A Buying Opportunity in the Car Rental Industry

Market overreactions create great buying opportunities, and the latest victim is a hedge fund favorite.

Jun 18, 2014 at 1:13PM

Hertz Global Holdings (NYSE:HTZ) is the leading car rental company in the U.S. But shares are down 12% over the last week. Accounting problems have pressured the stock and may potentially delay the spinoff of its equipment business.

The accounting issues
Hertz recently announced that there is at least one material weakness within the company's internal controls for financial reporting. Financial statements all the way back to 2011 might need an adjustment. The costs relating to these accounting issues are expected to pull fiscal first-quarter earnings below consensus estimates. 

But there's also speculation that Hertz could be looking to replace its CEO. That could be a consolation prize for investors, and shares were up slightly on the news. Despite its issues, Hertz is still one of the most loved stocks by hedge funds--at the end of the first quarter, there were 33 hedge funds with Hertz as one of their top 10 stocks.

The industry has gotten a lot smaller
The industry has consolidated a lot over the years, which should help with pricing and margins going forward. For instance, Hertz bought up Dollar Thrifty Automotive for $2.3 billion last year. The three major car-rental players make up a large part of the market share, including Enterprise Holdings, Hertz, and Avis Budget Group (NASDAQ:CAR).

After losing the bidding war over Dollar Thrifty, Avis went out and bought up car-sharing company Zipcar. The business failed to live up to the hype, and Avis was able to buy up Zipcar at a 30% discount to its IPO price. But Avis' move did not put it at the forefront of the hourly rental market.

Getting out of the equipment business
Hertz is looking to exit the equipment-rental business. Hertz's equipment business makes up less than 15% of total revenue. Big name hedge funds got active in the company in an effort to push for a spinoff. It plans to complete the spinoff of its equipment-rental business some time next year. The move will give the company net proceeds of $2.5 billion.

It plans to spend upward of $1 billion of that on share buybacks. The big advantage for the spinoff is that the company can focus solely on growing its car rental business. Hertz CEO, Mark Frissora, said that there's the potential for multiple expansion after the spinoff.

Meanwhile, the Hertz spinoff will be left to compete with the likes of United Rentals (NYSE:URI), the world's largest rental company. United Rentals has exposure to the construction industry, which is starting to pick up. It owns 13% of the rental market for construction equipment.

United Rentals is also working on expanding its rental services. Its acquisitions of National Pump and the HVAC unit of Blue-Steam give it a presence in the pump-rental sector and the air/heat equipment market.

How shares stack up
Hertz already trades at one of the cheapest valuations in the industry. It trades at a P/E ratio of 11.6 based on next year's earnings estimates. Avis trades at a forward P/E of 12.9, while United Rentals is at 15.9.

But shares of Hertz are down 8% year to date; meanwhile, United Rental and Avis are both up more than 35% over the same period. Hertz has an operating margin of 14%, while Avis' is only 11.1%. In addition, Hertz's return on equity is 28.6% versus Avis' 9%.

Bottom line
The car rental business should accelerate on the back of a rebounding economy. The other big benefit to the industry will be margin expansion, where the remaining companies have pricing power. For investors looking for a niche play on the auto industry, Hertz is worth a closer look.

Warren Buffett's worst auto-nightmare (Hint: It's not Tesla)
A major technological shift is happening in the automotive industry. Most people are skeptical about its impact. Warren Buffett isn't one of them. He recently called it a "real threat" to one of his favorite businesses. An executive at Ford called the technology "fantastic." The beauty for investors is that there is an easy way to invest in this megatrend. Click here to access our exclusive report on this stock.


Editor's note: A previous version of this article stated that Hertz, rather than United Rentals, had acquired National Pump and the HVAC unit of Blue-Steam. The Fool regrets the error.

Marshall Hargrave 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers