Hertz Is Driving Down A Hill And The Brake Lines Are Cut

With rental car provider Hertz (HTZ) down 80% since its 2014 highs, it could be tempting to look for a value play, especially when it was a 1,200% rally from a previous bottom that led to the 2014 peak. Despite the reduced price, Hertz is still overvalued, and the low in stock price is much different this time around. The main difference this time around is that we are not in a recessionary bottom. We are somewhere near a market top, with an economy that continues to be strong. Yet, Hertz continues to struggle. The competition from ride sharing apps represents a significant headwind for Hertz to overcome. For short trips, ride sharing apps like Uber and Lyft are often a more convenient and affordable choice. This trend is especially strong in business travel. Some trips will have too much driving involved to make Uber affordable, which provides some protection for traditional rental companies. However, startup company Turo is a platform for peer to peer car rental, like an AirBnB but for car rentals instead of rooms. Turo, in addition to Zipcar (owned by Hertz competitor Avis (CAR)), offers even more ways for travelers to bypass Hertz for services more suited to their specific travel needs. I don’t think these startups are going to make car rental companies obsolete anytime soon, but any loss in market share to ride sharing will reduce revenue and intensify competition between the traditional rental companies, putting pressure on already thin margins. It could be enough to squeeze out the weakest in the industry. Typically, a large company would respond to a significant change in their industry by investing money to better compete in an altered environment. Another option would be to acquire another company to widen their offering. Coke (KO) or PepsiCo (PEP) would be good examples of this, as they have created and acquired less sugary beverages as consumers become more health conscious. For Hertz, innovation and acquisition would be stifled by the large amounts of debt on the books. They have $17 billion of debt, stagnant revenue, and net income hovering around $500 million. (It has frequently been negative over the past few years.) Their balance sheet doesn’t seem to be in any condition to handle additional debt from an acquisition, and they certainly don’t have the cash for it. With the apparent lack of ability to make significant improvements to their business, there is risk that they could be crushed on both sides. On one side are the startups and innovators previously mentioned. The other side is occupied by traditional rental competitors who have a the balance sheet to invest in improvements that will set them ahead. Not only does Hertz have a lot of debt, but in addition much of it is in asset backed securities. As their most recent 10-Q filing shows, this debt often has a maturity period under five years, and as a result they will have to continue to cycle debt. This means that they are sensitive to any increase in borrowing expense, either as a result of an interest rate hike by the fed, or a credit rating downgrade of Hertz itself. If we divide interest expense by total debt we can find that Hertz pays about a 4.5% interest rate on its current debt. If we adjust that percentage it shows that for every .5% increase in that rate would increase annual interest expense by close to $90 million. My worry is that Hertz is caught in a downward spiral. Their massive debt prevents them from improving their core business; as a result their precarious financial situation will likely deteriorate further and lead to an increase in borrowing cost. This would make the debt even more crushing, and so on it would go. Even if the future isn’t so gloomy, I fail to see where the upside would be to make anything remotely close to a compelling risk/reward ratio. Hertz is an indebted company in a struggling, low margin industry. Personally, I am keeping my money far away from it… ….with the exception of an opportunistic put option or two. Happy investing!

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