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On Aug 30, we downgraded our recommendation on Avis Budget Group, Inc. (CAR - Analyst Report), to Underperform based on the company’s dismal second-quarter 2013 results and the rising fleet costs.

Why the Downgrade?

Estimates for Avis Budget, which provides vehicle rental services, have been declining ever since the company reported second-quarter results on Aug 6. Avis Budget’s second-quarter revenues of $2002.0 million missed the Zacks Consensus Estimates of $2,027.0 million. Moreover, quarterly earnings fell 47% year over year to 50 cents a share; however, it came a penny ahead of the Zacks Consensus Estimate.

Following the results, Avis Budget reaffirmed fiscal 2013 revenues in the range of $7.8–$8.0 billion. However, the company narrowed its adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) guidance range to $750–$800 million from $750–$855 million forecasted earlier. Moreover, Avis Budget reduced its median earnings forecast for fiscal 2013 to $2.20 from $2.30 projected previously.

Consequently, we observed that the Zacks Consensus Estimates for 2013 and 2014 fell 6.8% and 7.1% to $2.20 and $2.73, respectively over the last 30 days. With the Zacks Consensus Estimates for both 2013 and 2014 going down, the company now has a Zacks Rank #5 (Strong Sell).

Causes of Concern

The prevalent sluggish economic scenario in both Europe and Australia, along with rising fleet costs continue to weigh upon the company’s performance. However, Avis Budget is optimistic about its disciplined pricing initiatives and expects them to offset a possible rise in its North American business fleet costs.

Nevertheless, we consider this to be difficult, owing to the company’s long-term agreements with corporate bigwigs and the aggressive pricing strategy adopted by competitors. Moreover, the company upped its forecasts for per-unit domestic fleet costs, which are expected to increase nearly 25% to $300 per month in 2013. Hence, Avis Budget’s margins may be under pressure in 2013.

Moreover, Avis Budget is highly dependent on third-party distribution channels. In the reported quarter, nearly 47% of Avis Budget’s domestic car rental reservations came through third-party distribution channels. Consequently, any disruption and termination of relationships with third parties or reduction in transaction volume may have an adverse impact on the financial condition and results of the company.

Given the second-quarter performance and Avis Budget’s tepid outlook, we do not see any significant catalyst that could drive the shares in the near term.

Stocks That Warrant a Look

While we prefer to avoid Avis Budget till there are signs of improvement in the company's performance, other retail stocks worth a look include Cardtronics Inc. (CATM - Snapshot Report), comScore, Inc. (SCOR - Snapshot Report) and Interval Leisure Group, Inc. (IILG - Snapshot Report). All these carry a Zacks Rank #1 (Strong Buy).

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