Investing.com -- S&P Global Ratings has revised the outlook for Avis Budget (NASDAQ: CAR ) Group to negative from stable, citing weaker financial performance. The rating agency has also affirmed the 'BB' rating for the car rental company and lowered its debt ratings.

The revision comes in the wake of higher vehicle costs straining Avis Budget's financial performance in 2024 due to lower residual values. The company also announced in the fourth quarter of 2024 that it would accelerate its fleet rotation, leading to an impairment charge of $2.5 billion.

The agency expects the fleet refresh to provide better fleet cost visibility in the longer term, but it also warns that credit metrics will likely be weak for the rating in 2025, with debt to capital of 105%-110% and EBIT interest coverage around 1.2x-1.4x.

S&P Global Ratings has lowered the issue ratings on Avis Budget's secured debt to 'BB' from 'BB+' and on its unsecured debt to 'B+' from 'BB-'. The recovery ratings on the secured debt have been revised down to '3' (50%-70%) from '2' (70%-90%), and on the unsecured debt to '6' (0%-10%) from '5' (10%-30%).

The negative outlook reflects the likelihood of a downgrade over the next year if EBIT interest coverage remains below 1.3x or debt to capital remains above 100% on a sustained basis.

In 2024, Avis reported a pretax loss of $2.6 billion, compared with pretax income of $1.9 billion in 2023. This loss was largely due to a $2.5 billion impairment charge in the fourth quarter of 2024, associated with the announcement of a fleet rotation program.

The company plans to accelerate the disposal of vehicles that were purchased over the last few years at higher costs amid constrained supply, as new vehicle supply has now improved, and new-vehicle incentives have returned, although not to pre-pandemic levels.

Excluding the impairment charges, the company's pretax income was about $150 million in 2024, significantly lower than in prior years. This was due to declining residual values amid falling used-car prices, resulting in losses on car sales and higher depreciation expenses.

The agency forecasts moderate pretax income in 2025, but fleet costs will likely remain high through the first half of 2025 due to the ongoing fleet rotation.

The potential for a prolonged 25% tariff on imports from Mexico and Canada, along with announced tariffs on steel and aluminum could benefit Avis in the near-term if residual values increase, but will likely result in increased vehicle costs, particularly in 2026 and beyond.

S&P Global Ratings expects EBIT margins to improve modestly to 12%-16% in 2025 from 11.3% in 2024, mainly because of lower vehicle depreciation and lower operating costs. The agency also expects debt and interest expenses to decline modestly, given management's intention to maintain a somewhat smaller fleet, and instead focus on improving fleet efficiency.

The agency forecasts EBIT interest coverage to improve to around 1.2x-1.4x in 2025, but for debt to capital to remain 105%-110%. It also forecasts funds from operations to debt of 13%-16% in 2025, similar to 14.5% in 2024 (and 16.7% in 2023).

Car rental demand is expected to remain relatively steady, supported by strong travel demand. However, global air passenger traffic growth is expected to slow as the recovery plateaus and capacity growth is constrained.

The global economic outlook remains resilient, and global GDP growth is forecasted to be above 3% in 2025 and 2026. Both Avis and competitor Hertz have been slowing their fleet growth as demand normalizes. Constrained industry fleet growth is likely to support rental prices around current levels, but industry-wide fleet supply could rise faster in 2025 amid declining new vehicle prices, which could result in higher competition and lower rental rates.

The negative outlook on Avis reflects the expectation that its credit metrics will improve somewhat but remain weak for the ratings in 2025, amid ongoing fleet refresh.

S&P Global Ratings could lower its ratings on Avis over the next year if EBIT interest coverage remains below 1.3x or debt to capital remains above 100% on a sustained basis. This could occur if operating performance deteriorates due to weak execution, decline in demand, or market share losses; used car prices decline beyond current expectations; or the company pursues an aggressive financial policy.

The outlook on Avis could be revised to stable over the next year if EBIT interest coverage improves above 1.3x and debt to capital approaches 100% and remains close to those levels.

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