Hertz Global Holdings
August 4, 2015
- NYSE: HTZ
- Recent PPS: $16.55 (8/3/15 close)
- Shares Out: 454 million
- Market Cap: $7,514
- Corporate Net Debt: $5,807
- Enterprise: $13,321
- Uber a limited threat over the next 3 to 5 years
- Large-scale operational turnaround underway, driven by the operations-first, value-oriented John Tague
- Hertz Equipment Rental (HERC) spin-off in 1H16, preceded by a $1B repo, acts as near-term catalyst
- YE 2016 SOTP conservatively $42.26; excludes upwards of $5.42 per share of NOLs, and the use of $3.33 per share of incremental debt for an additional repo program. FVPS and 1.5-Year IRR $36.63 and ~87%.
- Icahn $30 take-out?
This is a re-initiation because I was originally involved in the stock between mid-June 2014 and early November 2014, and wrote it up in early October 2014. My original analysis was overly aggressive on pricing and Fleet D&A assumptions – as evidenced by 2014 U.S. RAC sales growth of less than 3% versus industry growth of ~7%, and Fleet D&A PUPM (Per Unit Per Month) of $294 versus $218 in 2013 – which the stock price ruthlessly demonstrated with a peak to trough decline of ~51% over the last 52 weeks. Fortunately, I saved myself a significant amount of absolute and relative performance by dumping the stock in early November 2014 after the price failed to outperform the market on the way out of the October 2014 market bottom. In the meantime I monitored the situation from the periphery, but failed to gain conviction even at significantly depressed levels, as it was next to impossible to verify earnings power without updated filings and limited Company communication. I noted on Twitter that I thought somewhere in the low- to mid-teens would be an interesting entry point, but never acted on it.
On July 16th and 17th, alongside restated SEC filings HTZ filed an excruciatingly detailed Restatement 8K and held a highly informative call with investors outlining future strategy and earnings power building blocks. The stock initially shot up to over $19, then sold off to below $16 before settling out to between $16 and $17 where it resides at present. I am somewhat of a hypocrite because typically it is a bad sign when a stock sells off on presumably good news, and I generally heed those signs. However, I tend to weight those signs more heavily if I am uneasy about the fundamental backdrop.
The fundamental and investment backdrop is superb here, so I am willing to overlook negative technical signs at present. After years of mismanagement, accounting issues, and tepid 2015 guidance, investors have a right to be wary…but at a higher price. A MUCH higher price…
Uber. The Uber threat gets a lot of press; and while certainly a wildcard in the long run, I believe the risk is overblown over the next 3 to 5 years, as Uber needs to find out where it ultimately wants to land on the cost curve. Certainly the technology is cutting-edge, but if the all-in cost matches or exceeds a traditional taxi service, I do not know how wide of a moat Uber will be able to carve technologically if traditional taxi services ramp up their technological game. And lastly (admittedly something I need to dig into more), what % of traditional car rental customers would forgo a rental car for a glorified cab? (More than likely an asinine question.)
Operational Turnaround. President & CEO John Tague – formerly of United Airlines (2003-2010) – is the crux of the operational turnaround aspect of the investment thesis. Hired in November 2014 by a search team headed by Carl Icahn, he is an operations guy thru and thru – maniacally focused on customer service, cost controls and value-oriented growth. Tague is not unlike Peter Hancock at AIG, Tom Rutledge at CHTR, and Hunter Harrison at CP; all three of whom brought an operations-first, value-oriented approach to turning around a historically under-/mismanaged asset. The projected outcome for HTZ is simple and three-fold: higher RPD via innovative product development & customer loyalty; higher utilization via value-oriented capacity growth; and a lower cost structure via better management.
Catalysts. HTZ has guided to a $1B repo program, followed by a spin of HERC, within the next 12 months. The repo will collapse shares by 11% to 14% pre-spin; while the spin will afford HERC management the ability to either be consolidated by URI, or to be a consolidator itself. Regardless of the consolidation outlook, with HERC capacity utilization still below pre-recession levels, depending upon where we stand in the economic cycle in mid-2016 HERC could be in fantastic position to grow its earnings power over the near- to medium-term. Lastly, HTZ will have upwards of $725MM to buy-in shares immediately post-spin, collapsing shares by a further ~6%.
Valuation. HTZ RAC – free of HERC and Donlen – will earn approximately $2.40 in 2017. Valued at 15X, HTZ RAC is worth approximately $35.93 at YE 2016. Incremental debt and HERC add another $6.33, for an all-in YE 2016 FVPS of $42.26. From the recent close, the 1.5-year IRR is ~87%.
Icahn. At $30, an HTZ take-out would cost Icahn approximately $13.6B – well within his capacity given his historical take-out proposals (i.e. Dell, Clorox). This potential is discussed very little (if at all, to be honest), so I could be far off base here; but given the operational outlook under Tague’s leadership, portfolio rationalization potential, debt capacity, tax assets, and strong core FCF generation, I struggle to see why Icahn would not want to take a crack at it.
Market. HTZ estimates the 2014 global car rental market was approximately $51B, comprised of $26B U.S., $13B Europe, and $12B APAC. With $6,439 of 2014 U.S. RAC rental revenue, HTZ U.S. market share is ~25%. The U.S. market grew 7% in 2014.
Industry. In the U.S., HTZ – Hertz, Dollar, Thrifty, Firefly – competes with Avis Budget Group – Avis, Budget, Zipcar, Payless – and Enterprise – Enterprise, National, Alamo.
History. Founded in 1918, HTZ was owned by Ford Motor Company from 1987 to 2005. After being taken private in 2005, HTZ IPO’ed in 2006, and the PE sponsors sold down their remaining stake between 2006 and 2013. HTZ acquired Dollar Thrifty in 2012.
Avis and Budget were founded in 1946 and 1958. Avis Budget Group (NASDAQ: CAR) purchased Zipcar and Payless in 2013.
Enterprise, National and Alamo (owned by privately-held Enterprise Holdings, with over $17B of revenue) were founded in 1957, 1947, and 1974.
Accounting. Due to a lack of appropriate operational controls, and misaligned incentives emanating from the former C-suite that resulted in aggressive reporting practices, HTZ misstated its 2011-2013 financial statements. Under accounting investigation since 2014, HTZ was unable to file with the SEC for over a year. In the long-awaited restatement filings on July 16th, HTZ revealed that it had overstated 2011, 2012 and 2013 EBT by 23%, 20% and 11%. After a long investigation, complete management turnover, and significantly enhanced monitoring and controls, I am fine with the accounting in the restated financials and moving forward.
2014. The real disaster of 2014 was operational performance – not the accounting investigation. As a result of the following key factors 2014 Actual Adj. Corporate EBITDA was $1.331B versus original guidance of $2.24B (courtesy of Credit Suisse):
- Higher U.S. RAC DOE: $400MM
- Lower Revenue Contribution: $165MM
- Other/International: $59MM
- Higher Fleet Depreciation: $200MM
- HERC-related: $85MM
HTZ’s over-arching operational problem was an aging fleet, which resulted in a lack of a competitive offering, poor capacity utilization, and thus elevated costs. Exacerbating utilization problems in 2014, HTZ moved rapidly in 4Q14 to turnover its aged fleet.
Management believes all but higher fleet depreciation is recoverable.
Efficiency Ratio. On the July 17th restatement conference call, management honed in on what I refer to as the ‘Efficiency Ratio’, or DOE + SG&A divided by Revenue. Based on management commentary regarding the 2014 Adj. Corporate EBITDA gap (outlined above), the ‘core’ 2014 Efficiency Ratio for HTZ RAC (U.S. RAC + International RAC, ex. HERC, Donlen and Corporate) is approximately 60.4%, versus ~66% headline. The CFO guided to sub-60% long-term, which I believe is (easily?) attainable with modest RPD and utilization improvements.
[I believe there is some confusion regarding the recovery of 2014 excess cost vis-a-vis the announced $300MM cost-cutting program. ‘Street’ commentary indicates the cost-cutting program is meant to recover 2014 excess cost; but after following up with HTZ post-call, it appears the cost-cutting program is incremental to the recovery of 2014 excess cost.]
I derive the ‘core’ Efficiency Ratio by adding back the $400MM of excess U.S. RAC DOE and $100MM of remaining DTG synergies. $300MM of cost cuts are excluded from the calculation in order to cover non-Intex Corporate costs, which were less than $200MM in 2014.
U.S. RAC. I project top-line growth of 5.3% per annum from 2014 thru 2017, assuming: 1% annual capacity growth, 2% RPD growth, and utilization of 77.77%, 80%, and 82% in 2015, 2016 and 2017. Per Unit Per Month (PUPM) Fleet Cost and Corporate D&A remain constant with 2014 levels of $323.25 and $36.40 (Fleet Cost is Fleet D&A + Fleet Intex); Opex Per Day (OPD) remains constant with the adjusted 2014 level of $24.59; and Corporate Intex estimated using 3X leverage on LTM Corporate EBITDA and a 6% interest rate.
International RAC. I project top-line growth of .92% per annum from 2014 thru 2017, assuming: .5% capacity growth, 0% RPD growth, and utilization of 77.5%, 78% and 78%. PUPM Fleet Cost & Corporate D&A remain constant with 2014 levels of $288.10 and $20.47; OPD remains constant with 2014 at $35.47; and Corporate Intex estimated using 3X leverage LTM Corporate EBITDA and a 6% interest rate.
Repo. I assume HERC is spun with leverage of 4 times 2014 EBITDA ($672MM v. $600MM 2015 guide), or $2,688 at year-end 2015; and using the above RAC projections, I estimate HTZ RAC will end 2015 with debt capacity of $3,624, for consolidated year-end 2015 debt capacity of $6,312. With $5,807 of Net Debt at 1Q15, incremental debt capacity is approximately $505MM.
Credit Suisse believes HTZ will sell its Donlen unit for approximately $520MM, and that its Car Inc. (699-HK) is worth ~$800MM. I discount the Car Inc. stake to $700MM, bringing non-core asset valuation to $1.22B.
All-in repo capacity is approximately $1.725B.
Assuming a $1B pre-spin program at a $20 PPS, and a $725MM post-spin program at $28.57, HTZ will retire ~75MM shares by year-end 2016.
Valuation. Looking out to year-end 2016, HTZ RAC is valued at 15X 2017E EPS of $2.40, or $35.93; HERC at 17X adjusted 2014E EPS of $.17 (using 404MM pre-spin share count), or $3; and YE15 to YE17 debt build of $3.33, for an all-in SOTP target price of $42.26. From the recent close, the 1.5-year IRR is approximately 87%.
Sources: Company Filings. Company Presentations. Wells Fargo. Deutsche Bank. Credit Suisse. Factset. Analyst Estimates.
Disclaimer: Do your own work