One of the more notable earning reports and subsequent market reaction came from Hertz Global Holdings (HTZ). In an after hours press release on November 4th, the company posted better than expected top and bottom line numbers for its third quarter, while re-iterating its earlier lowered guidance for the rest of the year. In the pre-market of November 5th, ahead of the earnings conference call with the management, shares traded a few points above the earlier close of $23.80. Following the call, shares took a major tumble - a whopping 17% from the day before on more detailed commentary regarding near-term issues facing the company. After recovering partially in the afternoon session from the $19.73 low, shares have been oscillating in the $21-22 price range. So what caused the original reaction and was it a panic sell, or is there much likelihood we'll revisit the prior week lows?
Results in Brief:
For the most part - the results came in very decent. U.S. off-airport operations generated 11% revenue growth and Donlen Leasing increased 10%, while HERC NA equipment rental segment grew 12.3% (adjusted for FX). Overall, U.S. rental revenue was up 33% on higher volume and 2% in pricing. International operations generated 11% revenue growth and 265 bp margin expansion. Both transaction days and pricing were up - 6.4% and 3.4% (excluding Firefly discounts).
Operationally, company is on track for its forecasted revenue and cost synergy realizations from Dollar Thrifty (DTG) acquisition - with $100 (of $120) million and $95 (of $140) million recognized in each segment respectively.
In summary, most important business aspects have improved. Revenue growth was strong, margins expanded and overall volume and pricing also improved year-over-year. Unfortunately, the few negatives in the report have significant potential impacts - meaningful enough to have caused the short-term overselling reaction that has been witnessed.
Transaction Days, Over-fleeting and Depreciation:
One negative result - the flat year-over-year growth in largest business segment - the airport rental service. The impact in this segment has caused the original drive for lowered guidance in September, as government shutdown and related impacts caused much lower business-driven volumes. In the third quarter revenue-per-day increased 2.5%, but was offset by lower transaction days which "declined nearly 3% YoY ... versus forecast of a 4% increase". Growth expectations which were based on 2013 GDP growth estimates as well as 2012 actual growth clearly turned out overly optimistic, leading to a 7% spread between guided and actual figures as well as 300 bp decline in fleet efficiency. The decline was further escalated by "loss of fleet-sharing efficiencies" on Advantage divestiture as well as "unusually high amount of fleet subjected to manufacturer recalls". As a result, "most of the $60 million impact actually flowed through to pretax income".
As a result, management is forecasting further impacts to efficiency from additional recalls in fourth quarter, and increases in depreciation "up 1% to 2% for the full year instead of down 2% to 3%" as the company is working through these over-fleeting issues.
The other major piece of news - bankruptcy protection filing intent announced by Advantage brand which was earlier spun off from Hertz. The issue comes to the sublease agreement - Hertz will come into possession of all loaned out vehicles and plans to "sell those mark-to-market". The likely impact is the impairment that company may have to take on these sales if the transaction prices come in below the book value accounted for within company assets.
These two issues while potentially minor could actually turn out into major headaches for the company and investors. And it is not surprising share price took a dive the day after release.
While the over-fleeting and airport volume declines have already been factored in the September guidance, it is none the less a significant aspect as it raises concerns about the U.S. airport traffic real growth rate. I guess the question to raise is whether the miss a one time event driven by government shutdown concerns and related business travel slowdown, or if the 3% decline in Q3 2013 is the logical correction to the 3% overshooting in Q3 2012.
The Advantage issue is a hit to potential earnings as well as shareholder equity, further escalated by the short-term overlap with the company having to reduce its own fleet as well as liquidate the vehicles coming in from terminated sublease. Advantage has also made "allegation about Hertz's involvement in their liquidity issues" putting further pressure on the situation.
In the fourth quarter, company expects further recover in equipment rental and recovery in European volume and pricing. In the U.S. airport volume and pricing seems to be increasing as well. These positives, as mentioned, will be offset by increased vehicle recalls, increased depreciation and whatever financial impacts encountered from the Advantage litigation.
I think Hertz CEO, M. p. Frissora stated it best in his commentary: "As we work through these short-term issues, we remain focused on the big picture, and there, nothing has changed".
No matter the size of impacts from de-fleeting and potential impairment encountered after liquidating subleased vehicles - these events are one-time and unlikely to cause major long-term issues for the company's performance.
In fact, looking out into the future, business model appears to be robust and capable of growing shareholder returns. Major revenue drivers - volume and pricing - continue to grow, expanding margins and giving company leverage. Hertz also continuously innovates and keeps pulse of latest technologies and market trends.
From the valuation perspective, the revised 2013 guidance for adjusted net income is lower by $50 million - right inline with earlier Q3 impact commentary, meaning that company does not expect any adjustments to fourth quarter results. And from valuation perspective - at $1.73 EPS midpoint for 2013, P/E stands at 13.3x and if company maintains double-digit growth into the future - trades at the PEG valuation of roughly one, suggesting at least a fair valuation at present price levels with little downside.
For a long term investor looking for multi-year value aggregation I think Hertz is a definite portfolio must have. I myself have initiated positions in the $22.50 range at the time of original fallout, and added twice more after the conference call panic - once at $22 and yet again at $20. I believe the come back into the $25-26 range is likely as more clarity is introduced on airport volumes in the fourth quarter and as Advantage bankruptcy resolution progresses.
On the Contrary:
To balance out on my commentary, I would like to cite a fellow article presenting an opposing, yet as much justified argument for why Hertz is richly valued at this time and may need to be avoided in the short term.