HTZ - Why Avis Budget Group Might Be An Interesting Ride Long Term

Summary

• The car rental sector seems very attractive long term (3 to 4 years).
• Avis offers generally strong fundamentals and a low PE ratio.
• Short-term risk factors don't necessarily change the long-term bull case.

With strong fundamentals, a sound financial base and a positive outlook for the entire industry the Avis Budget Group ( CAR ) makes a compelling case for an attractive long-term value stock.

By looking at the stock chart alone an investor might not be too thrilled with the idea of including CAR into a stock portfolio. On a year-to-date basis the stock is almost down by 19% slightly outperforming the S&P 500. From its high in March 2022 it depreciated roughly by 45%. All nine rating firms who currently cover the stock gave it a "hold" rating, as MarketWatch reported. Yet, its average 12 months price target is $217 which would mean a return of about 32%. So, is Avis an attractive investment at the current price for someone adding new stocks to a long-term portfolio or will hopes be in vain?

Let's look at the sector first.

Bright times ahead for car rentals

As car sharing becomes more and more attractive so does renting a car. However, car sharing shouldn't be considered as competition to car rentals but merely as yet another alternative to traditional car ownership. As published by Statista , the car rental market is expected to grow by 7.98% annually until 2027 with most of the growth happening in the United States. Also revenue of the entire sector is expected to reach more than $81 billion with an average revenue per user of more than $197. This offers us a reasonable time horizon of three to four years (while some analysts expect this trend to continue even until 2029).

Judging from my experience this growth can be partly explained by two major factors. One being the different views of Millennials and Generation Z when it comes to car ownership. Owning a car that we only use for a fraction of the day might not seem as financially attractive as renting one on occasions when we really need it. This also holds for car sharing. Therefore, we might see a more profound transformation of the entire car industry in the coming two decades although this transformation will most likely not be steady. GetJerry.com even reports that car ownership trends upwards in some parts of the U.S. (California).

The other major factor is inflation. With skyrocketing car prices consumers might find it harder to buy (or even finance) a new car. And with higher costs of living in general the desire of owning a car might fade, as reported by the UK magazine Motortrader.com. While owning a car makes a lot of sense in rural areas where public transportation is scarce or at least somewhat inconvenient, more and more "urbanites" find it more appealing to rent a car once in a while avoiding a long-term commitment to as costly luxury.

Strong Fundamentals

Looking at Avis' balance sheet and income statements, one year does (quite unsurprisingly) stand out: 2020. Like many other car rental firms, car fleets were partly sold due to a lack of demand while prices for used cars dropped instantaneously. And yet, while 2020 was a terrible year for the entire industry, in 2022 Avis managed to grow their revenue by 26.6% compared to 2021 and by more than 28% compared to 2019. (I will simply ignore the year 2020 for now and calculate the 2022 figures with the last reported TTM numbers). In 2022 gross profit was up 48.8% compared to 2021. Net income rose by 111.9%.

Let us focus on the net profit margin next which tells us how much net income a company retains from its revenue. Avis managed to grow their net profit margin significantly during the last couple of years. In 2018 the net profit margin was as low as 1.8%, in 2019 it rose to 3.2%, in 2021 to 13.8% and finally in 2022 to 23.1%. This makes Avis an increasingly profitable business despite its negative stock performance in 2022.

We will have a look at the asset turnover next. This measure tells an investor how efficient a company uses its assets. From this perspective Avis is a pretty efficient business with a high asset turnover hovering in (or near) the 40s. In 2018, Avis had an asset turnover of 47.6% (i.e. the dollar value of their revenues was 47.6% of the dollar value of their total assets). In 2019, the asset turnover slightly decreased to 39.7%, while it rose to 41.2% in 2021 and to 46.8% in 2022.

It wouldn't be financially sound, of course, to disregard a particular bad year as one bad year could easily end a company. So, let's focus on the financial health of Avis next to see whether 2020 significantly affected the company's leverage or not.

The soundness of Avis' financial health

To focus on the soundness of Avis' financial health I am going to look at the total-debt-to-total-assets ratio of the company to answer one utmost important question: How leveraged is the company? The higher the number, the higher the leverage.

In 2018, Avis' total-debt-to-total-assets ratio stood at 0.98 meaning the company had almost as much total assets as total liabilities. It slightly improved to 0.97 in 2019, while it rose to 1.01 in 2021 and finally to 1.02 in 2022. So, yes, we do see a (very) slight deterioration concerning the total ratio for a number below zero indicates more assets than liabilities. However, a deterioration of this ratio from 0.98 (2019) to 1.02 (2022) might not be that surprising when considering the dramatic impact of Covid to the overall economy. This shows us that despite the fact of having a detrimental effect on net income as reported in the company's income statement, the year 2020 did not significantly increase the company's total ratio as it did not significantly increase the company's leverage. Therefore, we can disregard 2020 for that matter. (When it comes to cash flow, however, Avis reported - quite unsurprisingly - the lowest cash flow from operations during the year 2020.)

The Alternative

Compared to one of its biggest rival, Hertz ( HTZ ), Avis seems to me to be the better alternative especially when focusing on revenue growth and net income between 2018 until 2022. While Avis could grow their revenues during that period, Hertz' revenues are still short of their high in 2018 and 2019 (yet growing again). Moreover, Hertz' net income was negative from 2018 throughout 2020.

Then again, Hertz might not seem so unattractive as a long-term stock when looking at the company's total-debt-to-total-assets ratio. While it stood at 0.95 in 2018, it improved to 0.85 in 2021. And even if we calculate it for 2022 with the last reported numbers this ratio is 0.87 meaning the company has more total assets than total debt.

With a 2022 net profit margin of 19.5% (calculated with the last reported numbers as stated above), Hertz was slightly less profitable than Avis yet had a moderately better total ratio.

So, what could possibly go wrong?

The stock has currently an astonishingly low PE ratio of 2.9. Despite the fact that the company managed to increase their EPS during the three quarters, a low PE ratio often means that investors fear lower EPS in the future. Lower earnings per share are, indeed, a possibility in a not-so-mild recession. In case of a somewhat more serious recession there are several factors that could impede the car rental business.

Reduction of tourism. Should we see a reduction of tourism - as unlikely as that might seem now - we are also likely to see a reduction in car rentals. It is doubtful that this negative effect would be mitigated by more business related car rentals that are also likely to decline during a moderate recession.

Rising oil prices. It is hard to tell where the oil price might trade ten months from now as this not only depends on the war in Ukraine but also (and even more so) on the continuing re-opening of China. A fast and continuous large scale re-opening could generate a significantly higher demand and thus considerably higher energy prices. The resulting increase in gas prices would also increase the overall cost of renting a car and can also be regarded as a potentially negative effect for the industry.

Inflation. In case inflation stays high and does not decline to its pre-pandemic level, customers will have to cut their expenses in the long run, especially if wages continue to not keeping up with inflation. Again, a fast and steady re-opening of China is likely to create upward pressure for inflation.

Market risk. Despite the already low PE ratio of Avis, PE ratios tend to fall during recessions. According to Schroeders , the trailing PE ratio of the S&P 500 "generally bottoms around 12x" during recessions (including the Great Depression), while the current PE ratio of this major index is currently at 20.29. Should we face a typical recession, this would mean another drop of the S&P index by as much as 40%. Even though Avis might seem as a good investment in the long-term, market risk would potentially mean more pain for short-term investors.

Conclusion

Looking at the industry outlook in general and at Avis' fundamentals the company seems as an interesting addendum to a long-term (3 to 4 year) stock portfolio. On the other hand, a lot of potentially negative short-term factors could hurt short-term investors looking to hold on to the stock only for six to twelve months. Yet, such negative short-term risks do not seem to change the overall 3-to-4-year outlook of this stock.

For further details see: