What Does Hertz' Overcapacity Say About the Auto Market?

What Does Hertz' Overcapacity Say About the Auto Market?

The fact that the US auto market is gathering strength is by now well-established. Recent sales figures demonstrate this trend. There are also other signs, if perhaps less direct, that people are buying more cars. Hertz recently announced that it would be selling off a larger part of its fleet than usual due to weak rental demand, on the one hand, and solid retail demand, on the other.

Reducing overcapacity
Americans seem to be renting fewer cars, at least over the last few months. As a result of weaker-than-expected demand at airports, especially in July and August, Hertz announced that it will gradually start reducing its fleet. According to management, the company will be offloading these vehicles to retail consumers directly over the next six months.

CEO Mark Frissora stated that the weak rental demand was due to government cutbacks, soft consumer confidence and a lower amount of business travel . On the road itself, the company is currently moving its base of operations to Florida where it plans to build a new $68 million headquarters .

The news comes on the back of a lowered outlook last month which sent the stock plunging 16%. The company previously expected full-year earnings per share between $1.78 and $1.88 and now expects to make $1.68 to $1.78. While volume was down quite significantly, higher prices in the rental industry should allow the company to still deliver record earnings for the year .

Interestingly, this overcapacity seems company-specific. Avis Budget CFO David Wyshner announced that the over-fleeting was largely Hertz' problem and not something Avis was suffering from. The company will be adhering to its regular fleet-reduction schedule, and overall demand was seen fitting well with fleet capacity .

Retail market thriving
Theoretically, it could be argued that weakness in rental demand is a consequence of strong retail sales. With more people buying cars, there may be less need for people to rent cars. Yet, correlation is not causation and there are other factors in play here. Most importantly, rental cars, especially those at airports, often have a different function from the cars that consumers own. Rental car companies often cater to business travelers. What we can say with relative certainty is that Hertz is confident it will be able to sell these cars.

In any case, US auto makers are thriving with August sales at six-year highs. GM , while having recorded a somewhat disappointing September sales report, has been on a tear for most of the year. In August the company reported sales up 15% while its Q2 global market share improved 3.2% year-over-year to 11.4%. Still heavily reliant on the US, the firm gets some 62% of its revenue from the North American market .

Ford , for its part, has been closing the sales gap with GM. Ford now trails GM by a mere 25,000 vehicles a month. In fact, Ford nearly beat GM in terms of sales in September and the F-series of pick-ups drove much of the gains. Additionally, the company recently set a new sales record in Canada, outselling all of the competition. Canada sales surged 10% in September, with the new Fiesta proving especially popular.

Hertz' own retail operations seem to be doing fine as well. Through September 26, 2013, the company's used vehicle sales were up 39% compared to last year. Additionally, the company plans to expand its retail operations significantly. It will go from 40 lots to around 140 by 2014 . Despite the weaker-than-expected results from its rental division, Hertz' willingness to adapt to a changing market is encouraging.

Fundamentals and metrics
The news is certainly no reason to dump rental stocks just yet, although Hertz' recently lowered outlook is somewhat worrying. Hertz is also a bit pricey. Of the two main car rental stocks, Hertz is more expensive by far with a P/E of 29.60 times trailing earnings versus Avis Budget's 20.82. The price-to-sales ratio paints the same picture with Hertz trading at 0.92 and Avis at 0.42. On the other hand, Hertz' quarterly revenue growth of 22% is considerably higher, which might explain the premium. In any case, Hertz is not an inexpensive stock at the moment. It trades at a premium to the industry as well as the broader market.

The bottom line
Weaker-than-expected demand for its rental cars has led Hertz to unload more of its fleet than usual. This tells us that rental demand isn't too strong, but it also tells us that retail demand is picking up. Americans are buying cars again, which may be a factor in lower rental volume. In any case, Hertz seems to be willing to adapt to shifting market conditions and its retail division is still performing well. The stock does seem a bit pricey at the moment, though. Investors may be best off waiting for a pullback.

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The article What Does Hertz' Overcapacity Say About the Auto Market? originally appeared on Fool.com.

Daniel James has no position in any stocks mentioned. The Motley Fool recommends General Motors. 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.

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Originally published