Avis Budget Group (CAR) is up 16.5 times since the beginning of the year, and more if your starting point is the March 9 low. Of course the stock first collapsed before partially recovering. On August 7, 2007 Goldman Sachs rated CAR a buy at $23.26 a share. Back then CAR was enjoying robust pricing and volume growth. The stock had fallen 30% from early July to early August. That fall in the stock price was due to concerns about competition and fear that CAR would have to cut prices. But the second quarter of 2007 showed the pricing concerns were unfounded and CAR’s cost control plans were impressive. That triggered Goldman’s buy rating. Unfortunately CAR’s stock price did not recover. It continued falling, finishing 2007 down 50% from Goldman’s buy point. But analysts did not give up. In early 2008 management announced a $50 million share buy back program.
On March 7, 2008 Value Line wrote, “This unranked stock’s appreciation potential to 2011-2013 is well above Value Line’s median, assuming, as we do, a partial rebound in the P/E ratio by that period.” In 2007 CAR generated $16.58 a share in cash flow. That was impressive and more than needed to service CAR’s substantial debts. As we now know the economic fundamentals changed suddenly and dashed all hopes for CAR’s profits and stock price.
In March 2008 Value Line expected CAR to earn $1.60 a share, rising to $1.80 in 2009. Instead CAR lost $0.49 a share in 2008 and is on track to report another loss this year. The current estimate is a loss of $0.25 a share. Value Line now says investors would do well to look elsewhere even though they see a possible return to profitability next year. CAR’s stock price has basically made a round trip from the middle of 2008 to a crisis low and back.
An optimist might say hold on to CAR. Cash flows are still substantial, $17.04 a share last year and likely slightly more this year. CAR is comfortably in compliance with all of its debt covenants. If the economic recovery is robust, a V shape, CAR’s stock price might go higher, maybe all the way back to its 2007 high above $30. However the risks are substantial. The stock could just as well fall sharply or do nothing for the next couple of years.
As of June 30, 2009 revenues were down 17%. In response, management slashed staff by 26%, laying off 3,700 employees. Cost cutting is how management has managed to stay in compliance with debt covenants. There is hope that rental car demand has stabilized. But there are no signs of a return to growth. In my opinion it will be a long time before business travel returns to the levels of 2007. And business travel is the backbone of the rental car business. Moreover in my view pricing is too high. Rental car companies are pleased with gains in pricing. So far competition among rental car companies has not been aggressive. That is likely to change. Airlines have had to cut both capacity and prices to keep the planes full. The rental car companies have just cut capacity. Price cutting will be next. That will put more stress on CAR’s cash flows and profit margins. News of more aggressive competition could be the trigger that sends CAR’s stock price sharply lower.
CAR has a lot of debt. After the collapse of Lehman Brothers, CAR’s stock price collapsed because of fear the company might not be able to roll over debts and get the essential financing for its fleet. Fortunately, management has been skillful enough to stay in compliance with debt covenants and obtain all necessary financing. But the debt is still there, at 94% of capital. Any adverse change in CAR’s fundamentals could put the debt back in question.
In addition to pricing pressures, there are all the underlying fundamental economic risks, the greatest being high unemployment. High unemployment discourages consumers and business managers alike. Fed chairman Bernanke recently said unemployment could remain high, 9% or so through the end of next year. The labor department says the unemployment rate rose to 9.8% in September. Officially there are now 15.1 million Americans out of work. But the Labor Department does not count those who stop looking for work or who settle for part time work. When they are included the unemployment rate soars to 15%. And the economy is still losing jobs, 263,000 in September. It is unlikely that business travel and therefore rental car revenues will grow again until the U.S. starts creating millions of new jobs. Under present circumstances, that looks to be a long ways off.
Risk management is an essential part of any successful investment strategy. The risk in CAR shares has risen with the stock price. My advice is to sell CAR. Hold on to the cash, there will be opportunities with less risk.
Full disclosure: No position.