While one or two trading halts often make the news, halting over 10 times indicates the volatility that is vastly beyond any normal levels. That sort of price action happened with Avis Budget Group, Inc. (NASDAQ: CAR), as the perfect storm took the stock over 100% up within a single day. This article will explain 3 factors that cause such moves and reflect on the company's current state, especially regarding its debt.
Third-quarter 2021 results:
- Revenue: US$3.00b (up 96% from 3Q 2020).
- Net income: US$675.0m (up US$630.0m from 3Q 2020).
- Profit margin: 23% (up from 2.9% in 3Q 2020).
Over the last 3 years, on average, earnings per share have fallen by 28% per year, but its share price has increased by 130% per year, which means it is well ahead of earnings.
3 Factors that Create the Short Squeeze
- High short interest: For the squeeze to occur, there has to be a significant number of short-sellers who would be forced to buy back their positions. CAR had a high short percent of the float (over 20%), and it would take almost 7 days to cover the average daily trading volume.
- High option speculator interest: Highly shorted stocks often attract the short-term speculators who buy out-of-the-money (OTM) call options, often before the earnings. This, in turn, causes the market makers (option sellers) to hedge their positions by buying shares on the market, pushing the price higher.
- Positive catalyst: Usually in the form of positive development – internally or externally. In terms of Avis Budget Group, it was in the form of positive earnings and an announcement about adding electric cars to its fleet – potentially suggesting partnerships similar to Hertz's recent news about Tesla.
Yesterday's developments caused downgrades and price target adjustments across the board as J.P. Morgan sees the stock as underweight with a price target of US$225, while Deutsche Bank has it as a sell with a price target of US$210.
Why Does Debt Bring Risk?
Debt assists a business until it has trouble paying it off, either with new capital or free cash flow. In the worst-case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it usually represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Avis Budget Group Carry?
The image below, which you can click on for greater detail, shows that in June 2021, Avis Budget Group had a debt of US$14.8b, up from US$12.6b in one year. On the flip side, it has US$1.32b in cash leading to net debt of about US$13.4b.
A Look At Avis Budget Group's Liabilities
We can see from the most recent balance sheet that Avis Budget Group had liabilities of US$2.47b falling due within a year and liabilities of US$19.5b due beyond that. Offsetting these obligations, it had cash of US$1.32b as well as receivables valued at US$1.06b due within 12 months. So its liabilities total US$19.5b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the US$11.4b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. Avis Budget Group would probably need a significant re-capitalization if its creditors were to demand repayment.
To size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt and the interest rates paid on it.
Avis Budget Group has a relatively high debt to EBITDA ratio of 6.5, suggesting a meaningful debt load. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. However, the silver lining was that Avis Budget Group achieved a positive EBIT of US$1.9b in the last twelve months, an improvement on the prior year's loss.
The balance sheet is the area to focus on when you are analyzing debt. But it is future earnings, more than anything, that will determine Avis Budget Group's ability to maintain a healthy balance sheet from now on. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Looking at the most recent year, Avis Budget Group recorded a free cash flow of 40% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more challenging to handle indebtedness.
Despite the incredible squeeze that doubled the market cap overnight, there are no significant fundamental changes. The company is likely at the height of the favorable short-term tailwind. The car industry's supply and logistical pressures have caused a spike driving the profit margins up, but this is hardly sustainable. In the long-term, we can expect them to revert to historical averages.
Avis Budget Group's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Overall, it seems to us that Avis Budget Group's balance sheet is quite a risk to the business.
However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Avis Budget Group you should be aware of, and 2 of them make us uncomfortable.
When all is said and done, sometimes it's easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.