http://www.wsj.com/articles/its-time-to-look-under-the-hood-of-chinas-carheard-on-the-street-1426223889

It’s Time to Look Under the Hood of China’s CAR

ABHEEK BHATTACHARYA

Updated March 15, 2015 10:14 p.m. ET

China’s largest car-rental firm has novelty, size and, now, technology on its side. But at the end of the day, it’s still a company that could get weighed down shifting big assets back and forth. Shares in CAR, previously called China Auto Rental, climbed 34% after the company’s Hong Kong initial public offering last September. Investors couldn’t wait to drive away with this rare public play on growing Chinese auto-rental demand. The company, which counts Hertz as a major shareholder, controls a third of the market. Investors again piled into the stock Thursday after CAR announced that it would rent vehicles to an Uber-like Chinese service called UCar. CAR also reported that it swung to a big net profit in 2014 after a loss in 2013.

Before investors start awarding CAR an Uber- or Lyft-like valuation, though, it’s worth remembering the more mundane costs involved in managing a capital-intensive fleet of auto rentals. One key expense is depreciation of aging cars. CAR’s depreciation charges fell last year in absolute terms, dropping to 19% of total revenue from 26% in 2013. Falling depreciation played a part in CAR’s robust 23.4% operating profit margin last year. That’s puzzling because depreciation should have risen as CAR expanded its fleet by 20% last year. Depreciation is equal to 31% of revenue at New York-listed Chinese rental firmeHi Car Services, and about 24% at Avis Budget Group. Unlike Avis, CAR can’t lock in any depreciation expenses because Chinese auto makers don’t promise to buy back cars at predetermined prices as U.S. counterparts do.CAR says depreciation fell in part because it purchased new vehicles at greater discounts than before, so it doesn’t have to write down their value as much. But depreciation also fell because CAR is selling off more old cars. Used-car sales rose 32% in 2014, slightly faster than revenue from rentals, and account for 19% of all revenue.

Investors have to wonder whether CAR’s depreciation costs and acumen at selling used cars can hold up. China’s elevated inventory of unsold cars at dealer lots is putting pressure on car prices. That could hurt overall revenue. And if the company can’t unload cars at the price it penciled in, it may be forced to take write-downs on those cars.

CAR shares trade at 21.8 times forward earnings, compared with an average 17.9 times at its peers. That premium faces a test March 18 when lockups on share sales by major IPO investors expire. The way CAR handles its fleet, even a mild selloff could push the stock downhill.