HTZ - Hertz Is Undervalued As Global Travel And Tourism Reignites

2023-07-13 03:10:41 ET

Summary

• Hertz Global Holdings trades at just 7.6x forward P/E and 2.0x P/B but has delivered impressive ROEs over the years.
• Not only do we expect HTZ's car rental business to rebound in the next 12 to 18 months, but we think cost-cutting measures and improved operational efficiencies will sustain profitability and high ROEs.
• Not only is HTZ a much leaner and more operationally efficient company after cost-cutting measures and job cuts, but the fresh leadership at Hertz will also be under pressure to perform.
• Given that global travel and tourism volumes have yet to fully recover to pre-pandemic levels, we see room for sustained earnings growth in the medium term.
• We initiate our coverage of HTZ with a "Strong Buy" rating.

Value investing is a challenging business because high-quality companies rarely trade at a discount. However, certain factors and market conditions occasionally create compelling opportunities for generating alpha. And market sentiment is one of the factors that we have repeatedly exploited to successfully identify value over the years.

Here at Stratos Capital Partners, we search for companies that are trading at depressed valuations because they have been ignored or disliked by investors for various reasons. We then look into those reasons carefully and objectively to assess if market sentiment adequately justifies the depressed valuation on that stock.

Occasionally, we uncover companies like Hertz Global Holdings Inc. ( HTZ ), which trades at just 7.6x forward P/E and 2.0x P/B at the time of writing, but has delivered an impressive ROE of 67% in Q1 2023 and pre-pandemic ROEs of above 30% (Q4 2017 - Q1 2018).

Moreover, this improvement in ROE wasn't accompanied by increased leveraged. As the accompanying chart shows, total net debt levels have only recently returned to pre-pandemic levels.

We have repeatedly mentioned pre-pandemic figures when comparing the recent performance of HTZ for good reasons. Not only do we expect HTZ's car rental business to continue to recover in the next 12 to 18 months, but we think recent cost-cutting measures and improved operational efficiencies following the restructuring of the business will sustain profitability and high ROEs in the coming years.

Why Investors Are Ignoring HTZ

HTZ, which owns other brands such as Thrifty and Dollar, was one of the major companies that filed for Chapter 11 bankruptcy protection in May 2020 after missing payments for a lease for a global fleet of around 660,000 vehicles. Many analysts would suggest that HTZ's bankruptcy was a consequence of various reasons including being heavily indebted, operational inefficiencies, poor execution of strategy by management, or even having the wrong strategy to begin with.

However, none can ignore the devastating circumstances that were created by the Covid pandemic. Within just a matter of months, global travel and tourism were halted, and businesses and entertainment venues were also shuttered. As the accompanying chart shows, the revenues of U.S. rental car companies plunged by around 20%-25%.

Global rental car companies actually fared much worse given that the U.S. was less keen to lock down cities during the pandemic compared to many other European countries.

From a sentiment perspective, it makes sense that investors gradually lost interest in HTZ's recovery as the pandemic dragged on. When HTZ eventually filed for bankruptcy, most investors had already given up on the company.

But should investors continue to look away?

Restructuring & Renewal Of HTZ

Fundamentally, HTZ's global rental car business is pretty straightforward and simple to understand.

Firstly, leisure and business rentals make up the lion's share of revenues, with replacement cars and other short-term use cases making up an estimated share of just 10-15% of the total. Thus, the performance and profitability of HTZ's business are intimately linked to the global travel and tourism volumes, which HTZ have limited control over.

Secondly, optimising fleet utilization is the other piece of the puzzle that determines HTZ's operational efficiency and profitability. Ideally, management wants fleet utilization to be as high as possible without sacrificing customer satisfaction, creating supply bottlenecks, and lost sales. Excelling at fleet optimization likely requires a blend of foresight, skilful demand forecasting and planning, as well as nimble management.

As the global economy continues to recover from the pandemic, pent-up demand for leisure and business travel should continue to drive healthy volumes for the car rental business. Accordingly, we expect HTZ to deliver a steady improvement in earnings over the next 12 to 18 months. Given that global travel and tourism volumes have yet to fully recover to pre-pandemic levels, we see room for sustained earnings growth in the medium term.

Had HTZ survived and avoided bankruptcy in 2020, one might suspect that the stock would have rebounded and meaningfully outperformed the broader S&P 500 Index ( SPX ). On the contrary, we think the restructuring and renewal of HTZ brought about by its bankruptcy will eventually prove to be a better long-term outcome for the stock.

Not only is HTZ a much leaner and more operationally efficient company after cost-cutting measures and job cuts, but the fresh leadership at Hertz will also be under pressure to perform. And that is always a good thing for shareholders. Some of the new strategic initiatives aimed at optimizing fleet utilization, improving operational efficiencies, and modernizing the brand appear well aligned to fully capitalize on the global travel and tourism recovery in our view.

In Conclusion

We view HTZ's depressed valuations as a compelling opportunity for investors looking to capitalize on the global travel and tourism rebound.

Not only do we expect HTZ's car rental business to continue to recover in the next 12 to 18 months, but we think recent cost-cutting measures and improved operational efficiencies following the restructuring of the business will sustain profitability and high ROEs in the coming years.

We initiate our coverage of HTZ with a "Strong Buy" rating.

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