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Car rental industry – between a rock and a hard place?

Mobility is one of the hottest sectors today for a variety of stakeholders, from environmentalists to venture capitalists. In a context where new and sexy services and business models, such as ride-hailing, car sharing and self-driving vehicles, grab a lot of focus and attention, the car rental industry, a historical provider of mobility, comes across as something between the ugly duckling and a red-haired stepchild.

Through an analysis of the H1-2016 performance of the four major, listed operators with a global presence (Avis Budget, Europcar, Hertz and Sixt) I aim to shed some light on the current state of the car rental industry. Overall, the sector is going through a rough patch, as evidenced by muted top-line growth, with the exception of Sixt, and pressure on margins. Operating KPIs are a mixed bag and, once more with the exception of Sixt, based on recent share price development there is not much love for the sector in the investor community. This all begs the question, does the car rental industry in 2016 find itself between a rock and a hard place?

Volume

A bright spot in the first half of the year was volume, defined as rental or transaction days. As seen in Figure 1, all three operators providing data saw growth in volume in the period.

Figure 1 Volume Y/Y

Sources: Avis Budget, Europcar, Hertz, Nedrelid Corporate Advisory analysis

A caveat is that growth is not necessarily organic. Avis Budget has been particularly active on the M&A front recently, acquiring the Italian operator Maggiore in Q2/15 and its licensees in Scandinavia and Poland early and late 2015 respectively.

From a volume perspective the underlying picture is positive in that there is an increase in demand despite a variety of new mobility solution providers appearing, many of which offer solutions that could serve as an alternative to car rental.

Utilization

Fleet utilization, a measurement for asset efficiency, is considered a key metric across the industry. For the listed companies in question right-sizing the fleet is referred to as a key objective, with increased utilization being the preferred outcome. Figure 2 summarizes the change in reported utilization rate in H1-2016 vs H1-2015.

Figure 2 Fleet utilization rates Y/Y

Sources: Avis Budget, Europcar, Hertz, Nedrelid Corporate Advisory analysis

At all of the operators for which data is available, the increase in volume has been absorbed by strict fleet management, with a tighter fleet being used. The outcome has been an increase in utilization rates across the industry, with Hertz having improved the most. While increasing utilization may intuitively be a rational objective and look good in a quarterly report, considering how the industry prices there is evidence, detailed in a recent article of mine, suggesting that it may not be optimal from a financial performance perspective.

Pricing

Pricing is, and has been for quite a while, a major issue in the car rental industry. Figure 3 summarizes development in average RPD in H1/16 vs H1/15.

Figure 3 Change in RPD Y/Y

Sources: Avis Budget, Europcar, Hertz, Nedrelid Corporate Advisory analysis

The chart speaks for itself and the pain for the operators is obvious when considering that changes in pricing by and large fall straight to the bottom line, either as incremental profit or erosion of profitability. As such, everything else equal, it is largely preferable to grow revenue through improved pricing rather than through higher volume as there are few related costs.

While not disputing the soft pricing conditions early 2016, particularly in the US, the picture is somewhat more nuanced than the bottom falling out and the floor collapsing. The three operators in Figure 3 all operate a portfolio of brands targeting various segments in the market, from premium (Hertz, Avis) via value (Dollar, Budget) to deep value (Payless, Interrent) and a change in the business mix would potentially impact the consolidated RPD reported.

Revenue

The two main revenue drivers, volume and RPD trended in different directions in the first half of 2016. As seen above, volume was up with RPD declining, which left the industry with a mixed bag in terms of revenue growth, summarized in Figure 4.

Figure 4 Car rental revenue Y/Y

Sources: Avis Budget (1), Europcar, Hertz (2), Sixt, Nedrelid Corporate Advisory analysis

Notes:

(1) Vehicle rental only, consolidated revenue growth is 2.5%

(2) Car rental only, consolidated revenue growth is -3.7%

Sixt, for which the operating metrics are not published, did exceptionally well with a 17.9% Y/Y revenue growth in its car rental operations. In a market context as outlined previously, this is obviously very impressive. According to its half-year report growth was solid, i.e. more double-digits, in most of its corporate markets, including Germany, the US, France, Spain and the UK. Avis Budget also saw revenue growth, though much more moderate than its German peer, though the impact of acquisitions (Maggiore, Scandinavia, Poland) has not been specifically broken out. Both Europcar and Hertz saw a drop in revenue in H1-2016 as the decline in average pricing far outpaced volume growth.

Revenue per unit

Fleet is the major revenue generator for car rental operators and simply put, in general the more revenue generated per unit the better. Figure 5 shows the monthly rental revenue, i.e. excluding pass troughs, license fees taxes collected etc., per unit.

Figure 5 Rental revenue per Unit (monthly, USD)

Sources: Avis Budget (1), Europcar, Hertz (2), Sixt, Nedrelid Corporate Advisory analysis

Notes:

(1) Possibly understated as rental revenue excludes car and trucks whereas not clear what is comprised in fleet count

(2) Total revenue excluding reported FX and ancillary vehicle disposal revenues

The trend for revenue per unit is negative, except for Sixt, which is up 1.4% Y/Y. Accordingly, the pressure on pricing is so strong that even an increased utilization rate means that operators see a drop in revenue per unit.

When interpreting the numbers, one should keep in mind that these are consolidated numbers both with regards to brands and fleet mix, and a change in either could potentially have played a role.

Fleet depreciation

Management of fleet cost, particularly fleet depreciation, is key to financial success in the car rental industry. A key metric used is monthly fleet depreciation per unit, which I have summarized in Figure 6 below.

Figure 6 Monthly fleet depreciation per unit (USD)

Sources: Avis Budget, Europcar, Hertz, Sixt, Nedrelid Corporate Advisory analysis

Across the industry average fleet cost, for which monthly depreciation per unit serves as a proxy, is up. The exception is Europcar, which can possibly be explained, at least partly, by the growth in its deep-value brand Interrent.

One caveat with regards to fleet depreciation per unit is that at a consolidated, average level a change in the fleet mix, which is not broken out, and a shift in the procurement mix (risk vs. buy-backs vs. leasing) could possibly explain at least some of the change.

Spread

The closest thing one comes to an equivalent of “gross margin” in the car rental industry is the spread, i.e. the difference between revenue and fleet depreciation. The key metric is the spread per unit, i.e. the difference between revenue per unit and depreciation per unit. Figure 7 shows the monthly spread per unit in USD for H1-2016 vs H1-2015.

Figure 7 Monthly spread per unit (USD)

Sources: Avis Budget (1), Europcar, Hertz, Sixt, Nedrelid Corporate Advisory analysis

Notes:

(1) May not be correct due to some ambiguity with regards to revenue and depreciation between car rental and car sharing/ trucks, but directionally assumed right as consistent methodology across periods

There is downward pressure on the spread per unit, which so far in 2016 has been squeezed on both ends with both lower revenue and higher depreciation expenses on a per unit basis.

Margin

There is significant pressure on margins across the industry, with all major operators reporting a margin decline Y/Y in the first half of 2016, as seen in Figure 8.

Figure 8 Corporate EBITDA margin

Sources: Avis Budget (1), Europcar, Hertz (2), Sixt (3), Nedrelid Corporate Advisory analysis

Notes:

(1) Consolidated

(2) Includes allocation of corporate overheads

(3) Pretax + Non-fleet depreciation + Estimated non-fleet interest expenses

I have focused on (Adjusted) Corporate EBITDA, which is a generally used metric in the sector. While there may be some discrepancies in how it is calculated from company to another, for this purpose direction is more important than actual margin levels.

The situation is worst for the Americans, i.e. Hertz, which incidentally saw the largest decline in RPD, and Avis Budget, suggesting that the US/ American market is softer than in Europe. Sixt can probably attribute at least some its margin contraction to its focus on expansion and growth, whereas Europcar most likely benefits from its various improvement initiatives to limit the margin erosion.

Share price

There are no two ways about this, for shareholders in all companies except Sixt, the last year has been painful, as seen in Figure 9.

Figure 9 12-month share price development in USD

Source: Capital IQ

The share price development is a reflection of the challenging operating environment, with the one bright spot being Sixt’s growth rate, which is rewarded by the market. For the others, tough pricing conditions and limited growth combined with margin contraction has taken its toll on investor sentiment.

Takeaways

The car rental industry is clearly not in great shape these days, at least not the major, listed operators. Pricing, using RPD as a proxy, is under pressure, revenue per unit is down and fleet depreciation per unit is on the rise. An increase in utilization across the sector is insufficient to serve as a panacea and there is pressure both on the top line, except for Sixt, and the bottom line, which translates into poor share price performance, once more with the exception of Sixt.

Does this suggest that the industry is betting on the wrong horse? In a couple of recent articles I looked at the relationship between RPD and utilization based on how the industry prices at major locations in Europe, which I found to be negative, and how maximizing for one or the other may impact profitability. Figure 10 shows the Y/Y development for the 3 operators reporting both utilization and RPD.

Figure 10 Utilization vs RPD

Sources: Avis Budget, Europcar, Hertz, Nedrelid Corporate Advisory analysis

It is interesting to note that in the period considered, RPD has decreased and utilization increased, which does fit with my findings that an increase in utilization drives RPD down. Figure 10 does not necessarily tell the full story, i.e. to what degree the mix between premium and value oriented brands have changed, causing an impact on the RPD, but it does serve as circumstantial evidence that chasing utilization may not necessarily be the most value creative option.

To summarize, based on the performance of the listed, global operators in the car rental industry there are significant operational challenges currently. For three of the four companies in the sample, Sixt being the exception, the top line represents a real challenge and higher fleet depreciation rates also takes its toll so far in 2016, with margins suffering as a consequence. All of the above creates a negative sentiment around the sector. Having said that, growth at Sixt, evidence of continued growth at Enterprise, and independents, at least in Europe, continuing to perform well with Goldcar taking strong momentum into 2016 with a solid 2015 revenue growth suggests that while some issues are industry-wide, there are also company-specific problems. Thus, it is probably more accurate to conclude that the death of the car rental industry is not imminent, but certain operators do have some real work to do to achieve satisfactory performance.

Nicolay Nedrelid is Founder & Corporate advisor at Nedrelid Corporate Advisory, an independent advisory and consulting boutique focused on the car rental industry based in Geneva, Switzerland.

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