For this week’s bond review, Durig Capital ventures into the auto world to look at one of the leading auto rental companies in the U.S. and around the world. Hertz Global (NYSE:HTZ) had a fantastic 2018 and 2019 looks to be shaping up much the same.
- First quarter 2019 is the seventh consecutive quarter the company has recorded year-over-year growth.
- Total revenues were up 2% (during one the company’s historically slow quarters), up 4% on a constant currency basis.
- Revenues in the U.S. grew by 7%.
- Cash flow provided by operating activities grew by 28% over first quarter 2018.
- First quarter 2019 interest coverage of 3.4x.
Hertz has done a fantastic job addressing the former revenue disruptions from services like Uber and Lyft, and turned it into a business opportunity, creating an additional revenue stream for the company. It has rolled out a new subscription service to address the changing attitudes of transportation in many of the country’s urban areas. Hertz 2022 bonds are currently trading at a slight discount, giving them a very competitive yield-to-maturity of just over 6.5%. In light of Hertz’ solid performance in 2018 and its ability to address the changes in the auto and transportation marketplace, the company’s 2022 bonds are ideal for additional weighting in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, the aggregated performance of which is shown below.
Hertz Posts Results for First Quarter 2019
Hertz has again posted year-over-year gains for the seventh consecutive quarter. The company’s first quarter results show the positive outcomes from the company’s growth initiatives, fleet management, service excellence, as well as driving operational efficiencies.
- Total revenues were $2.11 billion, up 2% from first quarter 2018 revenues of $2.06 billion. Revenues were up 4% on a constant currency basis.
- U.S. RAC revenues for the first quarter were $1.53 billion as compared to $1.43 billion in the first quarter of 2018, representing an increase of 7%.
- Adjusted corporate EBITDA improved 93% to negative $4 million.
- Cash flow provided by operating activities totaled $514 million as compared to $401 million in the first quarter of 2018, an increase of 28%.
Hertz continues to answer the changing needs of the marketplace (read on to find out about their new subscription service and their answer to Uber and Lyft). The company has strung together consecutive quarters of growth and is now moving into their busiest season of the year, which should continue to feed the momentum built over the last 18 months.
(Source: Hertz Q1 2019 Investor Presentation)
About the Issuer
Hertz Global operates its vehicle rental business globally through the Hertz, Dollar and Thrifty brands from approximately 10,200 corporate and franchisee locations in North America, Europe, Latin America, Africa, Asia, Australia, The Caribbean, the Middle East and New Zealand. The company is one of the largest worldwide airport general use vehicle rental companies and the Hertz brand name is one of the most recognized in the world, signifying leadership in quality rental services and products. Hertz has an extensive network of rental locations in the U.S. and in all major European markets. The company believes that it maintains one of the leading airport vehicle rental brand market shares, by overall reported revenues, in the U.S. and at major airports in Europe. Hertz is also a leading provider of comprehensive, integrated vehicle leasing and fleet management solutions through its Donlen subsidiary.
Hertz New Subscription Service – “Hertz My Car”
Hertz recently unveiled a new vehicle subscription service. Named “Hertz My Car,” the service is initially being rolled out in Atlanta, Georgia and Austin, Texas. Hertz has been promoting the service as an alternative to more traditional vehicle ownership, especially in more urban areas of the country. The company cites a recent study done by Cox Automotive where 40% of those surveyed said that while access to transportation is necessary, auto ownership is not. Also, for that same study, 57% of urban respondents said that car ownership is not necessary. This study, coupled with the company’s growth in longer-term rentals, helped fuel the introduction of the Hertz My Car service. This service offers customers two tiers, one at $999 per month and one at $1,399 per month. It allows customers to exchange cars up to two times each month in order to provide the customer with the best fit transportation for their needs. The monthly fee also covers all vehicle maintenance, damage and liability protection as well as roadside assistance. Jayesh Patel, Hertz Senior Vice President of Brand described the new service.
“Hertz My Car enables customers to choose vehicles that best match their needs and offers freedom and flexibility from vehicle ownership and maintenance costs, which is especially appealing to those seeking alternatives to owning or leasing a car.”
While the program is new to Hertz, other car rental companies are also eager to jump into the subscription space. In the beginning of May, Enterprise rolled out its own subscription service. Unlike the Hertz program, there is only one level, priced at a hefty $1,499 per month. It remains to be seen how successful these programs will be in the long-term. But with the shifting attitudes in regards to car ownership, programs like these provide the consumer with additional choices in transportation.
What About Uber and Lyft?
Within the last five or six years, the presence of companies like Uber and Lyft have only increased as well as the number of people using them and their frequency of use. This model of transportation has been dubbed the Transportation Network Company (TNC) model by industry insiders. Initially, for rental car companies, the fear was that this model would have a profoundly negative impact on the number of customers renting cars which ultimately would mean lower revenues. Fast forward to present day. The impact has been much less dramatic than initially forecasted and in fact, rental car companies, like Hertz, have found a way to participate in this (relatively) new transportation phenomenon. Ironically, the company has found a new revenue stream – renting to TNC drivers.
Kathryn Marinello (left), Hertz CEO, recently remarked that renting to Uber and Lyft drivers has replaced Hertz revenue erosion from these services, and then some. In fact, in 2018 Hertz earned nearly $300 million in TNC revenues with 42,000 cars dedicated to that market. And in the company’s most recent earnings call, Jamere Jackson, Hertz’ CFO, commented that the company’s TNC business grew 84% and contributed approximately three percentage points of revenue growth through the company’s U.S. RAC segment. It’s clear that as transportation needs continue to change, companies like Hertz will continue to look for new ways to address the ever-changing needs of the consumer.
The Car Rental Market
What’s in store for the rental car market moving forward? Lucintel, a leading global strategic consulting and market research firm recently completed a report on the car rental industry. Globally, the value of the car rental industry is expected to reach approximately $99.6 billion by 2022, with a CAGR of 5.5% between 2017 and 2022. The report goes on to say that the major drivers for growth are an increase in international air travelers as well as an increase in the volume of domestic tourists. These drivers indicate that the leisure customer segment is forecast to remain the lion’s share of the market. The number of leisure customers is expected to increase up through 2022. The report also forecasts that North America will remain the largest region for car rentals. This is largely due to its highly developed road and highway infrastructure and limited public transit. Increased corporate travel is also predicted to increase car rental demand in North America.
Interest Coverage and Liquidity
Interest coverage is simply a measure of the bond issuer’s ability to service its existing level of debt. For its most recent quarter, Hertz had operating income (without the effects of non-cash depreciation expense) of $626 million and interest expense of $183 million, for interest coverage of 3.4x. In terms of liquidity, as of March 31, 2019, the company had $554 million in cash and an additional $1.0 billion on the company’s revolving credit facility.
The risk for bondholders is twofold. First, can Hertz continue to address the changes in attitudes toward not only rental cars, but transportation in general? Second, the company has bonds coming due in 2020 and 2021 that will need to be addressed before these 2022 bonds come due. The company has shown amazing flexibility to adapt to changes in the marketplace, especially its relatively new revenue stream coming from renting its cars to Uber and Lyft drivers. In addition, its new subscription service provides yet another transportation alternative for those not looking for traditional car ownership. In terms of addressing the 2020 and 2021 maturities, Jamere Jackson, Hertz CFO, hinted at the possibility of refinancing these notes when and if the opportunity presents itself. In addition, although unlikely, the company could choose to use its revolver to pay the balance of the 2020 notes if need be. Based on Hertz’ solid consecutive quarter performance and its nimble response to market changes, it does appear that the more than 6.5% yield-to-maturity on its 2022 bonds outweighs the risks identified.
(Source: Hertz Q1 2019 Investor Presentation)
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
Hertz Global has been logging consecutive quarters of growth over the last 18 months. The company has been making changes in how it does business from a technology, customer service, fleet management and operations efficiencies perspective. These efforts appear to be taking hold as the company showed great growth in 2018 and is starting off 2019 on the same foot. The company brilliantly took the Uber / Lyft model, something that had originally eaten into their revenues, and turned it to something they could profit from. As the company heads into its “peak season” during summer travel, things seem to be building to another great year for the 100 year old auto rental company. Hertz’ 2022 bonds, currently trading at a bit of a discount, still offer a very competitive yield-to-maturity of over 6.5%. With the excellent yield and the chance to provide additional diversification into the auto sector, these bonds make an ideal candidate for additional weighting in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, shown above.
Issuer: Hertz Global
Ratings: B3 / B-
Yield to Maturity: ~ 6.52%
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Disclosure: Durig Capital and certain clients may hold positions in Hertz’s October 2022 bonds.
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