Moody's Investors Service raised the long-term rating of ERAC USA Finance Company to Baa1 from Baa2; the rating is based on a guarantee from ERAC's parent, Enterprise Rent-A-Car Company. The upgrade reflects Moody's expectation that Enterprise will preserve its highly competitive position in the replacement rental market, continue to manage the residual risk of its rental fleet in an efficient manner, and maintain a prudent financial strategy as it expands its operations. This should enable the company to generate strong cash flow and maintain appropriate financial flexibility. The rating also recognizes Enterprise's private ownership structure, but anticipates that the company's financial condition will not be materially weakened as a result of potential estate taxes or by other financial issues effecting the company's owners.
ERAC's Prime-2 commercial paper rating, which is also based on an Enterprise guarantee, is confirmed at the current level, and the outlook for the long and short-term ratings is stable.
Enterprise has established a leading position in the replacement car sector of the automobile rental market. This sector provides a number of advantages to Enterprise relative to other large car rental companies; most of these competitors focus on the airport daily rental sector. Demand in the replacement market is driven by consumer need for temporary replacement cars when a leased or owned vehicle has been stolen, damaged, or left with a dealer for service. This affords a degree of stability to Enterprise's revenues and allows the company to utilize its fleet in an efficient manner. Rental companies that focus on airport locations cater primarily to business and vacation travelers. Demand in this sector is more vulnerable to economic cycles and is skewed toward weekday travel. In addition, airport rental locations have relatively high rent and fee expenses.
Moody's anticipates that insurance companies and car dealers will continue to use replacement vehicles as an important and growing part of their marketing strategies. Enterprise should benefit from the trend. We also expect that the growth in discretionary in-city rentals, while in closer competition with the airport rental companies, will allow Enterprise to leverage its existing infrastructure into newer markets.
The favorable characteristics of the replacement market are attracting increasing competition from a number of airport rental companies. Nevertheless, we believe that Enterprise is well positioned to meet this challenge. Its extensive and strategically situated rental locations, its proprietary billing systems, and its intimate understanding of customer needs has enabled Enterprise to provide a very high level of service to automobile body shops, car dealers, and insurance companies. The critical success factors in the replacement rental market and the airport rental market are very different. We expect that it will take considerable time and investment for airport rental companies to replicate the systems and operating practices necessary to effectively service replacement market customers on a wide scale basis.
Enterprise is the largest purchaser of vehicles in the U.S. and maintains the nation's most extensive fleet of rental cars. For the majority of its vehicle purchases, Enterprise takes on the residual risk. Although the average service life of Enterprise's fleet of vehicles is modestly longer than the 10-12 month average for other US rental companies, Enterprise sells a large number of vehicles into the used car market each year. Consequently, demand and price levels in the used car market can have a significant impact on Enterprise's operating performance and cash generation. As a result, the company has developed highly efficient internal operating systems and procedures for tracking and marketing vehicles that it will sell into the used car market. These systems and procedures have enabled Enterprise to manage residual risk in a very efficient manner and to enhance its returns by selling vehicles at a profit. They have also helped the company to minimize the potential decline in earnings that can occur during a weak used car market. Despite the sophistication and historic effectiveness of Enterprise's strategy for managing residual risk, used car market conditions will remain an important risk factor in our ongoing assessment of Enterprise.
Other rental companies acquire the majority of their vehicles under program purchase arrangements. These programs require the automobile manufacturer to repurchase the vehicle at the end of its service life at a specified price. These programs provide rental companies with an important degree of insulation from vehicle residual risk. However, they also limit the potential to benefit from profitable used car sales.
Enterprise's successful operating strategies have resulted in healthy growth in earning and cash flow. As this growth has taken place the company has steadily built its equity base, reduced its leverage, and enhanced its financial flexibility. We expect that the company will continue to embrace a prudent financial strategy and maintain debt protection measures that are supportive of a Baa1 rating.
Enterprise Rent-A-Car Company, headquartered in St. Louis, Missouri, is believed to be the largest rental car company in the United States as measured by number of branches and fleet size. It services primarily the replacement rental car sector. ERAC USA Finance Company is a wholly-owned finance subsidiary of Enterprise Rent-A-Car Company.
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