Hertz Global Holdings
October 20, 2014
Events: Fleet Cost Deep Dive
- Goal of the analysis is to determine whether or not HTZ persistently understates D&A.
- The analysis looks at:
- Rental Car (Car) segment Revenue-Earning Equipment (REE) Turnover, defined as Car Revenue divided by average Car REE
- Total REE D&A Margin, defined as reported REE D&A (which combines the Car & Equipment segments and includes lease payments) divided by Car & Equipment Revenue
- REE Net CAPEX, defined as reported REE purchases minus reported REE disposals
- Original REE D&A, defined as the top line REE D&A estimate in the “Depreciation of Revenue Earning Equipment and Lease Charges” note to the financial statements (typically Note #6, 7 or 8 – found on page 117 in the 2013 10K for example)
- Other Revenue is excluded for all years except 2012 and 2013 when Donlen becomes a larger part of the operation.
- Car segment Turnover highlighted because the reported “problems” within HTZ have historically originated out of the Car segment.
- Combined D&A and Net CAPEX highlighted due to ease of analysis (lack of segment data early on, etc…)
SUMMARY & CONCLUSION
- 19 years of HTZ financials reviewed – 1995 thru 2013.
- Car REE Turnover has steadily risen over the highlighted time frame.
- From 1995 thru 2013, HTZ revised its $13.92B original D&A estimate down by less than 2% as a result of gains on REE disposals.
- From 2006 thru 2013, HTZ revised its $15.7B original D&A estimate up by less than .10% as a result of losses on REE disposals.
CONCLUSION: If HTZ was persistently understating D&A, then Car REE Turnover would decline over time, and D&A would be revised upward on a consistent basis. Based on my analysis, I see little evidence of D&A accounting impropriety.
My original HTZ write-up was a situational investment analysis that assumed reported historical financials are largely representative of HTZ’s steady-state operations. My belief was/is that with a large cohort of sophisticated investors involved in the stock, likely it was/is a reasonable bet that the accounting is proper and that the on-going financial review will not result in a material restatement. It is not dissimilar to the VRX situation – I am not even remotely in a position to conduct an in-depth accounting analysis such as the one Pershing Square conducted on VRX…but I know that Pershing has a highly reputable research process, and that more than likely I can take the “fraud” case off the table when analyzing the investment situation. Now, in my opinion there is a huge difference between blindly following someone into a stock and leveraging their research in a particular area. For example, I can leverage Bruce Berkowitz’s extensive real estate analysis on SHLD all I want, but it is critical to come to my own conclusion on whether or not Lampert is going to redirect RE proceeds into the SYW sinkhole. Point is, do your own work and selectively leverage others’ efforts.
All that to say, however, after reading some rather harsh criticism of HTZ’s D&A accounting practices, I decided to take a deeper dive into HTZ’s D&A accounting history because I thought I must be missing something. The most striking criticism I’ve read is that HTZ is running a D&A Ponzi scheme where reported earnings are inflated due to understated D&A and the true economic cost flows thru the cash flow statement. The only way for me to tackle this issue is to assume the reported financials are real – i.e. HTZ and its auditors are not making up numbers. If the financials are in fact real, then I believe a D&A Ponzi scheme would show up in two places – 1) a gradually declining asset turnover ratio, and 2) consistent losses on equipment disposals. The following analysis focuses on the history of these two areas for HTZ going back to 1995.
FLEET COST ANALYSIS
Period 1: Ford Ownership – 1995 thru 2005
- Average Car REE Turnover: .77X
- Average Total D&A Margin: 26.4%
- Average REE Net CAPEX Margin: 35.2%
- Total Original REE D&A: $13,920.5 million
- Total D&A Adjustments: -$267.5 million – 1.92% of the original estimate
- (A negative adjustment means D&A was revised downward from its original estimate = GOOD)
- Total Car D&A Adjustments: -$73.8 million – .53% of the original estimate
- 4 negative adjustments – i.e. Car D&A was revised upward 4 times
- 7 positive adjustments – i.e. Car D&A was revised downward 7 times
Period 2: Post-Ford Ownership – 2006 thru 2013
- Average Car REE Turnover: .87X
- Average Total D&A Margin: 24.4%
- Average REE Net CAPEX Margin: 21.7%
- Total Original REE D&A: $15,697.4 million
- Total D&A Adjustments: $16 million – .10% of the original estimate
- (A positive adjustment means D&A was revised upward from its original estimate = BAD)
- Total Car D&A Adjustments: $2.5 million – .02% of the original estimate
- 5 negative adjustments – i.e. Car D&A was revised upward 5 times
- 3 positive adjustments – i.e. Car D&A was revised downward 3 times
Car REE Turnover. During Period 1, Car REE Turnover ranged from .68X in 2003 to .82X in 1998 while Car Revenue climbed from $2.9B in 1995 to $5.9B in 2005. Likewise, during Period 2, Turnover ranged from .80X in 2012 to .95X in 2008 while Car Revenue climbed from $6.3B to $9.2B. 2012 and 2013 Turnover is below the Period 2 average due to the rise in slower-moving Donlen REE. While HTZ’s Car REE Turnover is cyclical, I see no evidence of the sustained decline in Turnover that would result from D&A understatement.
Original D&A. As stated in the Discussion section, unless HTZ and its auditors are lying about the D&A adjustments made as a result of gains and losses on REE disposals, then there is zero evidence of rampant D&A understatement. Even in Period 2, which saw more Car D&A upward revisions than Period 1, the revisions are a rounding error.
HTZ’s total D&A margin was 23.4% in 2013, which is slightly below the 2006-2013 average of 24.4%. If D&A is brought up to 24.4%, then 2013 EPS would go down by $.13 assuming a 40% tax rate and 465 million shares outstanding. Outside of this potential adjustment – which I find unnecessary given the D&A margin was even lower in 2006-2007 period – I do not see evidence that there will be a material restatement of HTZ’s financials.