Uncertainty grips rental-car agencies

Rental-car companies, the industry's largest buyers and sellers of light vehicles, face a slew of challenges that threaten their earnings in the short term and their business model in the long term.

Like automakers, the rental industry has a business model that's been largely static for decades. It's ripe for disruption from the likes of ride-hailing services such as Uber and Lyft and from a potential future in which autonomous vehicle fleets could make the very idea of renting a vehicle to drive obsolete, analysts say.

As the rental companies begin to grapple with their futures, they must also deal with more immediate challenges. Namely, they must find a way to get more crossovers and SUVs into their fleets to meet shifting consumer demand. And it's a problem that could be difficult to address, according to analysts, because automakers, many of which are already cutting back on fleet sales, could be inclined to steer those vehicles toward more profitable retail channels.

For the publicly traded Hertz and Avis, that could spell bad news for earnings, which have been pummeled in recent quarters as they attempt to adjust their fleets, and for their share prices on Wall Street, which stand at a fraction of what they were just a few years ago.

While the rental companies are often looked down upon as places for automakers to dump vehicles unwanted in the marketplace, the fact remains they are easily the biggest players in the new- and used-vehicle markets, accounting for millions of sales each year. Last year, the seven largest automakers sold nearly 2.8 million vehicles to rental companies in the U.S. alone, according to the Automotive News Data Center.

How the rental companies, including the privately held Enterprise Holdings, address these challenges in the coming months and years will go a long way toward determining their roles in a future poised to transform the automotive industry, according to analysts.

"Over the past few years, most of these companies have put too much emphasis on the thought that things will keep going the way they've been going. That needs to change," said Arun Kumar, a director at ​ AlixPartners.

Following six months of sales declines, most analysts and industry observers expect to see annual industry sales dip this year for the first time since the depths of the Great Recession, though 2017 will likely still go down as one of the strongest sales years on record.

It is a decline driven in part by automakers cutting back on fleet sales following years of growth.

Mixing it up

The major rental-car companies have their work cut out as they try to get more crossovers and light trucks into their fleets to meet shifting consumer demand. That's partly because automakers could be inclined to steer those vehicles toward more profitable retail channels. Here's how the retail mix of various segments compared with their fleet mix in 2016.

For many automakers, moving away from lower-profit fleet sales means creating a mix that is more profitable and less inflated. General Motors, for instance, again pinned its year-over-year sales decline in June on a shift away from fleet sales, which were down 54 percent from June 2016.

Hyundai-Kia has followed a similar path, as it saw its June sales decline 19 percent year-over-year despite a 1 percent gain in retail sales. Fiat Chrysler, Ford and Honda are among the other major automakers to largely shun fleet sales.

Nissan and Toyota are proving to be the two largest exceptions to the rule this year. Toyota said this year it would rely on sales to rental companies and other fleet sources in an effort to boost sales in a market that has hit sedans such as its best-selling Camry hard.

Nissan, meanwhile, has shown no signs of backing off of its aggressive push into fleet sales. The automaker, in its quest to attain 10 percent U.S. market share, boosted its sales to the rental market by 37 percent in 2016, according to Bobit Business Media.

Nissan North America Chairman Jose Munoz told Automotive News this year the company has no plans to change course.

"It's part of the business," Munoz said. "The dollars we get are relevant, so we're going to continue to be there, even if other companies don't want to."

Having just one or two major players selling into the rental market at a given time could leave rental companies exposed to risks, said Eric Lyman, chief industry analyst at ALG.

"Let's say you stocked your portfolio with a bunch of vehicles from Automaker X and they have some sort of public relations crisis or a massive recall," Lyman said. "There's damage to that automakers' value, and that would impact your portfolio significantly.

"On the flip side, you could have a brand on the upswing, like Kia or Hyundai that when the Hyundai Sonata was overhauled in 2010 along with the Kia Optima, they did a lot better than their predecessors."

Either way, the impact typically proves to be short-lived, Lyman said. Damages to a brand's public perception tend to heal rather quickly in the court of public opinion, while retail success with a new vehicle can make an automaker less likely to sell it in large quantities to rental companies.

Kurt Kohler, Enterprise senior vice president of fleet acquisition and remarketing, said the company works with its regional offices to get high-volume models into markets where they might be in higher demand.

Kohler said Enterprise purchases vehicles with different trim levels so as to not oversaturate either its fleet or the wholesale market with thousands of virtually identical vehicles. "We're both concerned with how it will proceed and how it will be sold back into the marketplace," he said.

More crossovers

Making sure vehicles retain as much value as possible in the used-vehicle market has become more complicated after the recent dip in used-vehicle values.

The Black Book Wholesale Used Vehicle Retention Index, one of several seasonally adjusted indexes that measure the strength of used-vehicle pricing, stood at 113 points in June, down 12 percent from a record 128.1 points in 2014.

Used prices have dipped as a glut of off-lease vehicles begins to return to market and as new-vehicle incentives have pushed prices downward. The result is a market that is less friendly to rental companies looking to push vehicles back into the market through auctions.

That was a problem made even worse for Hertz, which has reported weak earnings in recent quarters as it has sold off its economy cars into a market that prefers light trucks.

"We are focused on getting the fleet right," Kathryn Marinello, Hertz Global Holdings CEO, said during a conference call in May. "We are bringing in higher-quality, prestige full-size vehicles that are what our customers want to rent."

Hertz and Avis Rent A Car did not respond to requests for comment.

ALG's Lyman said the shift toward crossovers and SUVs can "be a challenge" for the rental companies for several reasons, including higher costs and weak demand for cars even in the used-car space.

"Understanding those shifts in retail demand is something we're sort of in the throes in right now," Lyman said. "On the consumer lease side, we're still in the process of remarketing vehicles that are aligned with consumer taste from three years ago."

"On the rental-car side, it's a shorter window of about a year, but we've still seen consumer taste shift even in that time frame. So that's why you're seeing some of that realignment in the model mix."

AlixPartners' Kumar said it could be tough for Hertz and Avis to get the right mix of crossovers in their fleets. Because crossovers are in such high demand in the retail market, it would be tough for most automakers to justify selling them to rental companies since there is more money to be made on the retail side, he said.

"If I'm an automaker, I'm protecting my CUVs," Kumar said. "It's going to be tough for them. Demand on the used-vehicle side is high as well. And if there is demand on the retail side, they'll be very cautious about selling to the rental companies."

The future

At the same time, rental companies are dealing with disruptions to their business model from sharing services and the emergence of autonomous technology.

The companies have worked to adjust to this emerging world. Enterprise, for instance, has its own sharing service called Enterprise CarShare in certain U.S., Canadian and U.K. markets, allowing members to rent vehicles by the hour or the day.

Hertz and Avis, meanwhile, made splashes this year by entering partnerships with Apple and Waymo.

Apple will lease a small fleet of cars from Hertz to test its autonomous technology, while Avis will manage the autonomous fleet for Waymo, Google's self-driving car affiliate.

"For Google and Apple, this makes sense," Kumar said. "And the autonomous space poses a great opportunity for rental companies. It's good to get partnerships now because no one knows what this new world is going to look like. The fact that they know how to buy fleet and sell fleet, that brings a lot to the autonomous world."

ALG's Lyman agreed, saying the partnerships play to the companies' strengths.

Apple and Waymo "don't necessarily want to own the cars themselves," Lyman said. "Even if they do, they want to focus on the areas of their expertise. Those areas for Apple and Google are not managing a fleet of vehicles. That's a really complicated logistical challenge that the rental-car companies have done for years."

Still, Kumar said, the partnerships and initiatives are only first steps on what will be a long journey for the rental companies to discover what they will be in the future.

He said they can start by working to better differentiate themselves, and their offerings, from competitors and by learning from the likes of Uber and Lyft when it comes to providing a simple customer experience.

"The rental-car experience is still a 20th-century experience," he said. "There has been almost no innovation in the customer experience. There's no real thinking about [adopting] more of a Silicon Valley mindset — of putting the customer in the middle of the experience and building out from there."

Kumar said rental companies, particularly those that primarily service airports, could boost their reputations by making the rental process quicker on smartphones and by providing features such as a GPS that tracks where their shuttles from the airport to their lots are at any given moment.

"Most rental companies are focused on fleet and operations," he said. "They're not as focused on making it easy to rent a car."

Bloomberg contributed to this report.