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Summary

  • Hertz announces that it has to re-state its financial statements for the past three years.
  • Accounting issues appear serious, although they don't affect the main depreciation charges on the fleet, yet.
  • A premium valuation and challenging conditions make it very easy for me to pass on this.

Hertz (NYSE:HTZ) had a nasty surprise for investors on Friday announcing that it found severe accounting errors which require the company to restate its financial statement for the past three years.

I already found shares not appealing, and the latest revelations obviously don't improve the investment case for Hertz.

Accounting Restatements

On Friday, Hertz announced that it was forced to restate its annual results for the past three years.

On the 13th of May, Hertz already announced the delay of the 10-Q Form filing for the first quarter. Hertz announced that errors were identified which relate to the capitalization and timing of depreciation for non-fleet assets as well as allowances for doubtful accounts in Brazil.

Recent investigations found additional errors for uncollectible amounts for obligations for damaged vehicles and restoration obligations. Unfortunately Hertz has not quantified the size of these errors.

The Audit Committee of the Board of Directors concluded that financial statements for 2011 are no longer reliable and require a restatement. As a matter of fact, the financial statements of 2012 and 2013 would have to be adjusted as well.

First Quarter Delay

Based on the findings, Hertz will amend the 10-K filings to correct the errors and disclosures. The 10-Q first quarter form will be filed at the same time the 10-K filings will be amended. This means that the conference call for June 9 will be not be held. No new date to release the final first quarter results has been set as of yet.

Originally, Hertz already scheduled its earnings report on May the 7th, but at the time, it already had to delay the quarterly earnings report after finding irregularities. Adjustments for doubtful accounts in Brazil would reduce earnings in 2011 by an amount ranging from $10 million to as much as $174 million.

The accounting problems have revealed at least one material weakness in internal controls for its financial reporting and disclosure controls. The company is in the process of implementing new procedures and control to strengthen its accounting and finance departments.

While the outcome of the restatements is still unknown, Hertz anticipates that the first quarter results will come in below consensus. This is not due to accounting restatements themselves, but rather reflects additional costs incurred with the accounting review, as well as certain anticipated operating results.

Update For The Operations

For the first quarter, Hertz sees U.S. rental car revenues increasing by 4.5%. Residual values are stabilizing and better-than-expected, yet they are still down year-on-year.

Total revenues per day are down by 1.6% due to the excess fleet which created greater supply, while the loss of the Easter holiday impacted demand as well. Actions to reduce the fleet are expected to drive the sequential improvements in fleet costs in the second quarter.

International rental car revenues were up by 1.7% as conditions in Europe improved and the company opened 12 new airport locations. Strong improvements in fleet efficiency boosted the productivity, offset by higher insurance claims.

Equipment Rental

The equipment rental business ¨HERC¨ has been in the process of transitioning into a new publicly-traded company. The efforts for the accounting issues could delay the separation, although work for the separation remains on track, according to Hertz. The capital intensive business is divested under pressure of high-profile investors who push Hertz on boosting its capital efficiency.

Worldwide equipment rental revenues rose by 2.4% on the year before, driven by the strong performance of the North American operations.

Implications For Investors

The second largest U.S. car rental firm has seen real struggles to benefit from the economic recovery despite the fact that it controls nearly the entire market alongside competitors Avis Budget (NASDAQ:CAR) and Enterprise Rent-A-Car.

Following the 9% decline in its share price, shares in Hertz now trade in the red for the year. Retail guys are not alone in those suffering from the news. Prominent investors like Daniel Loeb have positions in the stock as well, anticipating the proceeds from the divestment from the equipment rental business.

The spin-off from the rental business should raise $2.5 billion, which could be used to reduce debt and finance a $1 billion buyback program.

At the start of the year, I last took a look at the prospects for Hertz. The company adopted a poison pill at the time which sent shares 10% higher after the company noted unusual and substantial trading activity in its shares. This could possibly relate to trading from Dan Loeb's Third Point Capital.

At the time, I remained very cautious given the leverage and premium valuation. Overall, shares have not really moved since that time, while the market has been grinding up. The latest big red flag obviously does not help the investment case.

I remain on the sidelines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Hertz - More Problems On The Horizon As Accounting Problems Continue And Worsen