2023-10-31 23:22:22 ET
Summary
- Hertz emerged from Chapter 11 bankruptcy in 2021 with the help of creditors, shareholders, and new investors. The company eliminated over $5 billion of debt to emerge from bankruptcy.
- Today, Hertz is a better-managed business, and a deep dive into the balance sheet suggests bankruptcy risk is minimal in the foreseeable future.
- The company's seemingly attractive valuation got me hooked, but a careful evaluation of growth prospects and challenges looming on the horizon has forced me to avoid ithe company today.
Hertz Global Holdings ( HTZ ), one of the largest vehicle rental companies in the world, emerged from Chapter 11 bankruptcy in 2021. Hertz filed for bankruptcy protection in May 2020, after the Covid pandemic severely impacted its business and liquidity. However, with the help of its creditors, shareholders, and new investors, Hertz was able to successfully restructure its debt, operations, and fleet, and exit bankruptcy by the end of June 2021. Hertz's Plan of Reorganization was confirmed by the Bankruptcy Court in June 2021. It was described by Judge Mary Walrath as a "fantastic result" that surpassed any result she had seen in any Chapter 11 case during her 20-year career.
Under the Plan, Hertz eliminated over $5 billion of debt, including all of Hertz Europe's corporate debt, and received over $5.9 billion of new equity capital from a group of investors led by Knighthead Capital Management LLC, Certares Opportunities LLC, and certain funds managed by affiliates of Apollo Capital Management. Hertz also secured a new $2.8 billion exit credit facility and a $7 billion asset-backed vehicle financing facility, each on favorable terms. The Plan provided for the payment in cash in full to all creditors and for existing shareholders to receive more than $1 billion of value. Following the exit of Chapter 11, Hertz implemented several operational initiatives to improve its efficiency and profitability, such as launching a cost reduction program, right-sizing its fleet, optimizing its location footprint, negotiating cost reductions and concessions at certain airport locations, and completing the sale of its Donlen fleet leasing business for $891 million in cash.
Nonetheless, the road ahead remains challenging. Despite signs of recovery in the travel sector, persistent economic headwinds continue to impact the long-term earnings growth potential of the company. Hertz's third-quarter results , although strong, fell short of analyst expectations. The company is certainly making hay while the sun is shining for the vehicle rental market, made possible by the ongoing supply-chain challenges faced by automakers and the resurgence of global travel demand in the post-pandemic era. The sun, however, will not shine every day all day, and I believe investors will wake up to the reality that Hertz is no longer the corporate giant it used to be although credit needs to be given to how the company emerged out of bankruptcy. In the long term, I believe growth opportunities will be minimal, and as a growth investor, I am not ready to invest in a business just because it is valued cheaply from a historical perspective or compared to its peers. HTZ stock has declined by more than 40% this year, which has pushed the company into seemingly undervalued territory at a forward P/E of below 5. I am not taking the bait to invest in Hertz regardless of how attractive the company may seem.
Macroeconomic Tailwinds Are Boosting Hertz’s Growth
During the third quarter of 2023, Hertz achieved a milestone by reporting its most impressive quarterly revenue to date, totaling $2.7 billion, marking an 8% increase when compared to the same period in the previous year, and transaction days increased 16% YoY. The company also posted a net income of $629 million, or $0.92 per diluted share, up 9% year-over-year. The company attributed its strong performance to the continued recovery of travel demand, especially in the leisure and rideshare segments, as well as stable pricing and fleet optimization. Hertz also achieved an adjusted corporate EBITDA of $359 million at a 13% margin and an adjusted free cash flow of $313 million in the quarter.
Exhibit 1: Transaction days
During an earnings call , Stephen Scherr, the Chair and CEO of Hertz, said that the company produced record revenue in the quarter, reflecting ongoing strength in demand and stability in pricing.
During an earnings call , Stephen Scherr, the Chair and CEO of Hertz, said that the company produced record revenue in the quarter, reflecting ongoing strength in demand and stability in pricing. The company’s ridesharing sector performed exceptionally well during the quarter. Consumer spending trends underscore the significance of this upturn in the rideshare industry. In September, it was observed that U.S. rideshare sales at Uber Technologies, Inc. ( UBER ) experienced a 6% year-over-year increase. Data for September reveals that the average monthly sales per customer at Uber amounted to $93, reflecting a 1% year-over-year increase and an impressive 11% surge from September 2021. In contrast, Lyft Inc’s ( LYFT ) average sales per customer in September 2023 stood at $87, which was 4% lower than in September 2022 but a notable 9% increase from September 2021.
Exhibit 2: Average monthly rideshare sales per customer in the U.S.
These dynamics indicate evolving consumer preferences and spending behaviors within the rideshare market, contributing to Hertz's positive financial trajectory. CEO Scherr also said that the company's premium Hertz brand performed well. The company’s rideshare volume was up 50% year-over-year, which is a strong indication of how the company is continuing to benefit from the pent-up demand for travel in the post-pandemic era which shows no signs of slowing down.
Additionally, the Car rental market, as indicated by Statista , is poised for steady but gradual growth in the coming years. Projections for 2023 point to revenue of $29.94 billion. The market is expected to grow at a CAGR of approximately 1.52% from 2023 to 2027. The steady growth in the car rental market is expected to come on the back of a continued recovery of the travel market, the easing of geopolitical tensions, and the incorporation of technological advancements in the rental process.
Exhibit 3: Car rental market growth
While pricing exhibited sequential improvement in Q3, it declined on a year-over-year basis, reflecting a deviation from the elevated levels observed in 2022. Notably, the sequential pricing increase of slightly over 2% fell short of industry expectations, even as key segments of the business demonstrated more robust growth. Nevertheless, Hertz managed to maintain its market share during the quarter. A particular highlight within the North American leisure business was the remarkable growth in Revenue per Available Day [RPD], which surged by more than 6% during the quarter, excluding the dilutive influence of electric vehicles. In contrast, RPD in the company's more fixed-rate businesses in North America remained relatively steady on a sequential basis, resulting in a system-wide increase of 2%.
Exhibit 4: Global RPD
In line with these pricing dynamics, Hertz's strategic fleet management optimization efforts manifested in a notable 11% increase in its average fleet size. The global fleet size reached 590,000 vehicles, while fleet utilization remained high at 83%, a critical factor contributing to the quarterly achievement of global monthly revenue per unit of $1,596.
A closer look at the financial performance of Hertz since it emerged out of bankruptcy reveals how the company has benefited from an unusually favorable demand environment triggered by surging global travel, inflated new car prices due to supply-chain shortages that have made renting cars extremely attractive for first-time car buyers, and a strong used car market. I am certainly not trying to take the credit away from the management for executing a spectacular turnaround from the lows of 2020 but when we put things into perspective, it is evident that favorable macroeconomic conditions have played a key role in Hertz's recovery.
Hertz's Electric Transformation And Cost Management Efforts
Coming to electrification, Hertz has made significant strides in capitalizing on the growing EV market, particularly within its rideshare business, which experienced a remarkable 50% year-over-year growth in volume. The company is well-positioned for further expansion as it offers an affordable entry point for drivers seeking electric vehicles. The company's commitment to electrification is evident in its growing fleet, where approximately 11% of its total vehicles are now electric, encompassing a substantial 50,000 electric cars. Notably, nearly 80% of these EVs are Tesla models, reflecting a significant reliance on arguably the world’s most reliable EV maker.
However, Hertz's ambitious target of procuring 100,000 Tesla electric cars by the end of 2022 (yes, 2022) encountered some challenges. The company said it will fall short of its original objective to have EVs constitute a quarter of its fleet by the end of 2024. Hertz Global's CEO, Stephen Scherr, was instrumental in forming the company's ongoing collaboration with Tesla, with a primary focus on enhancing the performance of electric cars to mitigate the risk of damage incidents. This collaboration extends to aspects such as parts procurement and labor management, underscoring Hertz's commitment to optimizing its EV fleet and improving the overall customer experience.
It's worth noting that the EV rideshare segment has witnessed a higher incidence of damage, prompting Hertz to take measured steps in moderating rideshare growth and reassessing the rideshare driver base. This decision involved deliberately slowing the supply of EVs into the rideshare channel and diverting more of them into the leisure segment to ensure sustained utilization. Nonetheless, this strategy led to an oversupply of EVs in the leisure segment, consequently affecting RPD for EVs and contributing to lower overall RPD performance during the third quarter.
Simultaneously, the company has maintained its focus on cost reduction initiatives to enhance its margins. Direct operating expenses increased by 17% year-over-year in Q3, largely in line with the volume increase. Despite this, per transaction day DOE saw meaningful reductions owing to the company's productivity-driven efforts. The company remains diligent in addressing vehicle damage costs, particularly those related to EVs. Higher costs are associated with collision and damage repairs on EVs compared to traditional internal combustion engine vehicles. To tackle these challenges, Hertz has activated a comprehensive damage program, involving underwriting, collections, and educational tools, in addition to collaborating with original equipment manufacturers (OEMs) to improve vehicle performance. Excluding net collision and damage costs, per transaction day DOE was down by 10% year-over-year in Q3, consistent with the company’s 2023 goals, reflecting a concerted commitment to managing expenses.
Exhibit 5: DOE/transaction day
The transition to an EV fleet comes with its share of challenges and costs which have impacted the company's EBITDA margin. Recognizing the need for cost control, Hertz has leveraged investments in field technology and productivity enhancements to mitigate the impact. SG&A expenses, for example, were down 15% year-over-year, driven by reductions in incentive compensation coupled with the promising results the company is seeing from its productivity enhancement initiatives.
CEO Scherr expressed confidence in the future of Hertz and its role in shaping the mobility sector. He also said that the company is committed to delivering excellent service to its customers and creating value for its shareholders. In a strategic move to enhance shareholder value, Hertz initiated a $1 billion share repurchase program, with the utilization of $50 million to repurchase 3 million common shares during the quarter. This action reflects the company's proactive stance in evaluating opportunities to return capital to its shareholders while concurrently maintaining a robust liquidity position.
Hertz Is In Strong Financial Footing
Hertz's financial position as of September 30, appears strong and well-structured, reflective of a carefully managed balance sheet. With approximately $600 million in unrestricted cash and an additional $1.1 billion available under a revolving credit facility, the company has sufficient liquidity reserves at its disposal to remain solvent in the foreseeable future. Hertz maintains a net non-vehicle debt of $2.3 billion and does not face any substantial non-fleet debt maturities until 2026, illustrating a favorable maturity profile.
Exhibit 6: Non-vehicle debt maturity profile
The company's net corporate leverage stands at 1.9x, indicating a manageable level of debt relative to its operational and financial scale. Moreover, Hertz has prudently structured its asset-backed securities facility, which carries a blended average cost of 4%, featuring a significant 70% fixed-rate component. This strategic approach not only bolsters financial stability but also mitigates the risk associated with future interest expenses.
The Valuation May Not Be As Attractive As It Seems
Having successfully emerged from bankruptcy in June 2021, Hertz has shown resilience in the face of adversity. However, I always remind myself of three important factors whenever I feel Hertz is cheaply valued.
First, Hertz operates in a fiercely competitive landscape within the car rental industry, facing constant rivalry from other industry players. The capacity to navigate this competitive terrain will be pivotal in determining the company's long-term success. Hertz faces massive competition from ridesharing companies as well. Although the company has made lemonade out of lemons by partnering with rideshare companies, it would be naive to rule out the probability of ridesharing companies disrupting the global transportation sector in the long run, eventually pushing Hertz and many of its peers out of the business.
Second, Hertz has a lot of ground to cover in order to offer a technologically advanced experience similar to high-tech car rental/subscription platforms in key global markets. I live in Dubai, and many of my colleagues, friends, family members, and businesses are slowly but surely showing a preference to do business with homegrown rental/leasing services over Hertz and other international brands. The biggest selling point is the technological superiority of these platforms.
Third, we are assessing the effectiveness of the turnaround strategy of Hertz over a period when macroeconomic conditions have been highly favorable for the company and the industry. This is not going to last, however, and I would want to allow Hertz to go the full business cycle before categorizing Hertz as the best turnaround story in recent times.
Takeaway
Giving credit where it's due, Hertz has done a wonderful job over the last couple of years to emerge from the pitfall it found itself in. This, however, is not a good enough reason for me to invest in the company. The seemingly cheap valuation could turn out to be misleading in the long run given that there is a lot of room for disruption in the global transportation sector. On the other hand, as a growth investor, I prefer investing in companies that tell a compelling story backed by numbers. In Hertz's case, even in the best-case scenario, I believe investors will not be able to walk away with market-beating returns.
For further details see:
Hertz: Good But Not Good Enough