US car-hire stuck in the slow lane

Financial Times : August 12, 2008

North America’s car-rental operators are being squeezed from all sides, and the pain is apparent in their financial performance, share prices and credit ratings.

Downturns in the airline, hotel, financial services and vehicle manufacturing sectors have taken their toll.

Hertz Global Holdings reported a 39 per cent drop in second-quarter earnings last week while Avis Budget’s profit fell 35 per cent. Hertz sliced its profit target for the full year by more than a fifth.

Moody’s cut Dollar Thrifty’s ratings, citing “market and competitive challenges” as well as liquidity pressures as $300m in fleet financing facilities come up for renewal.

Dollar Thrifty shares have lost 90 per cent of their value in the past year, though they bounced back to close 5 per cent higher at $3.74 in trading on Monday.

JPMorgan removed its “buy” recommendation from Hertz on Monday owing to a more clouded outlook for pricing and volumes as well as the weakening US and European economies. Hertz shares are down two-thirds since last autumn.

Companies with a heavy exposure to airport rentals have taken the hardest knock. Explaining Dollar Thrifty’s one-third tumble in second-quarter profit, Gary Paxton, chief executive, said: “We saw softness in both demand and pricing relative to our expectations.”

By contrast, the biggest North American operator, Enterprise Rent-a-Car, has built its business largely on insurance and other replacement cars. Enterprise is privately owned and does not publish financial data, but is assumed to be faring better than many rivals.

The car-rental industry has also been hammered by a drive by the three Detroit-based carmakers to wean themselves from low-margin fleet sales.

The carmakers have pushed up vehicle prices, especially for models most in demand among renters, namely, small and mid-sized passenger cars.

With 1.7m vehicles in their fleets, rental operators are not only the carmakers’ biggest customers, but a big source of used vehicles.

“The real money is in the buy and sell,” says Mike Kane, head of Michigan-based Vehicle Replacement Consulting Group.

The tumble in used-car prices has thus created another difficulty.

Dollar Thrifty reported that its vehicle depreciation expense jumped 28 per cent in the second quarter from a year earlier. The Oklahoma-based group faces the extra problem that about four-fifths of its fleet is supplied by Chrysler.

The residual values of Chrysler vehicles have fallen further than most other models.

Car-hire operators have responded by stepping up purchases of “risk” vehicles, for which they must later find buyers rather than selling them back to the manufacturers under contract.

They have beefed up their “re-marketing” operations even as they cut back in other areas.

“We’ve been focusing on diversifying our car sales channels”, Hertz said.

Hertz sold about a third of its cars to dealers and through online sales in the second quarter. The remaining two-thirds were sold through traditional auctions.

Mr Kane says that while improvements have been made in the selling process, “most of the car-rental companies don’t sell their used machinery very well”.

He also sees scope for greater efficiencies in car-hire bookings.

Unlike airlines and hotels, car-rental companies seldom lock in customers by asking for credit card details when reservations are made.

Operators are seeking to push up revenues by promoting high-margin features in their vehicles, such as global positioning systems.

They are aggressively cutting costs. Hertz expects to cut its overheads by $300m this year, up from its previous estimate of $250m.

But Richard Kwas, analyst at Wachovia Capital Markets, says the savings will be more than offset by reduced rental rates, higher vehicle prices and new investments. Neil Abrams, another industry consultant, believes a radical approach is needed. “Each of the brands has to challenge their business models and go after non-traditional business”, he says.

Some groups show signs of heeding such advice. Hertz, normally viewed as the most upscale brand, has begun a thrust into the more value-conscious market. Dollar Thrifty and others are expanding their off-airport business.

The challenge, Mr Abrams says, is that “you don’t want to dilute the brand. Customers have a certain image of the car-rental company they do business with”.

Michael J. Kane is president of the auto-rental consulting company Vehicle Replacement Consultant Group, Inc., Southfield, Michigan. He has more than 20 years of experience in the auto-rental and leasing business.

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