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Hertz And Avis Are Driving Profits

I wanted to pick up from our story of last fall about the travel sector. Readers will recall that we had a good experience with our TripAdvisor trade (NDQ: TRIP), banking a gain of 48% in four months.

I think the fundamental investment thesis that led me to recommend TripAdvisor is still in place. With improving economies around the world and retiring boomers looking for something to do, strong companies operating businesses that cater to the travel industry should continue to do well.

Naturally, airlines are the first companies one thinks of when it comes to travel. But I've never had a good experience investing in that group other than a recent trade on American Airlines that worked out okay. It was a quick move in and out since good news in the airline industry is often fleeting.

Hotels are another group that should do well and I recently invested in Starwood (NYSE: HOT) and others in the group like Marriott, Wyndham, and Hilton. They should have improving earnings over the next few years.

Also, there are a number of players in the online travel group that make sense. Like TripAdvisor, they will benefit from the increasing trend of people to do their own travel planning and booking without the benefit of a travel agent.

Naturally, the credit card companies are worth considering as well particularly American Express (NYSE: AXP) and I well cover them in detail in future columns.

But the group that I want to focus on this month is the car rental companies. They should do very well going forward and benefit from this macro trend not only in leisure travel but business travel as well. Additionally, there are number of catalysts peculiar to Hertz (NYSE: HTZ) and Avis (NYSE: CAR) that makes an investment in these names even more interesting.

Up until a few years ago, the automobile manufacturers or conglomerates owned the major car rental companies. Ford owned Hertz and Chrysler owned Dollar Thrifty whereas Avis was owned by Cendant and Budget was owned by Transamerica Corporation. Both Avis and Budget were spun off to private equity groups, as was Hertz. So it wasn't until relatively recently that Hertz and Avis had the chance to operate as single-purpose businesses, not driven by either a desire to push excess inventory onto the market or by financial engineering.

Since they became independent they have been very busy on the acquisition side. Hertz was able to buy Dollar Thrifty Automotive Group for $2.3 billion after a long process that included a major battle with Avis over the property. Meanwhile, Avis had already acquired Budget while it was still owned by Cendant. I should mention that there were a number of other transactions involving these companies over the last couple of decades but I'm compressing the history in the interest of time and space.

The bottom line is that we now have coherent ownership and focused management and to some degree a duopoly (not counting Enterprise which is privately held). This should enable these companies to experience pricing power and margin expansion. Slim margins have been an issue for the rental agencies over the years but they should finally be able to expand them going forward.

Recently, Avis announced that it had raised prices by 4% in North America during the first quarter leading to an adjusted profit that exceeded Wall Street's expectations. That in turn prompted Avis to increase its full-year estimates. In fact, Avis has been able to raise its prices a total of six times year-to-date. Hertz was also able raise rates by similar amounts and volumes for both companies were up as well.

Both companies have continued to acquire additional related businesses. Avis bought out car sharing pioneer Zipcar in March and has begun expanding that franchise into more cities in North America. Avis also acquired Apex Car Rentals which helped their international revenue rise. Meanwhile, Hertz continues to digest their recent purchase of Dollar Thrifty and expanded their competition to Zipcar with hourly rentals of their own which they are calling the 24/7 platform.

So far Hertz is showing better results. The company reported a first-quarter profit of $18 million compared with a loss over the same quarter the previous year of $56.3 million (figures in U.S. dollars). Revenue jumped by 24%, to $2.4 billion. The average number of Hertz-operated cars was 757,100, up 27% from the prior year. That was mostly driven by the Dollar Thrifty acquisition.

Avis reported that quarterly earnings declined 33% from the prior year quarter although revenue increased by 4% to $1.69 billion. As mentioned, Avis revised its outlook to reflect the acquisition of Zipcar and forecast revenue increases year-over-year of between 6% and 9%.

Both stocks tend to trade in lockstep. I consider both as buys but based on the recent results I give a slight edge to Hertz but even though on a p/e basis it looks to be more expensive. Both stocks are up over 40% year-to-date but, as we discovered with our Boeing recommendation, waiting for a pullback can prove expensive.

If you want to hedge your bets, I recommend taking a half position now. You can add more later when and if we eventually get the long predicted market correction. It seems that everyone has been waiting for it, but so far it's been like waiting for Godot.

Action now: Buy Hertz Global Holdings with a target of $30. The shares closed in New York on Friday at $24.85.

Disclosure: I am long CAR.