Localiza Rent a Car, a dominant force in the Brazilian car rental market, recently released impressive fourth-quarter results for 2023. Revenue skyrocketed, margins widened, and the company showcased robust operational efficiency. However, a closer examination of the transcript unveils a potential weakness: a depreciation time bomb lurking within the fleet rental division.

While analysts zeroed in on the positive aspects of pricing and cost optimization, a deep dive into depreciation figures reveals a concerning discrepancy between Localiza's two primary divisions: car rental (RAC) and fleet rental. Despite a substantial decline in used car prices, depreciation per car in the fleet rental division surged by a staggering 24% quarter-over-quarter. This figure even surpassed the 7% rise in the average purchase price of new cars for the fleet.

This divergence, coupled with management's acknowledgment of persistent volatility in the used car market, raises a crucial question: is this spike in fleet rental depreciation a fleeting anomaly, or does it signal a deeper structural issue within the division?

Delving into the Numbers

Let's dissect the specific figures to gain a better understanding. In the fourth quarter, the average purchase price of new cars for the fleet rental division stood at BRL 91,600, indicative of a blend of light vehicles with favorable purchase conditions. However, the average selling price of used cars plummeted to BRL 66,900, a decline attributed to the challenging climate for used car sales.

Despite this drastic drop in selling prices, the average annualized depreciation per car in the fleet rental division escalated to BRL 6,689, a 24% jump from the preceding quarter. This suggests that the decline in used car prices is outpacing Localiza's capacity to modify depreciation assumptions, particularly within the fleet rental segment.

The situation in the RAC division presents a stark contrast. Here, the average annualized depreciation was BRL 6,113, a figure more in line with the 8% increase in the average purchase price of new cars. This implies that the RAC division is exhibiting greater resilience in navigating the turbulent used car market, potentially due to a faster fleet turnover and a more assertive approach to divesting older vehicles.

Potential Implications and Looking Ahead

The disparity in depreciation trends between the two divisions could have significant repercussions for Localiza's profitability, especially if used car prices continue to fluctuate or experience further declines. The longer duration of fleet rental contracts renders the division inherently more susceptible to variations in residual value assumptions.

Management, while expressing confidence in their ability to adapt to market shifts, has acknowledged the prevailing uncertainty surrounding residual value estimations. Although they haven't provided concrete guidance on depreciation trends, their cautious stance suggests a recognition of the potential risk brewing within fleet rental.

The pivotal question moving forward is how effectively Localiza can maneuver through this depreciation challenge. Despite the company's solid balance sheet and access to capital, sustained pressure on residual values could erode profitability and impede its ability to achieve its desired ROIC spread.

This depreciation enigma, concealed beneath the remarkable headline figures, is a crucial factor for investors to monitor closely. The ensuing quarters will be pivotal in determining whether this issue is a transient blip or a sign of a more profound obstacle that could impact Localiza's long-term growth trajectory.

Visualizing the Depreciation Divergence

The following chart illustrates the hypothetical disparity in depreciation trends between Localiza's fleet rental and car rental divisions. It underscores the challenge posed by the outpacing decline in used car prices compared to the company's depreciation adjustments, particularly in the fleet rental segment.

"Fun Fact: Localiza Rent a Car stands as one of the largest car rental companies in Latin America, boasting a network exceeding 700 branches across Brazil and Mexico. The company commands a fleet of over 650,000 vehicles and serves millions of customers annually."