Think you know what makes Avis Budget Group Inc. (NASDAQ:CAR) tick? Certainly it’s subject to the ebbs and flows of the economy; the more money people have, the more they travel. There’s a curious nuance of the car-rental business, however, that might not even by fully appreciated by long-term owners of CAR stock.
That is, for car rental companies to remain profitable they have to be able to sell their older vehicles at high enough prices to significantly offset the cost of new vehicle purchases.
And in the wake of an auto sales surge that’s now creating a record-breaking (and price-gouging) glut of barely-used automobiles, that’s been easier said than done.
A Tricky Nuance for CAR Stock
In most regards Avis Budget Group is just like any other company. It has to compete (mostly with Hertz Global Holdings, Inc (NYSE:HTZ) in this case), it has operating expenses like payroll and advertising, non-cash expenses like depreciation, and all the rest.
Car rental outfits have a couple of extra lines on their income statement, though, that other companies don’t have. Those are, “investment in vehicles” and “proceeds from sale of vehicles.”
These are very, very big numbers too… big enough to make or break an auto rental business.
In a normal environment, no big deal. Both Avis and Hertz have been around long enough to have mastered the math, and are able to adjust as needed. We’re not in a normal environment though, at least when it comes to cars. Cox Automotive believes consumers will turn in 3.9 million off-lease cars this year following last year’s 3.6 million.
Last year’s off-lease turn-ins were up 8.1% from 2016’s total. Meanwhile, the NADA predicts more than 40 million used cars will change hands in 2018, after they reached a record high of 39.2 million units last year.
It’s taken a toll on used car prices; whenever the supply of anything races higher, prices for those ‘anythings’ are pressured lower. Used cars are no exception to that dynamic.
Data from J.D. Power verifies this trend. Its Used Car Price Index, though up 0.9% in March, has been trending lower since 2011. The plunge really picked up in 2016 though.
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It’s been an increasingly tough headwind for Avis Budget, and by extension, for CAR stock. The company said as much with 2017’s Q2 report, with CEO Larry De Shon saying at the time “Our second quarter results in the Americas reflected both a 4% reduction in pricing resulting from industry over-fleeting and higher per-unit fleet costs due to lower used-vehicle values.” It was a concern that first surfaced with last year’s Q1 report, however.
A Picture Says a Thousand Words
It’s a trend that’s bit difficult to see from one quarter to the next. Hertz spends the most money on vehicles during the first and second quarters of the year, but does the most business in the second and third quarter. It sells most of those vehicles during the fourth and first quarters of the year. Some quarters are fiscal losers, but that’s by design — that loss is more than offset in other quarters.
If you can smooth out the erratic edges of the company’s income statements though, you can see how slowly but surely slumping used car prices (not to mention rising new car prices) are dragging Avis Budget lower.
To do just that — smooth out the unsynchronized auto sales, auto purchases and revenue trends — the graphic below plots the trailing-twelve month tally for each going back a few years.
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To its credit, Avis Budget at least partially countered the waning resale values of its fleet cars by cutting purchases of new ones. It doesn’t seem to have adversely impacted revenue. Some careful number-crunching, though, reveals that even with such an effort, the net cost of buying and selling vehicles is on the rise again.
There’s also an X-factor in play here that doesn’t immediately show up on the charts or on the books. That is, using vehicles a little longer than the company might have in the past can crimp consumers’ perception of the company. And, the older and higher-mileage a vehicle becomes, the more maintenance it requires.
In other words, Avis Budget may be doing long-term harm to CAR stock in an effort to defend short-term results.
The trick is finding the optimal balance.
Looking Ahead for CAR Stock
Sliding used car prices didn’t appear to be a significant problem in the fourth quarter… at least not like it had been in the middle of last year. One quarter doesn’t make or break a trend though. And, much has changed for the automobile market in just the past few months. And, much more could change in the foreseeable future.
We just don’t know what the future looks like exactly. We just know this particular undertow has the potential to grow from an annoyance into a full-blown fiscal problem for the company, and for owners of CAR stock. Where it’s going could be much worse than where it is.
It’s just something to pay close attention to in the Avis Budget numbers posted on Monday.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.
