The Booming Car Rental Industry

Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The rental car industry was hit particularly hard by the recession. As people delayed vacations and generally traveled less, revenues dropped and stock prices plummeted. Since the car rental companies typically carry a lot of debt, their bankruptcy seemed like a real possibility. But as the economy has recovered car rental companies have returned to prosperity. My favorite of the bunch, Hertz Global (NYSE: HTZ), has seen its stock price more than double from its 52-week low, and its acquisition of competitor Dollar Thrifty now makes it the world's largest airport general use car rental company. Is Hertz still a buy after the huge surge in its stock price?

A diversified company

In addition to its car rental business Hertz also runs an equipment rental business, which generated $1.4 billion of revenue in 2012. This is small compared to the $7.6 billion of revenue that the car rental business brought in, but the North American equipment rental revenue grew by 19% in fiscal 2012 and should see strong growth going forward.

The rental car business has two main components: airport and off-airport. Airport revenue was $4.4 billion, compared to off-airport revenue of $2.7 billion in 2012. While the airport business is fairly mature, the off-airport business offers substantial growth opportunities. The total market size is estimated at $11 billion, meaning that Hertz has plenty of market share left to capture. Since 2007 Hertz has increased the number of off-airport locations by 60% to 2,523 locations and is targeting at least 300 new locations annually. Off-airport locations are less expensive to operate than airport locations, with lower labor costs and longer rental times driving higher margins.

While the Hertz brand is considered a premium brand, the acquisition of Dollar Thrifty has given Hertz a mid-tier brand to effectively compete against privately held Enterprise. This fills a big gap in Hertz's portfolio of offerings.

Confident guidance

At the recent Hertz investor day the company unveiled its guidance for 2013 as well as its 3-year plan. The company expects revenue to grow by 20.9% in 2013, with adjusted EPS reaching $1.87 from $1.33 in 2012. Along with this guidance the company stated 2015 estimates, shown in the graphic below.

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Source: Investor day presentation (PDF)

The company expects revenue to grow between 12.5% and 13.5% annually over the next 3 years and EPS to be between $3.10 and $3.30 in 2015. With a stock price around $23 per share this puts the P/E ratio based on these 2015 numbers right around 7. Whether or not this guidance turns out to be accurate remains to be seen, but the significant growth in 2012 is a good indication that the company is taking the right steps.

The competition

The only big publicly traded competitor remaining in the rental car business is Avis (NASDAQ: CAR). Avis saw revenue growth of 24.6% to $7.36 billion in 2012, while EPS came in at $2.42. This puts the current P/E ratio at about 11. Avis, like Hertz, has seen its stock price soar over the past year as profitability returned. Earlier this year Avis acquired Zipcar, the car sharing company, for $500 million. Zipcar was unprofitable before the acquisition, so it seems the purpose was to simply accelerate entry into the car sharing market. Hertz has its own service, Hertz On Demand, but its only in a handful of locations at this time. While Zipcar had the early lead it has no real competitive advantage, so I expect the Hertz On Demand service to be successful as it grows to more and more cities. The big reason I like Hertz more than Avis is the equipment rental business. It's an extremely fragmented industry so it's fairly easy for Hertz to make various small acquisitions throughout the year. This provides an additional way for Hertz to grow its revenue.

The bottom line

I own shares of Hertz, which I bought on a few occasions last year for an average price of $12.76. The stock has almost doubled from that point, which of course I'm very happy about, but it still has incredible potential. If the company's guidance turns out to be close to accurate then the company will be worth a lot more than it is today in a few years. There are two avenues of growth, rental cars and equipment rental, which makes the company more attractive to me than Avis. Both will probably turn out to be good investments, but Hertz has a lot more potential.

Timothy Green has a position in Hertz Global Holdings. The Motley Fool owns shares of Hertz Global Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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