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Up 2,700% and Still Room to Run?
08/20/2009 1:00 pm EST
Jon Markman, contributor to MSN Money, says rental car companies have been extraordinary performers and may be the leading edge of a strong recovery.
[Meet] the most unlikely set of superstar stocks in recent memory: rental car agencies.
Dollar Thrifty Auto Group (NYSE: DTG) and Avis Budget Group (NYSE: CAR) are each up a touch more than 2,700% since the market's lows in March, while larger rival Hertz Global Holdings (NYSE: HTZ) is up 335%. And they are still so cheap that they may well have some gas left in the tank.
The vehicle rental business has long been considered an absolute backwater because it is so commoditized. There is virtually no difference in most consumers' minds among the top five companies that constitute almost 95% of the domestic business, as they all try to compete on price while providing the bare minimum of service.
Rental agencies are also incredibly capital-intensive businesses, as all of their vehicles must be financed with credit. Yet for years they have bought [most] of their cars from General Motors, Ford Motor (NYSE: F), and Chrysler, and costs rose as automakers forced this captive market to pay increasingly more to offset the losses they were incurring from consumers.
Moreover, rental agencies must sell tens of thousands of their cars each year into a used-car market that until recently was just as moribund as the new-car market.
So, you can see why the industry started sputtering and almost died once the recession began to bite in mid-2007: As a result, shares of Avis, Dollar, and Hertz all fell around 98% from summer 2007 through March 2009.
[But] Dollar and the others reduced their work forces and cut other expenses, and figured out how to encourage customers to spend more per day. It's addition by subtraction, and it works.
[And] as the economy has started to improve, companies are sending more salespeople on the road, families have resumed leisure traveling, and pricing pressures have eased as automakers cut prices to get volumes high enough to keep factories running.
And the cash-for-clunkers program [has given] rental agencies pricing power for the sale of their downsizing fleets.
What a difference five months have made: Dollar reported a 15% increase in earnings in the second quarter. Hertz and Avis have reported similar profit gains.
The rental agencies' turn higher is beginning to look less and less random. I realize it seems impossible that a strong recovery may be afoot, but ISI Group points out that the steeper the economic contraction, the more pessimistic forecasters become on the turn and the larger the opportunity for a surprise.
For rental companies, like the rest of American business, this is not just idle speculation, because GDP growth directly leads to employment growth. The nascent strength is being driven by government stimulus and tax incentives, which have bred skepticism about its sustainability. But historically, these measures have gained traction in the private sector as a positive feedback loop replaces the negative [one].
(Dollar closed above $20 Wednesday, while Hertz and Avis closed above $10—Editor.)
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