I'll say it again – investors need to be extra careful to avoid traps...
With both the S&P 500 Index and the tech-heavy Nasdaq Composite Index hitting all-time highs once again yesterday, I warned that investors have to be vigilant because "animal spirits" have returned to the markets.
As an example, I cited the foolishness surrounding the stock of near-bankrupt shoemaker Allbirds (BIRD), which soared 582% on Wednesday before crashing by 36% yesterday. (I expect the stock is ultimately on its way to penny-stock land, but I wouldn't be surprised to see more wild swings as it heads there.)
No sooner had I put Allbirds in my rearview mirror when car-rental company Avis Budget (CAR) hit my radar screen...
Take a look at this crazy 10-year stock chart:
Over the past month, the stock is up 358% – on no news. Even more oddly, as you can see in the chart, this isn't the first time that the stock has suddenly spiked in the past five years.
This is so weird – and there are so many lessons here – that it's worth a deeper dive...
Let's start by looking at Avis' fundamentals, which are terrible...
The car-rental business is highly cyclical and very capital intensive. It also suffers from ferocious competition among Avis, Hertz (HTZ), and privately held Enterprise.
Avis was barely profitable from 2012 through 2019, lost a lot of money in 2020, recovered strongly, but has gone back to losing money in the past two years. You can see what I mean in this chart:
The cash-flow statement tells a similarly dismal story...
Cash flow from operations, after a post-COVID spike in 2021 and 2022, has been declining steadily over the past three years.
Worse yet, Avis spends an average of more than $12 billion per year buying new cars for its fleet, while simultaneously selling roughly $7 billion of one-to-two-year-old cars. That has resulted in net capital expenditures ("capex") of about $5 billion annually over the past five years, which consumes more than 100% of operating cash flow.
The result is negative $1.2 billion of free cash flow ("FCF") over the past five years – and a mere $585 million over the past 20 years.
Here's the chart of cash from operations, capex, and FCF:
In light of such weak FCF, you might be surprised to learn that Avis recklessly spent about $5.7 billion buying back stock from 2021 through 2023. Take a look at the big spike:
All the buybacks reduced the shares outstanding by about 45%. You can see declining share count in this next chart:
However, the buybacks came at a high cost...
Avis' net debt – which was already extremely high – has skyrocketed even higher in recent years:
In summary, this is a bad business with a bad balance sheet, compounded by even worse capital allocation.
So you might think that the stock is cheap – or at least was cheap a month ago at around $100 per share before its latest silly run-up.
But no...
Analysts expect the company to earn $3.61 per share this year, meaning its price-to-earnings multiple was a rich 27.7 times at $100 per share. And now, based on yesterday's closing price of $448.98, it's trading at roughly 124 times earnings!
So... what explains this foolishness?
Part of the answer is the return of animal spirits due to the market ripping since its recent low on March 30.
But Avis' 358% in a month? That's due to some unique circumstances related to this particular stock...
For some insight, let's take a look at a spectacularly poorly timed short pitch of Avis that someone using the handle "scott265" posted on ValueInvestorsClub on March 30 (membership required), when the stock was at $143 per share intraday.
In the pitch, scott265 argued that Avis' run-up from $100 per share wasn't warranted by the tiny boost to Avis' business from a few travelers who, facing long delays at airports due to the partial government shutdown, switched to renting cars.
Based on the fundamentals, scott265 concluded that "I think [Avis] could be at $120 pretty quick and it's probably worth $50-70 over the medium term."
I agree.
But sometimes, the fundamentals don't matter. That's one of the (many) reasons why short selling is such a dangerous game – and why I think 99% of investors should never engage in it.
With Avis, scott265 missed some important factors...
First, at the time of the write-up, Avis only had a $5 billion market cap. But with about $28.1 billion of net debt, that gave the company an enterprise value of $33.1 billion.
Such high leverage usually results in a bad outcome for the equity – often bankruptcy. But it also means even a small positive change in investor sentiment will have an outsize effect on the stock price.
For example, let's say investors come to believe that Avis, instead of being worth $33.1 billion, is actually worth $40 billion. That's a 21% increase. But it results in a 138% increase in the stock price because debt remains the same at $28.1 billion, so the value of the shares rises from $5 billion to $11.9 billion.
In summary, stocks of highly leveraged companies can explode upward based on even a small improvement in investors' perceptions about the future – or based on technical factors.
I'm not saying to run out and buy the stocks of such companies, because the high debt often results in bankruptcy. But stocks can do a lot of crazy things before that happens...
One of my friends calls it the "rule of twos and threes" – meaning that every garbage stock, on the way to zero, doubles three times and triples twice along the way...
But what scott265 really missed was a key factor related to ownership of the stock...
Hedge fund SRS Investment Management, with more than $10 billion under management, has been an investor in Avis since 2010. It owns roughly half of the stock. And its manager, Karthik Sarma, sits on the company's board.
Another hedge fund, Pentwater Capital Management, loaded up on the stock earlier this year and owns another 22% of the shares...
Then add in roughly another 10% that are owned by passive/index investors...
Those percentages add up to about 82%, which would leave a float of about 6 million to 7 million shares. But the short interest is around 9 million to 10 million shares.
It would be hard to find a better setup for a short squeeze – and that appears to be exactly what's happening.
The "squeeze the shorts" game happens a lot in frothy, speculative markets...
When will it end? Who knows. I would guess that we're very close to the top and that Avis' stock will soon be back to around $100 per share.
But I wouldn't short this stock – or go long it – at these levels...
It's too dangerous in either direction because the shares could go to $100 (or $1,000) in a matter of days.
As I said, with animal spirits returning to the markets, you need to be extra careful out there!
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.