Find 9.4% Yield-to-Maturity with Hertz, Bonds Mature October 2022

  • Total (global) revenues increased by 8% for the three months ending March 31, 2018.
  • Adjusted corporate EBITDA improved by $51 million year-over-year, the second consecutive quarter of improved results versus the prior year quarter.
  • Total vehicle utilization increased 430 basis points to 79%. (Higher vehicle utilization means more vehicles are being utilized to generate revenue).

This week’s bond review ventures into the auto world, specifically car rentals. Hertz is one of the leading auto rental companies in the U.S. and around the world. The company has posted three back to back quarters where global revenues have increased year-over-year. It’s most recent quarter registered an 8% increase in total revenues, with adjusted corporate EBITDA improving by $51 million. For Q1, the company also posted solid cash flows from operating activities of $401 million as well as an outstanding interest coverage ratio of 3.5x.  Hertz has also recently begun a revitalization plan to improve its U.S. based revenues, including improving its technology platforms, customer service, marketing and fleet optimization. The company’s 2022 bonds, with a yield to maturity of around 9.4%, offer a fantastic opportunity to add diversification into the retail / consumer auto industry and make an ideal addition to Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio, the recent performance of which is shown below.


Results for First Quarter 2018

Hertz first quarter results are encouraging. The massive car rental company has implemented a revitalization plan and is beginning to see the fruits of its labor.

  • Total (global) revenues increased by 8% for the three months ending March 31, 2018.
  • Adjusted corporate EBITDA improved by $51 million year-over-year, the second consecutive quarter of improved results versus the prior year quarter.
  • Total vehicle utilization increased 430 basis points to 79%. (Higher vehicle utilization means more vehicles are being utilized to generate revenue).

In addition to these points, Hertz is recapturing share in the lucrative corporate car rental space, with customer satisfaction scores across its corporate accounts higher than they’ve been in the last three years. Also, the company has increased penetration of remarketing its vehicles through higher yielding channels, with 78% of the vehicles sold in Q1 remarketed through dealer direct versus 65% in the prior year quarter. Ultimately, this brings the best possible prices for the autos Hertz needs to sell in order to keep its fleet updated.

About the Issuer

Hertz Global operates its vehicle rental business globally through the Hertz, Dollar and Thrifty brands from approximately 10,200 corporate and franchise 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.

Q1 Results Continue to Build Positive Momentum

Hertz’ solid results for its first quarter is building on a trend that has been taking shape over the past few quarters. In each of the last three quarters, worldwide revenue has increased year-over-year. This is a noteworthy turn, given that annual global revenues decreased each year from 2014 to 2016. Then, in 2017, revenues were flat as compared to 2016. The quarterly year-over-year increases are definitely a positive trend, one that company management looks to continue. In support of this goal, management has put in place a revitalization plan, primarily aimed at its U.S. operations, as this represents the bulk of its revenues.

 

(Source: Hertz 2017 10-K)

Revitalization Program

In order to build its U.S. business towards sustainable growth, Hertz has begun investing in the following areas.

  • Get the right product: By mid-2017, Hertz had right-sized its fleet, rebalanced its car-class mix and upgraded trim on models as appropriate, taking into account current consumer preferences.
  • Upgrading technology: The company’s new revenue platform, combined with its new fleet allocation system gives Hertz greater capabilities to forecast demand and deploy its fleet with greater accuracy.
  • Improve customer service: In early 2017, Hertz introduced Ultimate Choice, a program that gives customers the freedom to choose the vehicle they rent. The program has been well received and the company now has Ultimate Choice available in 45 of the top 50 airports in the U.S. Also, the company is evaluating the rental process with the goal of making it more efficient for the customer.
  • Marketing: Hertz has launched campaigns to re-energize the brands, highlighting the higher quality fleet and services. These campaigns are already driving new and higher frequency rentals.

The Car Rental Market

In 2017, the U.S. car rental industry posted record total revenue of $28.6 billion. The increase was the smallest growth increase since revenues decreased at the start of the recession. Notably, this increase was achieved on a smaller overall fleet. This in turn translated to an increase in the revenue per unit per month (RPU) of $1,091, the first RPU growth year-over-year in four years and the highest RPU historically recorded.

Smaller fleets indicate that car rental companies are learning how to do more with less. Reducing capacity (Hertz calls it “right-sizing” their fleet) is a must in order for companies to survive at this point. And Hertz appears to be doing it right. The good news here is that there has already been consolidation within the industry, like Hertz’ acquisition of Dollar Thrifty in 2012 and the Enterprise / Alamo merger. Also, the intensive capital requirement of this business presents a very high barrier to new players entering the market.

Globally, the car rental market is predicted to grow over the next few years. According to Zion Market Research 2017, the outlook for the next few years in the global car rental industry is bright. In 2016, the market was estimated to be $58.26 billion, and is expected to grow at a CAGR of around 13.55 percent between 2017 and 2022. By 2022, this market is expected to reach approximately $124.56 billion.

Financials

Interest coverage is of paramount importance to bondholders as it indicates a company’s ability to service its existing debt. For the most recent quarter, Hertz Global had operating income (without the effect of non-cash depreciation) of $593 million and interest expense of $166 million for an interest coverage ratio of 3.5x.

Hertz also posted outstanding cash flows from operations for the three months ending March 31, 2018 of $401 million.

On the liquidity front, as of March 31, 2018, Hertz had no drawings on its corporate senior revolving credit facility, with almost $1.6 billion in corporate liquidity.

Risks

The default risk for bondholders is whether Hertz can continue its revenue turnaround and maintain the momentum it has built over the past three quarters. It appears Hertz has arrested declining revenues and begun to turn the tide. Corporate accounts are increasing, customer satisfaction is on the rise, the fleet has been appropriately adjusted and refined, and the company has become more efficient in managing its fleet demand. Considering these recent changes, the 9.2% yield to maturity on the company’s 2022 bonds, appears to outweigh the risks identified.

In 2018, Hertz has estimated its interest expense will increase by approximately $45 million due to the percentage of debt it holds with variable interest rates (approximately a third of its total debt). As interest rates continue to increase (as they are predicted to do in the short term), the increased interest cost could affect profitability.

Also, an important part of Hertz business is being able to sell the used cars from its fleet that it needs to replace on the open market. Values in this market fluctuate, affecting resale values for used autos. Used vehicle residuals were strong in the first quarter, but even a small decrease in the prices Hertz is able to secure will likely have a significant effect on the bottom line.

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 is the oldest, and probably most recognized car rental company in U.S. Management has been able to reverse the declining revenue trend of the last few years and begin to show year-over-year improvements for the last three quarters.  The new initiatives put in place in the past year –technology, customer service, marketing and right-sizing the fleet – are beginning to take hold and show results. The company’s 2022 bonds, couponed at 6.250% are presently trading at a discount resulting in a very competitive yield-to-maturity of about 9.4%. With the excellent yield and the chance to diversify into the retail auto / auto rental sector, these bonds make an ideal addition to Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio, the most recent performance of which is shown above.

Issuer:  Hertz Global
Ticker: NYSE: HTZ
Coupon: 6.250%
Maturity: 10/15/2022
Ratings: B3 / B
Pays: Semiannually
Price:   89.25
Yield to Maturity: ~9.4%

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About Durig Capital

Durig Capital provides investors with a specialized, transparent fiduciary service at a very low cost. Our FX2 (Discretionary Management) Portfolio over time has greatly outperformed our FX1 (Non-discretionary) Portfolio, giving significantly higher (at times double) the returns of FX1. Our professional service enables access to a broad spectrum of bond, high yields, and lower price points that are often found in less efficient markets, but not evidenced in many bond services.

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Disclosure: Durig Capital and certain clients may hold positions in Hertz Global’s October 2022 bonds.

We track thousands of bond issues and their underlying fundamentals for months, sometimes years, before finding any that achieve or surpass the targeted criteria we have found to be successful.  Our main priority is to provide the best opportunities for our clients.  Our bond reviews are first distributed to our clients, then published on our website and our free email newsletter, and lastly on the Internet and distributed to thousands of prospective clients and competitive firms. Bond selections may not be published if they have very limited availability or liquidity, or viewed as not being in the best interests of our clients. When high yielding bonds with improving fundamentals are acquired at lower costs, Durig Capital believes that investors will appreciate earning higher incomes with our superior high income, low cost, fiduciary services.

Please note that all yield and price indications are shown from the time of our research.  Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports.  We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.

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