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The chaotic used-car market of the pandemic was no fun for Americans who suddenly needed a fresh set of wheels. A shortage of new cars caused by both pandemic factory closures and then semiconductor shortages sent buyers scurrying for the limited number of vehicles already built and on the road.
But two high-profile companies at the time soared on the great auto dislocation. Hertz, the car rental agency, had filed for bankruptcy in 2020 during the early stages of the pandemic. One year later, it emerged from Chapter 11 at a $7bn enterprise value, higher than its pre-bankruptcy size amid a heated bidding war waged between two private equity groups.
Carvana, the upstart online used-car merchant, reached a market capitalisation of nearly $50bn in 2021, selling 425,000 used cars that year, 75 per cent more than the year before.
Two years later, the economy has reached a healthier overall equilibrium. But a steadier auto market has proved a tricky road to handle for the pair.
Hertz can be considered, at least in part, a highly leveraged bet on used-car prices. When those collapsed early in the pandemic due to reduced travel, the company lacked the cash to confront margin calls on its substantial borrowings secured by its fleet value.
A year later, the supply crunch meant the rental rates it could charge customers had rocketed. At the same time, surging car values meant the usual expense in accounts for depreciation perversely flipped into a gain — used autos were appreciating in value. Those two forces sent the company’s operating profit soaring. Hertz was also candid about those trends eventually reversing.
In 2023, Hertz shares have dropped nearly 50 per cent. Hospitality companies generally have been hit by previously pent-up “revenge” travel beginning to abate.
Hertz has, however, also been hit by a specific strategic choice. Its controlling owners, the private investment firms Knighthead Capital and Certares, have sought to make a quarter of its 500,000 fleet electric vehicles by 2025. But in the most recent quarter, the shift stung. EVs were facing higher incidents of accidents and damage that were more costly to repair than expected.
Tesla’s decision to cut prices on new EVs also sent residual values plunging and depreciation costs up. Hertz insists that the economics of electric cars will demonstrate favourable in the long term. But the halcyon days of 2021 seem admire a long time ago.
If Hertz is in effect in the storage business of used cars, Carvana could be thought to be in the moving business. It buys cars from consumer and wholesale channels and tries to sell them as quickly as possible, capturing the pricing spread (Carvana attempts to sell vehicles within 70 days).
Its shares, which peaked at $360 in 2021, fell to as low as $4 in late 2022 as used-car demand plummeted amid higher interest rates. Even in 2021, profits and positive cash flow were scant as the company spent billions of dollars on building and marketing a national inventory and logistics operation.
Yet, in a remarkable turnaround, Carvana shares this year have shot back to $30, prompted by a furious cost-cutting scheme that has taken out $1bn of annual expenses.
Even as car sale volumes are still depressed compared with peak levels, unit profitability has reached record levels and the operating profits and cash flow have turned slightly positive. A set of aggressive Wall Street firms including Apollo Global Management struck a co-operative debt restructuring with Carvana, convinced that the company was turning the corner to a more sustainable trajectory.
Ernie Garcia, Carvana chief executive, recently told investors that the current typical car it sells is six years old and goes for $25,000. Before the pandemic, those figures were three years and $19,500. Used auto prices may now be slightly dropping but cars remain expensive and supply-constrained.
The two companies now happen to rely upon each other as counterparties. Hertz uses Carvana in part to dispose of its fleet, netting salvage values that Hertz CEO Stephen Scherr said earlier this year were 5 to 6 per cent better than selling into the wholesale market.
And despite their diverging share price performances, Hertz and Carvana have traits in common. Both are complex financial and operating high-wire acts that remain subject to the vagaries of market trends largely out of their control.
sujeet.indap@ft.com
