Tags
Avis Budget Group, Car rental, Case Study, competition demystified, Emerging Moat, Hertz, rational pricing discipline, Whitney Tilson
In an interview with the Motley Fool, investor Whitney Tilson commented on the evolving car rental industry:
Brendan: You’re bullish on both Hertz (NYSE: HTZ) and on Avis (NASDAQ: CAR).
Whitney: Yes.
Brendan: You actually said the auto rental industry right now reminds you of railroads about 10 years ago. Could you expand on that?
Whitney: Yes. The auto rental industry in the United States has historically been a pretty terrible industry; cutthroat competition by a half dozen-plus competitors engaging in constant price wars. It’s a very capital-intensive business, generally bad balance sheets, low margins, low returns on equity — everything you would not like to see in an industry — that was the car rental industry.
But by the way, that was the railroad industry until about 10 years ago. What happened there was, there was consolidation. Some of the big players bought the smaller players, and it consolidated into more of an oligopoly, with just a few big players.
All of a sudden, competition started to become a lot more rational. They stopped cutting each other’s throats, and instead started collectively raising prices. Bill Miller, by the way, thinks this is what’s happening in the airline industry, and I think it’s what’s happening in the car rental industry.
More than 90% of the car rental industry today is in the hands of only three players; two public companies, Hertz and Avis, and Enterprise. Enterprise has about 70% of the off-airport market. Hertz and Avis are primarily the airport market in the U.S.
I see some of the same dynamics here. Industry consolidated from, say, eight players down to three. They’re all raising prices — and this isn’t theoretical — last quarter, Hertz and Avis both raised prices a little over 4% in North America, which is their biggest market.
When you consider the impact of a 4% price increase on low-margin businesses, it has tremendous benefits to the bottom line. I see the car rental industry following the same path as the railroad industry over the next 5-10 years.
Even this is a good example of “I missed it.” Both Hertz and Avis have doubled in the past year. I bought them at 52-week highs, after they’ve doubled, because I see another double or two in there over the next few years.
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We still think that the bulls like Tilson are too optimistic about rational pricing discipline taking hold in the industry. After all, as we stated in an earlier post, even OPEC could not maintain cooperation. We also think he is too confident that the railroad industry is the correct historical precedent. Nevertheless, this is an interesting issue.
Punch Card Investing 
Thanks, interesting article!
I think the big problem with the comparison of railroad with car rentals is, that the barriers to entry are much higher in the railroad industry as far as I know. That’s why I also fear, Tilson is too optimistic.
Yes, I agree with that. I talked about this a little bit in the first article. The barriers to entry are certainly much higher in the railroad industry. No one is building a new railroad in the US. It is impossible to imagine. Building a network of car rental agencies is certainly difficult and expensive but not impossible. I think the discount companies pose the biggest problem.
Interesting thesis, but my only quibble would be regarding capacity (you seem to have similar thinking) – for railroads it was constrained and regulated which meant pricing power could be sustained due to this newly limited supply. Doesnt seem like that for the car rental industry (or airplanes).
By the way, Buffett and Munger dismissed this thesis quickly at this years AGM (strange, given Tilson usually transcripts these things so should have heard it firsthand). In Short:
“Buffett: in some industries, you two competitors can compete with each other but can still stupid things
Munger: You couldn’t create another railroad. You could create another airline”
In theory, it should be even easier to create a rental car company – you dont even have to raise that much capital.
P.S. maybe a detailed look at the railroad industry would make for a good blog post?
Thanks
Hi, I quoted from this Buffett/Munger discussion in my original post which can be found here.
The railroad industry is fascinating and I will definitely write about it in the future. Thanks for the suggestion!
Could IBM and the integrated consulting IT sector be considered railroads? Few players and increasing pricing power due to the fact technology is becoming more complex and required to leverage to compete in today’s world. The economies of scale through IBM’s global distribution network looks very entrenched.
I actually worked at IBM, in a non-technical role, for 6 years. I think you are saying that, like the railroads, it takes an enormous investment to get to scale in the IT consulting sector. Rather than laying tracks or purchasing locomotives, a potential IBM competitor would have to make an enormous investment in R&D, IT infrastructure and assembled workforce in order to compete. Plus, IBM has an enormous horde of cash and seems to purchase every potential competitor while its still relatively small. So a competitor would have to fight that temptation as well. Interesting analogy. I would love to do a deeper dive on IBM at some point.