Contributing to these numbers were a number of good operational trends in the Hertz business -
- Cost savings continuing
- Labour efficiencies up again
- U.S. revenue per transaction and transaction duration improved
- Improving utilisation/general metrics in Europe driven by the leisure market
- Continued good performance by the equipment hire business
- Dollar Thrifty integration continuing to plan
- Feeling good about the residual market, shifting more to retail to try to get higher prices
This all sounds very positive. Even the inevitable slowdown in government spending with the company had a good message about market share wrapped around it. To quote the Chairman and CEO Mark Frissora on the conference call -
Anything that's related to the government, as well as the government business itself, has been weaker. Those accounts that are tied to the government are traveling a lot less, and so overall, that's -- those are the primary drivers. It's more of a economy; it has nothing to do with Hertz. We're not losing share or anything.
So why the skepticism of my title?
First the company got itself in a bit of a mess on the issue of forward pricing guidance on the conference call. The official line is flat pricing and 20% volume growth in the worldwide rental car business. Some analysts suggested this was an unlikely combination of numbers. It left me with the feeling that something has to give to really drive revenue forward.
Second, there was very little in the Q&A on the conference call regarding the balance sheet which remains, in my opinion, stretched.
As the slide below shows, the company made a big thing out of flat GAAP interest expenses as a percentage of revenues. However, look below and see that thanks to a combination of the Dollar Thrifty acquisition in the last year and quicker fleet growth, interest expense is rising.
Now the company has until 2016 until it has meaningful maturities of any of its bonds and it retains in some scope the ability to save on debt costs, at the margin, through new issuance and the retirement of old debt but big picture, I still find the interest cover the company is operating at a bit of a worry.
Including adjustments, interest cover during H1 2013 was just x1.8 and even excluding adjustments this figure only rose to around x2.5.
This was accentuated by the poor cash flow generation in the first half due to the continued high level of investment in the fleet due, I believe, to the older average age of a Dollar Thrifty vehicle. To be fair the company is still guiding to US$500m+ of free cash flow in FY13 (see below). This is a big turnaround even beyond normal seasonals and accelerated capex influences.
Slippage on the cash flow generation is not good news for the debt metrics, which even with full synergies from the Dollar Thrifty integration will be running over x3 EBITDA.
Using the company's financial guidance (below) in combination with the corporate debt numbers only (I make an assumption that fleet debt is at least asset backed and in extreme situations vehicles could be sold and free cash flow guidance above, I estimate that the company trades at around an EV/ebit of x15.8 (market cap of c. $10.5bn + $10bn of corporate debt minus $0.5bn of free cash all dividend by $1.3bn in pre-tax earnings). This feels a rich valuation to me.
The market, of course, could be anticipating the achievement of the 3-year plan (2013-15), which was unveiled at the investor day earlier this year. Using the $2.3bn in adjusted pre-tax earnings estimated below for 2015 does give a forward EV/ebit rating of about x9 EV/ebit. My personal view is that the semi-cyclical nature of this company means a fair value would be around x10 EV/ebit. So on a flawless execution I believe you have 10-15% upside cumulative in a couple of years.
The rationale for the Dollar Thrifty deal and integration is shown in the chart below but to me the other creeping concern remains the rise of the value segment in these times of austerity.
So, in conclusion, following the strong increase of the shares over the last year, I can see limited value in the shares unless you believe in flawless execution of the 2015 plan (and factor it in heavily now). The shares closed on Monday in the low $26s. I believe a fairer value today is in the low $22s before taking the time for another review. This would still be a premium valuation but would be a level attracting technical support (April 2013 low).
(click to enlarge)