Is Rental Service a Good Business?

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

Recently, the rental business has been delivering considerable upside, mainly due to higher U.S. pricing and a recovering economy. Leading companies in this sector now deserve more attention from investors; in this article we will look into two car rental and one equipment rental enterprises that dominate within their industries. These are Hertz Global Holdings (NYSE: HTZ), Avis Budget Group (NASDAQ: CAR) and United Rentals (NYSE: URI).

According to the American Rental Association, the forecasted growth rate for the equipment rental industry is over four times the expected 2013 GDP growth in the U.S. and something similar is projected for the car rentals. Although they target different demographics and benefit from diverse aspects of the economic recuperation -the growth in discretionary spending power and world travel or the recoup in the construction business-, their recent success and growth prospects (all above 10% per year for the next five years to come) justify a succinct analysis in order to elucidate if they compose worthy investments.

Avis Budget Group: A company with clear goals  

Last fiscal quarter, Avis reported a 4% increase in revenue, to $1.7 billion, mainly on the back of volume gains and higher prices. The company hopes to preserve this pricing power for the quarters to come. On the other hand, a GAAP net loss of $46 million was caused by higher fleet costs in North America. So, although consensus estimates expect a 30.17% per annum growth over the next five years, one should look into the company with more patience in order to determine if it’s a worthy investment or not.

Avis has been focusing its efforts in reducing the aforementioned losses through cost cutting initiatives. Its Performance Excellence initiative and a five-point cost reduction and efficiency improvement plan are expected to provide incremental savings of over $50 million in 2013, matching 2012’s achieved figure.

The company offers compelling prospects for the long term not only for its cost reduction initiatives, but also for its aggressive expansion plans that comprise joint ventures and acquisitions, including the recent purchase of ZipCar. These will continue to extend the firm's global presence and, consequently, its revenues. Further improvements, especially in the virtual car rental area, should also boost its top-line growth in the years to come.

However, the rising fleet costs, its high dependency on third party distributors and the risks associated with operating overseas remain as serious concerns that investors should keep in mind.

Having said this, I would still recommend buying and holding this stock that trades at 15.1 times P/E, well below the 30.9 industry mean, since it offers a great entry point and compelling prospects for long-term shareholders.

Hertz Global Holdings: Battling for pole position 

After posting a strong first fiscal quarter and almost doubling its stock price since last November, I’d say that Hertz deserves a look. Last quarter, worldwide revenues rose by 24.3% year-over-year, to $2.4 billion, and adjusted diluted earnings, 320%, to $0.21 per share. Withconsensus estimates expecting a 28.93% annual growth rate for this firm over the next five years, projections beat the industry average by 28% and position Hertz as as an interesting investment opportunity for long-term shareholders.

The company is now battling with Avis for the front-runner spot in the car rental industry and looks poised to success after the FTC approval for its purchase of Dollar Thrifty. This acquisition has been exceeding the management´s targets on integration and synergies , helping drive the growth in revenues. Also, both companies could benefit from a considerably reduced competitiveness in the industry since Avis bought ZipCar.

Furthermore, the Dollar Thrifty deal should help Hertz reduce its dependence on airport rentals that provide lower margins than the leisure car rental market, which is Dollar Thrifty’s main target. Early results look encouraging, as U.S. off-airport revenues rose by 13.5%, year over year, last quarter. Despite having had to give up some other assets, after the merger, Hertz counts with over 10,000 locations across 150 countries.

Moreover, airport travel is currently experiencing an uptrend; traffic is expected to rise by 3.5% over 2013 and by an additional 4.9% in 2014. Just like Avis, Hertz should benefit from higher rental demand, especially as it leads in airport presence, where it also holds considerable pricing power.

Another reason to feel positive about this company is its substantial capex reduction expected for 2013. Last year, the firm spent $2.2 billion on the Dollar Thrifty acquisition, boosting total capex to over $3 billion. This year, capital expenditures are projected in the $700 million range. Additionally, expenses should also be smaller, mainly on the back of improving utilization rates -meaning that cars spend less time unrented- will decrease future fleet growth requirements.

Trading above industry average valuations, at 37 times its earnings, but offering compelling long-term growth prospects, I’d recommend buying this stock for your portfolio.

United Rentals: A company that targets new sectors  

Last quarter, United Rentals, the world’s largest equipment leasing and rentals company, surpassed earnings consensus estimates again, for a sixth consecutive quarter. Revenue rose by 68% to $1.1 billion and EPS, by 12%, to $0.19. This growth is expected to continue as the firm targets sectors that are currently recovering, namely the industrial, construction, manufacturing and utility homeowner segment, alongside government entities; also, customers are increasingly tending to rent equipment over buying it.

The company has attracted the attention of several funds recognized by their returns on investments, like the Vanguard, Fidelity and BlackRock funds. I, like them, would recommend buying this stock, even despite its valuation of 69 times P/E rate (don’t worry, forward P/E is only 9.3 times ), principally based on its long-term growth potential, expected at over 20%, about 25% above the industry average.

The acquisition of RSC Holdings last year further expanded the firm’s presence in North America and substantially increased synergies, reducing costs and helping drive revenue growth over the last couple quarters. The purchase also allowed the company to add higher margin clients to its base; this has resulted in consistently increasing EBIDTA margins that are expected to top 46% this year.

Furthermore, last quarter, the company generated and extra $123 million in revenue from used equipment sales at a gross margin of 43.9%. The same period last year had registered $125 million of proceeds at a gross margin of 39.2%. This was a good start for what the management believes to be a pivotal year. In the last conference call, CEO, Michael Kneeland, portrayed an encouraging outlook for 2013. He assured that as United Rentals´end markets recover, opportunities to gain ground with key accounts of all types and specialty rentals abound. In order to capitalize on over $1 billion of net fleet purchases, it plans to expand its sales force by at least 10% before 2014 while continuing “to drive cost efficiencies and further lower (...) debt leverage.”

Its significant debt balance and weak liquidity position remain as concerns for shareholders. Nevertheless, if EPS and revenue keep surpassing estimates and if the momentum expected later this year actually comes through, I forecast strong upside for investors, even despite the elevated stock price. Consider buying; the profit potential is much as the construction market recovers.

Bottom line

Based on valuation and growth prospects my choice of investment would be Avis. Although Hertz and United Rentals are expected to deliver higher EPS growth rates over the upcoming years, Avis also is a dominant player in the segment while its stock trades at considerable discount to its peers. Entry points are open, make the best of them by purchasing this stock.

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Victor Selva has no position in any stocks mentioned. 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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