On November 24th, at $60 per share, we recommended a short position in Avis Budget Group (NASDAQ:CAR) based on the company's weak fundamentals, increasing debt load and unattractive market dynamics given the level of investment made by all major car rental players. The piece in its entirety can be found here.
In this note we address two brief points of interest that have been raised since that first article.
1. How valuable is the group's acquisitive growth strategy?
On top of the announcement earlier this year that the company would be acquiring its Southern California and Las Vegas franchisee, the group recently announced another acquisition - this time of its Scandinavian operator, to be slotted into its newly re-configured geographic group structure.
With the sum acquisition outlay of $300m (on a corporate level), this represents another incremental increase to the group's corporate debt load, on top of the additional $200m of share repurchases likely to take place after the group increased its authorization. The business already has historically high levels of debt and we view further increases in indebtedness - driven by low interest rates, readily available financing, and a benign risk environment in the market - as being dangerous in a cyclical company.
On the acquisition strategy itself, we sit on the fence. While there is good logic acquiring licensees - it's a less operationally intensive way of adding earnings, since you're basically integrating companies which already use your systems anyway - as usual, we find the presentation of said acquisitions a little ambiguous. Sales prices are made with reference to "adjusted EBITDA" "after synergies". This has three layers of complication to get back to earnings per share; interest charges will be incurred, some level of depreciation charges will be legitimate in terms of maintenance capex and "synergies" are, at best, typically a bit more troublesome than management teams like to think... and if we're being harsh, just a residual to slap back onto EBITDA to get to the multiple you want to present yourself as paying.
We are also curious as to the sizable EBITDA margin gap between the US acquisition (25%) and the Scandinavian one (10%), as well as group EBITDA margins (13%). Alas, we don't have the information to make an informed judgment about the group's current efficiency in allocating capital, since these businesses will be subsumed into the corporate whole.
In sum - the acquisitions do not change our thesis, no matter how cheap we might be told they are, and we view share repurchases of companies we think are expensive as being fundamentally a good thing.
2. Oil price woes
While we're not macroeconomists, it seems obvious to us that the oil price has a profound effect on car rental companies, for two key reasons:
- Cheap gas makes driving more attractive
- Cheap oil makes flying significantly cheaper, as a major input cost
Combine this with two industry dynamics:
- Avis does 71% of its business at airports
- A relatively small uptick in utilization (possibly arising from an increase in demand which is not immediately matched by an increase in supply) has a large effect on the bottom line
And you have a significant tailwind for Avis - particularly given the enormity of the slide in the price of oil. Avis is currently trading about 3% below our short call less than a month ago, versus a relatively flat market. Frankly, we find this surprising given the level of support a low oil price gives the company.
Straight from the company's risk section:
"If economic conditions in the United States, Europe and/or worldwide were to weaken, our financial condition or results of operations could be adversely impacted.
Any significant airline capacity reductions, airfare or related fee increases, reduced flight schedules, or any events that disrupt or reduce business or leisure air travel such as work stoppages, military conflicts, terrorist incidents, natural disasters, disease epidemics, or the response of governments to any such events, could have an adverse impact on our results of operations. Likewise, any significant increases in fuel prices, a severe protracted disruption in fuel supplies or rationing of fuel could discourage our customers from renting vehicles or reduce or disrupt air travel, which could also adversely impact our results of operations."
It stands to reason that the opposite scenario is a position which could greatly benefit the company.
While we're not traders and still feel good about the long-term short thesis, we are always uncomfortable shorting into obvious tailwinds. There may be better places to rotate a short if you're volatility-averse.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.