Since its unbundling from Barloworld and its subsequent listing on the JSE in December 2022, vehicle leasing and rental business Zeda has traded on a low single-digit earnings multiple. This despite a creative rebrand of it as an “integrated mobility service provider”.
The poor sentiment is perhaps understandable. Deemed noncore to Barloworld’s industrial machinery offering, it was first shopped around to prospective buyers, without success. Then it was dumped on Barloworld shareholders … and those with yellow equipment investment mandates were probably forced sellers.
Getting saddled with lots of debt after the unbundling didn’t help (net debt of R5.2bn for a R2.5bn market cap company), especially in a high interest rate environment. As a result, this capital-intensive business has a low dividend payout ratio of 20%-30% of net income after tax, with most of the cash flow used for debt repayments and capital expenditure. At a share price of about R14, Zeda trades on a trailing earnings multiple of just more than four and a dividend yield of just less than 6%.
Results thus far have been solid, if unspectacular, with the leasing and fleet management division — roughly 45% of earnings — the star performer. Catering for everything from passenger vehicles to heavy-duty transport trucks, the leasing business has the necessary track record and scale (20% of the local market share) to be competitive on tenders.
Zeda has long-term contracts with corporate clients, and the visibility on future cash flows from leasing makes the company’s debt load more palatable. In fact, some commentators believe this division should be compared with a secured lending financial services outfit such as WesBank, with its financial gearing seen in that context.
Whatever the case, it arguably provides more stable income than listed peers such as Combined Motor Holdings (CMH) and Motus, which have exposure to more cyclical vehicle retail sales (consumer focused).
The car rental segment has similar, if not better, scale benefits than leasing (38% of the local market share), while its internationally recognised Avis and Budget brands make it popular among foreign tourists (albeit requiring licensing fees for the global brand owner).
The recovery in inbound tourism should continue to support the car rental market as numbers are at only 80% of pre-Covid levels
Car rental isn’t just about tourism, though, as corporate contracts, public sector contracts, retail subscriptions and insurance replacements constitute a material part of the business. As a rough indicator, only 50% of revenue is derived from airport-based branches. This makes it far less seasonal than many investors believe.
Nevertheless, tourism trends remain important. After foreign tourist arrivals recorded a strong start to the year and despite continued growth at Cape Town International Airport, arrivals have weakened in recent months. Along with an increase in the size of rental fleets, this has weighed on rental and utilisation rates. Expect Zeda’s next set of rental results to be muted. Longer-term, however, the recovery in inbound tourism should continue to support the car rental market as numbers are at only 80% of pre-Covid levels. Peak holiday season should also produce better numbers.
The car rental model has vulnerabilities. As the major operators rely on their lease agreements with Airports Company South Africa for a significant part of their business (a nice moat against smaller competitors), lease renewals at the airports present risk, especially with regard to new entrants’ demand for access and the number of escalations. Zeda’s BBBEE level 1 rating for its operating entities is an important advantage in this regard. Competitor CMH, for example, has only a level 2 rating for its First Car Rental division.
Ride-hailing services such as Uber were once thought to be a threat to car rental companies. But the labour cost of the driver makes long trips expensive, so ride-hailing has mostly taken market share from taxis on short routes. Driverless cars could be a game-changer in the distant future, but for now the prohibitive capital cost of these advanced vehicles — and practical safety considerations — are constraints.
The one element that can inject volatility into Zeda’s earnings is second-hand car sales, with even small changes in margins capable of producing wild profit swings. As Zeda rebuilds its fleet after Covid, though, increased unit sales might compensate for lower sales margins. In terms of its licence agreement with the Avis Budget Group, Zeda has to replace car rental vehicles after 12 months.
While Zeda’s financial gearing is a challenge when interest rates are high, it also provides a nice tailwind during rate-cutting cycles. With the current cutting cycle just getting started, it will take time before it is reflected in lower financing costs. Lower interest rates should also boost second-hand car demand and sales values.
For the upcoming annual results, it’s expected that Zeda’s solid leasing performance was maintained. Judging from CMH’s recent results, and considering the drop in foreign tourist arrivals, the rental division might be softer. Second-hand vehicle sales should be in line with the previous year.
Unburdened from Barloworld’s shackles and with more freedom to chart its own path, Zeda will attract investor focus on management’s future capital allocation strategy.
Given its lower dividend payout ratio and higher debt load, Zeda’s discount to peers such as CMH is probably justified in the short term. Longer term, however, considering Zeda’s smaller exposure to the cyclical consumer market (vehicle retail), it might just turn out to be a smoother ride.
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