Dollar Thrifty Hits a Big Pothole

Shares of the car-rental outfit plunged Monday after it slashed its profit forecast, underscoring the tough conditions in the industry

by Ben Steverman

The problems of the car rental business are deepening. On Feb. 4, Dollar Thrifty Automotive Group (DTG) shares plunged 35% after the firm nearly cutting in half its expectations for 2007 profits.

Dollar Thrifty's news jolted the industry, raising worries that U.S. consumers are cutting back on their travel spending. Dollar Thrifty's larger rivals, Hertz Global Holdings (HTZ) and Avis Budget Group (CAR), at one point on Feb. 4 had fallen as much as 7% and almost 14% respectively.

Fears of a recession add to the difficulties for car rental firms, already battling it out in a brutal business. The car rental industry's problems are similar to those of the airline industry, which has been notoriously tough on investors. Both are highly competitive industries with high fixed costs, so they find it tough to squeeze out profits on a regular basis.

Dollar Thrifty says it expects its full year earnings to be 90 to 95 cents per share, way off analysts' estimates and the company's own prediction of earnings from $1.70 to $1.85 per share.

The results demonstrate "the headwinds that have affected the car rental industry," noted Christina Woo, an analyst at Morgan Stanley (MS). She listed the factors behind the disappointment, with a 40 to 45 cents per share hit from "weaker than expected travel demand" at the top of the list.

"It puts on display how sensitive their business is to overall consumer spending and consumer travel habits," says Morningstar (MORN) analyst Sumit Desai.

Poor Canadian results took a toll, causing a 25 cents per share hit to earnings.

But Dollar Thrifty also absorbed some of the problems afflicting Detroit automakers, the main vehicle suppliers to the industry. Problems delivering new cars caused a 15-cent hit to earnings, while the weak used car market made it less profitable to resell cars, causing a 10-cent hit.

Car rentals are basically a "commodity product," Desai says, with most customers choosing the cheaper rental every time. Troubled times for Chrysler, Ford (F) and General Motors (GM) mean the automakers are trying to extract more profits from rental companies. But, in such a competitive business, rental firms have a tough time passing those higher costs onto customers, especially if travel demand is weak.

"The car rental companies are basically at the mercy of Detroit," Desai says.

In the past year, Hertz is off 24%, Avis Budget is down 55% and Dollar Thrifty has fallen 65%. By late on Feb. 4, both Hertz and Avis Budget shares had recovered from their lowest levels of the trading day. That perhaps reflected optimism that they will partly escape the tough times afflicting Dollar Thrifty.

Investors can hope for better days ahead, but the danger for investors is that a serious recession could undercut profits even further. If consumers keep cutting back on spending, Dollar Thrifty's woes could be an early sign of worse times for not just rental companies but the entire travel industry

Steverman is a reporter for BusinessWeek's Investing channel.