| The Penny Sleuth Features: Penny Stocks, Options and High-Growth Opportunities! |  |      | Editor’s Note: Strategic Short Report’s Dan Amoss is here today to fill you in on the next sector that’s going to crash. Dan’s readers have made as much as $200,000 on some of his past predictions — and right now you can get FREE access to his research for a full month.
Make 50% By Selling These Junk Stocks Short
By Dan Amoss
November 4, 2009
Don’t be fooled into thinking that the stock market is out of the woods yet. “Junk stocks” are setting themselves up for a colossal fall in the coming months — and it’s going to make some investors incredibly rich. Here’s how you play one doomed industry for gains…
“Junk stocks” have dramatically outperformed the broad market since the bottom in March. There’s a reason that junk stocks — stocks in which total debt is three, four, or five times the value of equity — have rallied so sharply.
Written off as imminent bankruptcy risks, the market left these types of stocks for dead, assuming that equity value would be wiped out in any balance sheet restructuring scenario. But the credit markets have thawed enough to allow most of these stocks to hang on a little longer, in exchange for refinancing debt at much higher interest rates.
These temporary reprieves from bankruptcy court merited perhaps 100% or even 200% rallies in these stocks. But in the market’s frenzy to assume risk, it has bid up some junk stocks anywhere from 500% to 2,000% from the March lows!
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Car rental stocks are classic junk stocks — especially in protracted periods of depressed consumer and business travel. These companies operate with massive debt loads in a brutally competitive, commodity business. They’ve all been cutting employee head count and car fleets at incredible rates in order to stem losses. Yet even in good times, competition is so fierce that car rental companies tend not to return capital to shareholders via dividends (unless they are debt-funded dividends paid to private equity owners — as in the case of Hertz prior to its IPO). These companies also tend to repurchase stock only at peak prices, which destroys per share value.
It’s All About Fleet Management
Over the past few years, car rental companies have transitioned away from having mostly “program cars” in their fleets. Program cars are a convenient way for the likes of GM and Chrysler to sell heavy car volumes in a pinch, but these carmakers must sign agreements to repurchase the sold cars or guarantee a rate of depreciation during a specified period of time. Due to recent financial turmoil of both parties in this arrangement, this doesn’t make as much sense as it used to.
Now the car rental companies are adding mostly “risk cars” to their fleet.
These cars are bought without the security of repurchase agreements, so they will be sold into an uncertain future used car market. This gives car rental companies more control over the length of time they own the vehicles, but it’s transforming their balance sheets into speculations on the health of the used car market. If used car market values soften, then the car rental companies have to either accelerate their depreciation expenses or risk taking capital losses upon disposal. Used car prices have temporarily spiked since April, as demand exceeded temporarily tight supplies.
There are many reasons for this temporary spike in wholesale prices of used cars, but a big one has to do with the fact that “cash for clunkers” needlessly destroyed an estimated 700,000 vehicles that otherwise would have flowed into the supply of used cars. This spike is likely sowing the seeds for a bigger decline in the future values, because it squeezed dealer profit margins to the point that it’s brought financial stress to a huge swathe of regular buyers: small “mom and pop” used car dealers.
Fleet management has a huge impact on earnings, because most car rental companies turn their entire fleets over every 18 or 24 months. This makes the visibility of free cash flow for these highly levered businesses very uncertain.
Nevertheless, like moths to a flame, value investors fly to these stocks after getting burned over and over. They hope that one day these companies will deliver attractive returns in a utopian scenario in which cash flow doesn’t have to be reinvested into the fleet and customers will not flee to lower-priced competitors.
In the real world, we can see from history, car rental companies must constantly reinvest most of the cash flow into refreshing their fleets, servicing debts, and posting collateral for off-balance sheet fleet financing. Also, we know that the Internet prompts more and more consumers to shop for the best possible deal. The Federal Reserve board may appreciate a “welcome” rise in prices for car rentals, but consumers certainly do not; they’ll shop for alternatives in this commodity business if faced with higher prices.
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Lower Volumes, Competition, and Debts Are a Recipe for Disaster
All of the car rental stocks were left for dead in early 2009, because it was doubtful whether they could renew the billions in financing commitments for their gargantuan fleets. The car rental business, in my view, is a dinosaur left over from the era of cheap credit and steadily growing business and leisure travel. In the future, we can expect to see an overlevered, capital-intensive set of competitors battling it out for scarce business. This may be good for consumers, but it’s terrible for owners of car rental stocks.
The biggest driver of car rental stock prices during this rally has not been a revival in sales, but rather the hope that because the industry is shedding capacity at a fast rate, pricing power will return. I have my doubts, because once the most-anticipated “V-shaped” economic recovery in history fails to live up to expectations, many rental companies will resort to price cutting to generate cash for newly tightfisted creditors.
Shareholders of these companies are thus left with the claims of the skimpy, infrequent free cash flow that’s left over after the following senior claimants are satisfied: employees, landlords, suppliers of car parts, advertising, insurance, lenders who finance their fleets, and the tax man.
It’s time to bet against these “junkers” and collect serious gains in the process. I’ve already alerted my Strategic Short Report subscribers to what I think is the best way to play these soon-to-fall rental companies (Penny Sleuth readers can get access to my research free for an entire month by clicking here), but it’s not too late for you to position yourself too.
With more than a half dozen car rental stocks out there, your options are far from limited.
Regards,
Dan Amoss
P.S.: If you want to profit from dishonest, unprofitable, and overleveraged companies, you need to subscribe to my Strategic Short Report immediately. My readers have made hundreds of thousands of dollars by better against other “junk stocks” and right now you can get full access to my exclusive research at no cost. Click here for the full details…
Editor’s Endnote: Don’t forget to send all of your comments and suggestions for the Penny Sleuth to editor@pennysleuth.com.
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