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Shares of Avis Budget Group (CAR) rallied after the company reported strong first quarter results which prompted the company to raise its full year outlook for 2012.

First Quarter Results

The global vehicle rental service provider operating under its brand names Avis and Budget reported strong first quarter results. Revenues for the first quarter increased 30% to $1.6 billion. The company reported non-GAAP net income of $14 million while the net loss came in at $23 million driven by debt extinguishment costs and acquisition related charges. Consensus among analysts was that the company would report a non-GAAP loss for the period.

"We are pleased with our preliminary first quarter results, with our vehicle rental operations performing modestly better than we had projected and Adjusted EBITDA reaching record levels due to the residual values of our vehicles being significantly stronger than our original expectations," according to CEO Nelson.

Outlook
The company expects full year revenue growth of 24-29% to $7.3-$7.6 billion. Adjusted EBITDA is expected to come in at $825-$875 million, up 35-43% compared to last year. Pre-tax income excluding certain items is expected to come in between $460-$510 million. Consequently diluted earnings per share on a non-GAAP basis are expected to come in between $2.35-$2.65 per share, while analysts were looking for a guidance around $1.59 per share.

The company expects North American fleet costs to fall between 3 and 8% on a per unit basis for the entire year. This comes after the company has lowered its depreciation rates for its vehicle fleet in order to reflect the stronger residual values of its cars. Avis mentions that the integration of its European acquisition is progressing according to its plan and global travel demand remains healthy.

Investment Thesis

The company ended its fiscal year 2011 with roughly $534 million in cash and equivalents. The company operates with a large debt position of $8.77 billion in order to finance its vehicle fleet. As such the company operates with a debt position of $8.2 billion.

At today's valuation of $1.65 billion the company is valued at roughly 0.4 times annual revenues. This compares to a valuation of 1.5 times annual revenues for Dollar Thrifty Automotive (DTG) and 0.8 times for Hertz Global Holdings (HTZ) which were profitable for the entire year of 2011, while Avis reported a net loss of $29 million for the year.

Currently the company does not pay a dividend.

Valuation

Shareholders of Avis Budget have had a very good day. Today's 19% return marks a year to date return of 46%. Today's announcement that North American unit fleet costs are falling (by three to eight percent) comes as a surprise as the company previously expected an increase of 15 to 20%. Last week competitor Dollar Thrifty Automotive Group raised its guidance on the back of lower fleet costs.

The strong used-vehicle market boosts profitability for car rental operators such as Avis Budget. The company is able to sell its used vehicles at residual values which remain at historical highs. The company furthermore adds that the $1 billion acquisition of Avis Europe is progressing as expected although the economic malaise in Europe has impacted travel spending.

Despite the strong performance of today and in recent months, the company is still underperforming compared to its main competitors Hertz and Dollar Thrifty. Structurally lower operational profitability has resulted in lagging returns. While lower fleet costs and strong residual values boost short term profitability, I am not an aggressive buyer until the structures profitability improves.

Investors should value the firm on the back of its structural car lending profitability, not incidental capital gains on the sale of used cars.

Source: Avis Budget: Shares Rally After Guidance Raise