Shifting into fifth gear?

Growing at full throttle

When it comes to assessing the health of the car market, few companies are better placed than Hertz Global. The US car hire giant has seen the industry grow from its infancy. Founded in 1918, Hertz has listed on the stock market on three separate occasions and has spent time as a unit of both General Motors and Ford. As carmaking has sped through its series of boom-and-bust cycles, Hertz has been around to witness the moments of triumph and of torment.

And now Hertz will lend its vast experience to a booming new market: China. Late last month, it acquired a 20% stake in China Auto Rental (CAR). Under the pact, Hertz gets a seat on the board of China’s biggest car rental operator, while CAR gets a licence to operate on Hertz’s behalf for an initial term of five years at co-branded outlets.

Citing “reliable sources”, the Southern Metropolis Daily said Hertz is investing $300 million for its stake, valuing its partner at $1.5 billion. If true, it is paying a rich premium and one that other US investors balked at last year. Just 12 months ago CAR tried and failed to list in New York at a price that valued the company at about $1 billion. Perhaps it will try to IPO again in the future, hoping that its new strategic partner will help it complete the task.

But for Hertz, the move may be more about the long-term strategy of securing its position in China. “It’s a perfect fit,” explained Hertz’s chairman Mark Frissora in a post-deal statement, lauding CAR as the “largest and most recognised” car rental firm in China. Frissora also pointed to CAR’s 66-city footprint and 50,000-vehicle fleet as justification for the seemingly pricey punt.

CAR is growing fast. Founded in 2007, its listing prospectus revealed a rental fleet of 25,845 vehicles in 2011. After doubling its fleet since then, CAR still accounts for just 5% of the country’s fragmented car rental market, reports the Southern Metropolis Daily.

Any red lights on the dashboard for Hertz? Yes, CAR’s profitability has been poor. In the first three months of 2011, it made a net loss of Rmb118 million ($19 million) and was Rmb43 million in the red in 2010. The car rental market remains a “low-margin, asset-heavy” industry, CBN warns.

The road ahead might be brighter though. Most major cities have been imposing restrictions on the issuance of new licence plates in a bid to control congestion and improve air quality. If you can’t buy a car, the next best alternative might be to rent one. Meanwhile local tourism is picking up pace, meaning more fly-and-drive trips. Both factors helped CAR’s revenue to double in 2012 to $250 million. The company’s chairman Lu Zhenyao told 21CN Business Herald that CAR even made a “little profit” in 2012, and he expects to be in the black this year too.

The other thing Hertz shareholders should pay attention to is China’s used car market. Sales of new vehicles hit more than 19 million last year, again crowning China as the world’s biggest auto market. But less than 5 million used cars changed hands in 2012, i.e. not even a quarter of the first-hand market.

Sales of used cars, according to 21CN, could be “one of the biggest growth engines” for CAR. As it expands its fleet, CAR will need to sell older vehicles (typically it offloads a car after it has been driven for two and a half years). A healthy second-hand market makes that easier, allowing for sales at better prices. Hertz’s experience at fleet management could prove especially valuable here, says 21CN.

Another priority is to bulk up. CAR’s biggest domestic rival, the Shanghai-based eHi Auto, runs a fleet of about 10,000 cars – one-fifth that of CAR’s. Further support from Hertz – customers, finance and expertise – could allow CAR to grow faster, swallowing up more of its local competitors. Hertz’s own share price has climbed nearly 70% over the past year. If CAR continues on its current growth path, there could be more upside in its own stock in the coming years too.

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