia, Iran, and Venezuela to export oil more freely, leading to weeks-long declines in international oil prices.

The global logistics network, previously disrupted during the COVID-19 pandemic, has now been streamlined, bringing inflation caused by transportation issues under control.

As a result, estimates anticipate more controlled inflation in the US and Brazil. The Brazilian Central Bank projects an inflation rate of 3.90% for 2024 (measured through the IPCA index) with a GDP growth forecast of 1.5%.

With inflation nearing the target and GDP growing within potential, coupled with the US reducing interest rates, Brazil's central bank anticipates the Selic rate to fall to 9.25% next year. Such a move typically bodes well for stock markets, which have been upward since November.

Localiza could flourish in this scenario since it is the leader in a segment experiencing 30% annual growth due to an upswing in fleets and revenues. Whether for app drivers or fleet outsourcing, car rental has been a burgeoning activity in Brazil. São Paulo, for instance, which is Brazil's most populous city, is the biggest hub for travel apps globally, propelling the car rental segment.

Localiza currently trades at an EV/EBITDA of 16x, with an estimated multiple for 2024 at 8.6x, approximately 40% below its historical average over the last five years, and it is 23% below the sector average, having Movida as its main competitor in Brazil boasting of an EV/EBITDA of 4.5x. However, it is fair to say that Localiza commands around 40% of the market share in the country with a more robust operation.

With falling interest rates in Brazil, the company is poised to benefit from the ease of fleet expansion and increased profitability due to reduced financial expenses.

While valuation multiples indicate the market's anticipation of solid revenue and EBITDA growth for 2024, the overall scenario seems favorable for the leading company in the automotive rental sector, which has consistently outpaced Brazil's GDP growth.

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