Hertz Global Holdings
October 8, 2014
Events: Idea Write-Up
- NYSE: HTZ
- Recent PPS: $23.40
- Shares Out: 465 million
- Market Cap: $10.88B
- Corporate Debt: $6.42B
- 2013 Corporate EBITDA: $1.8B
- 2013 Adj. EPS: $1.50
- 2015E EPS: $2.00
- This “hedge fund hotel” has flopped around all year on a myriad of headlines, including activist involvement, accounting issues and missed guidance. Most recently the stock is down on a combination of poor guidance from primary competitor Avis Budget Group (CAR) and broad market weakness.
- While HTZ has yet to file a 2014 10Q, the financial restatements are likely to be immaterial – for example, 2012 Net Income was revised to $271.2 million from $275.7 million – and a thorough review, hopefully once and for all, ought to relieve market concerns.
- An oligopolistic market structure and an improving economy afford HTZ an attractive combination of volume- and pricing-based growth.
- The 2015 separation of HTZ’s equipment rental segment, HERC, alongside a buyback program of up to 20% of outstanding shares prior to the spin provides a catalyst for value realization.
- Icahn Capital board representation provides management downside protection.
- Excess debt capacity is approximately $5.43 per share, and 2015 EPS adjusted for excess debt is an estimated $2 per share. At a recent PPS of $23.40, HTZ trades for ~9 times pro forma 2015 EPS. FVPS is between $35 and $36 per share, and the projected 3-year IRR from $23.40 is ~33% per annum.
Company Overview. Started in 1918, incorporated in 1968, acquired by Ford Motor Company in 1987 and sold to private equity sponsors in 2005, which sold their last remaining shares in May 2013. HTZ acquired Dollar Thrifty in late 2012. As of 3Q09, HTZ and CAR (Avis Budget Group) had a 37.7% and 28.9% share of the top 185 US rental car locations, pro forma for recent acquisitions, for a combined share of 66.6% (HTZ 10K market share data last available in the 2009 10K). According to HTZ’s 2013 10K, the 2013 global car rental market was $49.4 billion with the US comprising $24.5B and Europe $13.4B. 2013 US car rental revenue for HTZ and CAR was $6.3B and $5.1B.
HTZ entered the equipment rental business (HERC) in 1965, and generated $1.54B of equipment rental sales in 2013. HERC’s closest competitor is United Rentals (NYSE: URI), which generated $5B of sales in 2013. HTZ estimates the North American equipment rental market was approximately $38B in 2013, but that its addressable market is slightly smaller. Given the size discrepancy between URI and HERC, as has been widely posited it would not be surprising to see some type of transaction between the two companies once the HERC spin is completed.
In 2013, 2012 and 2011 consolidated HTZ generated: revenue of $10.8B, $9B and $8.3B; adjusted pre-tax earnings of $1.2B, $.9B and $.7B; adjusted EBT margins of 10.8%, 10.1% and 8.2%; corporate EBITDA of $1.8B, $1.4B and $1.2B; and ROE of 21%, 17% and 14%.
As of FYE 2013: HTZ had total debt of $16,228 and cash of $1,283 for net debt of $14,945; fleet debt and estimated fleet net debt were $9,806 and $9,031; corporate leverage was 3.3 times trailing EBITDA; and corporate interest coverage was 4.8 times (EBIT/Interest).
ROIC Analysis. Given the vagaries associated with managing a massive fleet of rental cars – primarily due to the volatility of acquisition and disposal car market pricing – I expected to find HTZ’s ROIC profile to be worryingly volatile; on the contrary, it has been very stable the last three years. ROIC inputs are as follows:
Consolidated Invested Capital: Total Assets – Cash – Total Liabilities + Total Debt
Corporate Invested Capital: Total Assets – Corporate Cash – Total Liabilities + Corporate Debt
Fiscal Year Capital Employed: Average Invested Capital + Nonrecurring Charges
Consolidated NOPAT: (Adjusted EBT + Corporate Interest + Equipment Interest) x (1 – 40% tax rate)
Corporate NOPAT: (Adjusted EBT + Corporate Interest) x (1 – 40% tax rate)
In 2013, 2012 and 2011, Consolidated ROIC was 6.2%, 6.1% and 6.7%, and Corporate ROIC was 9.6%, 8.7% and 8.3%. While the spread between Consolidated and Corporate ROIC warrants attention – as poor Consolidated investments could be obscured by unsustainably cheap debt – at a 6% Consolidated ROIC, HTZ covers its WACC by a approximately 2%, assuming a 5% pre-tax cost of debt, a 10% cost of equity and a 40% tax rate. Corporate ROIC has climbed each year largely due to a decline in the cost of fleet debt.
It’s difficult to take a firm view of the future direction of ROIC. While on one hand a rise in interest rates would crimp Corporate ROIC as a result of higher fleet expense, on the other hand, higher interest rates could suppress fleet acquisition costs as 0% new car financing is reduced and thus new car prices come down. Further, if HTZ and CAR behave in an appropriate fashion, pricing could increase materially from here, which would greatly enhance ROIC.
Three-In-One. HTZ can be viewed as three companies under one corporate umbrella: a car rental company (CarCo), a car financing/car dealership company (LeaseCo) and an equipment rental company (EquipmentCo). I am increasingly of the belief that if HTZ separated LeaseCo into a stand-alone car financing/used car dealership company that it would go a long way toward improving its fleet management and as a result, its CarCo operating margins. A stand-alone company would be able to directly incentivize management to pursue the Retail & Rent2Buy market with full vigor and attempt to revolutionize the car rental fleet management business. Dare I suggest even a combination with CAR’s internal LeaseCo in order to create an industry behemoth that would have significant clout with car manufacturers and be able to compete head on with the leading car dealership companies. In an April 2014 Corporate Presentation, HTZ outlined on page 18 how Retail & R2B market generates an incremental $1,000 per car more than the auction market and $600 more than the Dealer Direct market. Retail & R2B made up only 15% of HTZ’s vehicle sales in 2013, thus making this a huge opportunity for HTZ to pursue.
SOTP Build-Out. While far from perfect, I attempt to break out LeaseCo from the consolidated financials as follows:
Target EBIT: I calculate LeaseCo’s pre-tax WACC based on the cost of fleet debt, the percentage of fleet debt funding revenue-earning equipment and a 5% cost of equity spread over the cost of fleet debt. The pre-tax WACC multiplied by the average revenue-earning equipment for the year equals the target EBIT a stand-alone LeaseCo would demand to earn from its revenue-earning equipment.
EBITDA: EBITDA is simply the target EBIT + equipment D&A.
Revenue: I use the average consolidated EBITDA margin for AeroCap Holdings – an airplane leasing company – and HTZ’s own HERC unit to come up with a targeted EBITDA margin for HTZ LeaseCo. The extremely undeveloped thinking here is that the difference in the average length-of-time-on-lease for planes versus construction equipment accounts for the difference in EBITDA margin for AeroCap (85%) and HERC (45%). As such, given car lease periods might fall somewhere in the middle, I took the average of AeroCap and HERC. Again, extremely unscientific.
Using the 2013 Income Statement for a SOTP overview, the HTZ constituent parts look as such:
- Revenue: $9,234
- EBT: $567
- Corporate EBITDA: $1,122
For 2013, 2012 and 2011 CarCo’s: Lease Expense (i.e. LeaseCo’s revenue based on the above calculations) was 48%, 50% and 50% of revenue; EBT margin was 6.1%, 5.2% and 2.7%; and EBITDA margin was 12.2%, 10.5% and 8.8%.
- Revenue: $4,410
- EBT: $318
- Corporate EBITDA: $318
- Revenue: $1,538
- EBT: $275
- Corporate EBITDA: $352
For 2013, 2012 and 2011 EquipmentCo’s Corporate EBITDA margin was 23%, 21% and 19%.
SOTP Valuation. Looking out to 2015, the “Street” consensus is for $12.1B of consolidated revenue, which is approximately 12% higher than 2013, a reasonable figure in my opinion. As such, I use this figure as base for my segment revenue projections. For CarCo, I assume 10% growth in revenue from 2013 to 2015 – 25% from pricing, 75% from volume. Implied EquipmentCo revenue is $2B, for 27% growth from 2013 to 2015. LeaseCo revenue grows 7.5% from 2013 to 2015, in line with the 7.5% estimated growth from volume for CarCo. I recapitalize CarCo and EquipmentCo at 5 and 3 times 2015E Corporate EBITDA, which frees up the $2.5B, or $5.43 per share, of excess capital, as cited in the Thesis section. 2015 pro forma EPS for CarCo, LeaseCo and EquipmentCo is $1.04, $.44 and $.49, for a combined 2015E EPS of $1.98 per share. CarCo, LeaseCo and EquipmentCo are valued at 17.5, 10 and 15 times 2015 pro forma EPS for fair values per share of $18.27, $4.41 and $7.42. Added to excess capital per share of $5.43, total HTZ FVPS is $35.53. At a recent $23.40, HTZ trades for 66% of its fair value.
Avis Budget Group (NASDAQ: CAR). Running CAR through the same ROIC template as HTZ shows it generated Consolidated ROIC of 5.1%, 6.6% and 6.3% in 2013, 2012 and 2011. Using the HTZ CarCo/LeaseCo valuation model, CAR’s FVPS is $63. At a recent $52.40, CAR sells for 83% of its fair value.
Conclusion. Barring an unforeseen operational collapse, HTZ is cheap at an adjusted 9 times 2015E pro forma EPS. With a well-defined catalyst in the 2015 EquipmentCo spin/large-scale buyback, and board protection by Icahn Capital, the risk-reward equation at current prices is highly attractive. Again barring an unforeseen operational collapse, the downside case is that HTZ core earnings remain at 2013 levels as a result of margin compression (fleet issues, D&A restatement, etc…), and the stock is fairly valued at 15 times 2013 earnings.
With HTZ and CAR operating an oligopolistic market and the U.S. economy slowly but surely improving, HTZ has a strong wind at its back that, if combined with Icahn-led management focus, can produce earnings growth well above what I have modeled. If further combined with a large-scale buyback program up to $30 per share, an investment in HTZ at current levels can be a home-run. Of course, an investment should not be made based on the hope for a home-run – rather, I view it as “upside risk” to my fair value estimate.
Full Write-Up w/ Financials: HTZ Idea Write-Up October 2014
Financials Only: HTZ Analysis October 2014