Wall St. Bullish On Cars, Even In Slower Economy

<B> Wall St. Bullish On Cars, Even In Slower Economy</B>

By Lynn Woods

Despite the lackluster performance of car rental companies' stock--which took a particularly harsh beating in June, August and October, falling below the Standard & Poor 500--the industry remains strong and continues to benefit from healthy earnings, according to financial and car rental analysts.

First, the bad news: In the last week of October, Dollar Thrifty Automotive Group's stock had dropped to 13-9/10, below the $20.50 price at its initial public offering last January. Budget Group's stock was selling at 17-15/16, also below the $22.37 price of the company's follow-on offering, when it was purchased by Team Rental.

Avis did better: Its stock was trading at 20-3/8, a tad above the $17.50 price at which it listed at the time of its IPO. Hertz's stock by far proved the strongest. It was priced at 35-13/16 at the end of October--a comfortable margin above the public offering price of 27, though still lagging behind its high of 51.

Third-quarter earnings for all the companies, however, were up over the same period in 1997.

Dean Gianoukos, an equity car rental analyst at J.P. Morgan, echoed the view of other experts when he noted that the car rental firms' performance on Wall Street reflected "the economic slowdown being priced into stocks," rather than a weakening in earnings or concerns about the firms' management. "Unless something disastrous happens with pricing, I don't think they'll lose earnings. All risk is priced into the stocks," he said.

Noting that the year has been a good one for the industry, Jon LeSage, vice president and director of research for Abrams Travel Data Service, a car rental consultancy in Long Beach, Calif., said the industry's growth in revenues and profits indicated that the recovery that began two years ago was still going strong. However, LeSage noted that gauging the actual profitability of the companies is difficult, given the numerous acquisitions made by some firms in the past year and the dependency on other segments of business, such as truck and equipment rental, at other firms.

The less-than-stellar performance of car rental stocks has more to do with shareholders' perceptions and fears about the fate of the companies in a possible recession than anything real, the analysts said. Some of this anxiety has to do with fear of the unknown, since car rental companies have been publicly traded for less than two years and so have no history of stock performance in an economic downturn.

Analysts nonetheless are optimistic, pointing to several factors that would help stabilize the car rental industry in a recession. Foremost among them is the fact that only 25 percent of the car rental industry's costs are fixed, compared with 75 percent in the airline industry. "Investors don't realize the variable costs in the car rental industry," said Robert Napoli, a senior equity research analyst at ABN-AMRO, in Chicago. "It's not like the airline industry."

The relatively low percentage of fixed costs provides the car rental firms with much greater flexibility and a better ability to adapt to changing economies than other more cyclical industries have. "Our revenue-earning equipment is fairly liquid," noted Lauren Babus, a Hertz spokesperson. "We can adjust our inventory and size fleet to demand."

In a recession, the actual purchase price of cars would fall, as would interest rates, further helping the car rental companies with their fleet costs, Gianoukos said.

The car rental industry is less at risk than other travel suppliers for a couple of other reasons as well. First, 80 percent of car rental revenues derive from enplaning passengers. A recession would result in more discounted airline tickets, but not necessarily fewer enplanements. Whether airline passengers are paying a lot or a little for their tickets doesn't impact whether they rent a car, according to Babus. In fact, statistics compiled by J.P. Morgan show that since 1977, the number of transactions at Hertz decreased in only three years, and at Avis in only two years.

Second, car rental rates tend to be much more stable than the cost of an airline ticket, where the discrepancy between the highest and the lowest price can be extreme. Car rental also is a much smaller portion of the total travel and entertainment pie--8 percent as opposed to 44 percent for air and 22 percent for hotels. Therefore, there is less incentive for corporations to cut back on car rentals because the savings are minimal compared with other travel segments.

But what about the beating the industry experienced in the early 1990s, when at least two major companies--Budget and Alamo Rent-A-Car--lost money and others barely squeaked into the black? Though only half a decade ago, it was a different era for the industry, insiders said. Analysts blamed the problems on poor management and an industry dynamic that had nothing to do with market conditions--namely, the ownership of the car rental firms by auto manufacturers, which were more interested in using their car rental holdings as convenient dumping grounds for unsold new cars rather than as profit-making enterprises in their own right.

So far, the talk of recession remains hypothetical; there has been no sign of flagging in the car rental industry, as measured by a number of factors. Rates continue to rise, at a pace ranging from 3 to 5 percent--not the gangbuster increases of a year ago, but nonetheless a respectable showing in a noninflationary economy. Demand is strong, with airline enplanements up 1.1 percent in August compared with the same period the year before, according to J.P. Morgan statistics. Transactions in the third quarter grew by an estimated 5.8 percent.

The major car rental companies continue to focus on revenue management, and as a result, they are getting better yields. "They're getting more per rental now, whether through upselling or yield management, than they would have a couple of years ago," said LeSage.

At the same time, the firms also are cutting costs by passing along airport concession fees, reducing their operating costs at airports and reducing the rewards in their frequent flyer programs. That last move could save Hertz as much as $30 million a year, according to Napoli.

The only bogeyman on the car rental industry horizon is stagnant or falling rates. However, analysts said that logic dictates against this development, because of the strength of industry leader Hertz, whose continuous pursuit of higher prices--but not at the expense of market share--has been driving rate increases.

Hertz's relatively large margins make it a formidable competitor, as was demonstrated earlier this year when National Car Rental tried to gain market share by lowering prices in some markets. Hertz quickly matched them, snatching the business back from National before raising prices. "National only got less profits," said Napoli.

Following is a brief look at the performance of each of the majors:

<ul><li>Hertz continues to report strong earnings--$756.7 million for domestic car rental operations in the third quarter, up 6.7 percent over the same quarter last year. Among Hertz's advantages are a great credit rating from Ford--which maintains an ownership in the company--plus diverse operations, including equipment rental and used-car sales, and a long track record of strong management. Hertz reported revenue per day up 4.4 percent for the third quarter of 1998 over last year.

<li>Even though number-two player Avis has to pay a 4 percent fee off the top to Cendant, its parent company, the firm is doing very well, said analysts, with revenues of $652.4 million, up 12.5 percent over the same period in 1997. However, that number does not account for the purchase of several of its licensees during the same period, resulting in a probable inflation of the percentage. Eighty-five percent of the company's revenues derive from domestic car rentals, with the remaining 15 percent coming from international rentals, according to J.P. Morgan.

"Avis is a very well-managed company with good cash flow," said Napoli, commenting favorably on the firm's recent announcement of a stock repurchase program. Avis' revenue per day increased 2.7 percent in the third quarter. This lower-than-anticipated amount was offset by an increase in the average length of rentals, reflecting the company's push into the weekend leisure market, Gianoukos said.

<li>Budget Group reported earnings of $335.8 million for its corporate car rental operations in the third quarter, up 11 percent from the period a year ago, or 5 percent excluding recent licensee acquisitions. Analysts lauded Budget's management team, which has transformed the former money loser into a growing, dynamic company with the most diversified operations in the industry.

Napoli said that in the short term, the firm has its hands full integrating its latest acquisition, Ryder TRS, into the company, although long term the purchase is seen as a good move. LeSage noted that in an effort to regain the market share it lost in the late 1980s and early 1990s, Budget, like National, had resorted to selective discounting. However, Budget's rates for a midsize car increased by 6.4 percent in the third quarter compared to the same period the year before. Its revenue per day increased 2.6 percent over 1997.

<li>Financial data on National Car Rental and Alamo, both of which are owned by Republic Industries, was not available to analysts, since Republic doesn't break out its car rental division from total company earnings. One analyst complained of discounting by the company, noting that "if National weren't in the industry, prices would go up a lot faster." LeSage, who said that National's performance was basically solid, noted that the purchase of EuroDollar last year had caused a temporary drain on the company's earnings.

Others said the attempt to integrate National's fleet and operating systems with those of Alamo was proving to be a difficult task, partly because of the two firms' different business philosophies. For example, while National manages its yield by price--raising rates as the number of cars on a given lot are rented out--Alamo seeks to increase the number of rentals by shuttling cars to the lot once the available cars have been rented, according to Ed McArdle, who runs E & E Consulting, a car rental consultancy based in Coconut Creek, Fla.

McArdle added that the introduction of National's new IT system, called Odyssey, has resulted in further disjointedness with Alamo's system, although those glitches no doubt will be ironed out once Alamo signs on for a similar IT system. Alamo was widely perceived to be experiencing problems, with a number of locations recently closed and management repositioning the company as primarily a leisure car rental firm, though rumors that it was for sale could not be substantiated.

<li>Dollar Thrifty Automotive Group reported earnings of $274.7 million for the third quarter, a 4.7 increase over the earnings for third quarter 1997. Revenue per day increased 0.5 percent over the prior year. Occupying a much smaller market position than its larger competitors, the group is unique in that Thrifty Car Rental is the only car rental firm to rely almost exclusively on franchising. "It's more of a finance company," noted Napoli. Thrifty accounted for $70.8 million of the group's third-quarter revenues, a 1.5 percent increase over the year before, while Dollar raked in $203.7 million, a 5.9 increase.