Description

Avis Budget Group

Company Description

Avis Budget Group (“Avis”) is a global provider of vehicle rental and car sharing services, operating three of the most recognized brands in the industry through Avis, Budget and Zipcar. Avis operates the Avis and Budget brands in approximately 175 countries throughout the world.

Investment Summary

Short equity at 57.31. Despite the Car Rental business consolidating into an oligopoly they face “Business Model Disruption” from the likes of Uber and Lyft, European Weakness and F/X issues that will pressure revenues. An increase in fleet costs and their high exposure to short term interest rates will increase expenses and compress margins as the Federal Reserve moves to increase short term rates in 2015. Additionally Low profitability, low return on investment, increasing exposure to Auto residuals and a high valuation relative to historical norms makes Avis a compelling short.

Capital Structure & Relevant Financial Metrics

Investment Thesis

• CAR has had a goal of achieving $1 billion of EBITDA in 2015, which is in fact the current consensus estimate for 2015

  • Company has expected to achieve this goal from a combination of revenue growth (mostly through pricing) and margin enhancement

  • Avis has done an excellent job of executing and will probably hit their 2014 numbers. But, they need to grow EBITDA even faster in 2015 in order to achieve their $1 billion goal

  • However, items that are out of the control of management will prevent Avis from achieving these goals and may eventually, cause a shrinking of the overall “car rental” market

• Revenues - Avis is expecting to increase revenues in 2015 (consensus 6% increase) mostly through price increases, especially since price increases are the largest driver of EBITDA (1% change in pricing = $49 million in EBITDA)

  • Since the Car Rental business has consolidated into an Oligopoly (Enterprise, Hertz and Avis have 96% of the market) the expectations are for continued pricing power

• However, the prolific increase in use of Car-Sharing & Ride-Sharing Companies (like Uber & Lyft, among other) will be highly disruptive to the Car Rental business. At the very least the will impact the car rental markets ability to raise prices. At a recent investor conference, Avis stated that they do not think ride sharing will have any impact on their car Rental business, but may have a slight impact on Zipcar. I think that they are in for a rude awakening

  • Renting a car is much more expensive than headline rate (generally 50% more), and is extremely inconvenient as Renters:

    • generally sign up for many of the “Ancilliary” options (like insurance & GPS)

    • must pay for gas

    • must pay for and find parking

    • must collect their luggage, then wait for a complimentary shuttle, schlep their luggage to the rental company, wait on-line for a representative and then finally get their car – all in all, a highly frustrating and lengthy process

    • Allocate extra time when returning the car before a flight

  • Car-Sharing services like Uber are now available in most major cities and will probably be available in most places in the near future

    • the ease of use, makes it an extremely pleasant experience – no waiting & or hailing

    • the cost, which is continuously declining, makes it an economical and competitive

  • Companies are already allowing employees to use Uber, instead of renting cars and the ease of use make it an easy preference, especially since these users care more about convenience than cost

  • Avis is currently using free cash flow to buy back stock as they believe that the $500 million they spent Zipcar will be their answer to evolving technology

    • I believe that Zipcar will actually be obliterated (and probably written down) as similar car sharing business are being started frequently (even car manufacturers like BMW have gotten into this business) and Uber & Lyft are much more convenient

  • In order for Avis to raise prices they will need Enterprise (the market leader with 50% share) and Hertz to raise rates as well

    • Unlike Avis, Enterprise has said that they are acutely aware of the disruption that can/will be caused by car sharing services

    • As Enterprise will look to maintain market share, and since they are the dominant player in the Insurance Accident Replacement market, I believe that they will be reluctant to raise prices and look to maintain their market share

  • Not implying that it will be a 100% substitution of the car rental market, but it will definitely be disruptive and will certainly be a headwind for their revenue

• Europe & F/X

  • The currencies of their big 4 international countries are currently down 9-15% against their 2014 average. If sustained, this will cause a $30-45 million hit to EBITDA

  • European economy is still weak and it is not realistic to assume much growth

• Costs: Avis has done an excellent job lowering costs and increasing margins. However, going forward, most of the margin gain will be attained from an increase in revenues. Additionally, they are now facing increases in costs that are beyond their control. Including:

  • Increasing car prices, which will increase their depreciation expense and financing costs. Company is expecting fleet costs to be up 3-6% in 2015, with acquisition costs up 1%

  • Increasing of Short Term Interest Rates: While many people think that long term rates will stay low for a long time, Avis is one of the few Non-Finance companies that have extreme exposure to short term (LIBOR) rates.

    • Fleet financing of its fleet is currently at $9.5 billion, with an average balance of $8.9 billion over the last 4 quarter

    • These financing are extremely lucrative, averaging around 3% rate of interest

    • The company expenses these costs and therefore they are included in EBITDA

    • The market is expecting the FOMC to raise interest rates this year

    • A 25 bps raise in interest rates would equal $22 million increase in this expense, which is a 8% increase in this expense line would result in approximately a 2.5% decrease in EBITDA

  • Residuals: Historically, Car rentals bought most of their fleet through “Programs” with the OEM’s where the OEM’s took the residual risk of the cars. However, since 2007, OEM’s have been shifting a higher percentage of the residual risk to the Rental Company’s

    • In 2007, 73% of their fleet were program cars with the OEM’s, in 2013 it was only 37%. Company is expecting to increase this number to 50% in 2015

    • Company has already said that they believe that there will be pressure on residual values next year (3%-6% increase in fleet costs, 3% of which is coming from a drop in residuals)

    • Used car prices have been very strong since 2009 and pretty steady for the last few years, but any significant drop in used car prices will have an exaggerated effect on earnings because of the amount of “risk” cars the company has. While this is not anticipated, it is a downside risk.

      • Residual prices are now approximately 79% of cost, they generally have been as high as 81%, so residuals are close to their highs. Company expects this to drop to mid 70’s in 2015. Residuals have dropped to below 70% during times of stress.

• To sum up, I believe that EBITDA will be pressured and the Company will be forced to lower their expectations for $1 billion in EBITDA in 2015. In fact, I think that EBITDA will be $940, 6% below consensus (implying $340 million of earnings or $3.20 a share), with a significant possibility that it will be even lower and a lot closer to 2014’s EBITDA

• Valuation:

  • Much like other Auto related business’s, Rental Cars are cyclical and therefore historical multiples have had large ranges over the past 9 years (since its spinoff).

    • EV / LTM EBITDA has ranged between 4.3x-17.1x with a 7.1x Median

    • EV / 1yr Forward EBITDA has ranged between 3.5x-24.6x with a 5.6x Median

    • P / LTM Earnings has ranged between 4.2x-46.3x with a 10.6x Median

    • P / 1yr Forward Earnings has ranged between 0.5x-43.6x with a 6.0x Median

  • Currently, Avis is trading above the historical Medians. Based on Consensus Avis is trading at

    • 10.1x EV / LTM EBITDA

    • 8.8x EV / 2015 EBITDA

    • 20.3x Price / LTM Adjusted Earnings

    • 15.0x Price / 2015 Adjusted Earnings

  • The current valuations suggest the market believes that Avis is in a period of “under earning” and that there will continue to be strong growth over the next few years

  • I believe that once investors see that the secular headwinds will overpower the cyclical earnings momentum and that Avis will indeed hit peak earnings in 2014 / 2015 then lower multiples will be assigned to the stock

  • Assuming that Avis will trade closer to its median multiples, Avis should trade somewhere between $22 and $34

    • 7.1x 2014 Consensus EBITDA = $34.3

    • 5.6 2015 EBITDA = $28.5

    • 10.6 2014 Consensus Earnings = $31.0

    • 6.0x 2015 Adjusted Earnings = $21.8

Catalysts

• 4Q Earnings where expectations regarding 2015 EBITDA will be reset

• Fed lifting short term interest rates

• Changes in Manheim Index

• Proliferation of Uber, Lyft and other car-sharing services

• Uber IPO

Catalyst

• 4Q Earnings where expectations regarding 2015 EBITDA will be reset

• Fed lifting short term interest rates

• Changes in Manheim Index

• Proliferation of Uber, Lyft and other car-sharing services

• Uber IPO