Hertz Global Holdings, Inc. (HTZ), Avis Budget Group Inc. (CAR): Oligopoly or Not, Car Rental Stocks Are Untouchable

Debt is nothing to fear by itself. Debt makes low-risk investments more rewarding. However, at the same time car rental services are adding debt, they’re also adding risk to their underlying businesses. The auto rental industry has concentrated revenue, and concentrated risk in the depreciation of their own fleets.

Avis Budget Group Inc. (NASDAQ:CAR) generated 71% of $5.3 billion in total car rental time and mileage revenue from its airport locations. Frequent fliers know the limited competition at on-airport locations, and the difficulty of shopping around on location. Hertz Global Holdings, Inc. (NYSE:HTZ) also generated 70% of its American car rental income from on-airport locations. Both companies are significantly exposed to air travel.

As of the latest annual report, Hertz is heavily invested in its own fleet. Only 19% of its cars in the United States are “program cars,” cars on which there is a repurchase guarantee at a contracted price with the manufacturer. As such, if Hertz has to cut back on supply, it runs a real risk of write-downs as it liquidates cars at a discount.

Avis Budget Group Inc. (NASDAQ:CAR) carries the same risk. The company has increased the proportion of “risk cars” in its fleet from 1% in 2005 to a company-estimated 65% in 2013. Thus, Avis is just as exposed to the cyclical nature of the automotive business as much as it is exposed to the cyclicality in car rentals. This comes at the same time the company levered up for an acquisition of ZipCar.

Let synergies show themselves

Car rental companies are already priced for near perfection in utilization, pricing, and cost synergies from their recent acquisitions. Smart investors will be paid to wait the industry out to see if these synergies actually develop – few do, as cost savings plans rarely take perfect shape.

At this point, investors are late to the oligopoly and pricing-power story. There’s little reason to chase a cyclical industry with high debt balances when all major players are trading at historically premium valuations. Wait and see – the economics of the car rental business are overstated for their ability to generate excess economic profits.

The article Oligopoly or Not, Car Rental Stocks Are Untouchable originally appeared on Fool.com and is written by Jordan Wathen.

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