Hertz: Downhill And Roundabout

| About: Hertz Global (HTZ)

Summary

Hertz's Altman Z score is below zero.

Net income is struggling.

Cash outflows from investing are greater than operating cash flow.

Hertz Global Holdings' (NYSE:HTZ) business is renting cars and equipment, and the stock has been struggling for over a year.

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Source: Worden.com

I would not have even glanced at Hertz if it had not been for a scan of stocks with poor Altman-Z scores and ratios of debt to equity above 5. I used I-Metrix software for the scan:

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Source: I-Metrix

Next, I performed DuPont Analysis on Hertz, both annual and quarterly, using data provided by I-Metrix and my calculations.

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Source: I-Metrix data and author's calculations

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Source: I-Metrix data and author's calculations

One odd thing while downloading this data from SEC filings via I-Metrix was that Hertz did not file any 10-Qs in 2014. This was because of accounting issues, although it did release some financial information via 8-Ks.

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Source: SEC

With some of the financial statement data missing for the quarterly reports, I arbitrarily used the last reported data point in creating the quarterly chart.

I noticed that the asset turnover is fairly stable and so the only way for Hertz to increase its Return on Equity to to increase its net profit margin or increase financial leverage. However, the highest the net profit margin has every been over that last 10 years was back in 2005. Getting above 3%, and staying there seems to be a chore.

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Source: I-Metrix data and author's calculations

This leaves only "financial leverage", i.e. debt to increase Hertz's Return on Equity which is indeed seen in the above data.

Then I took a look at Hertz's nominal net income, which ideally should have increased after the company purchased Dollar Thrifty in 2012.

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Source: I-Metrix data and author's calculations

However, there has been not much of an increase. Also, there appears to be some seasonality in the Hertz's earnings. To verify this, I preformed some econometric tests with seasonal, dummy variables and also a dummy variable for Q4 2008, which reflected the financial crisis.

Source: I-Metrix data and author's calculations using Gretl

One finds that the 1st, 2nd, and 3rd quarters are all influenced by seasonality. Net income slows down during the 1st quarter, from the 4th, picks up during the 2nd quarter, and finally peaks during the 3rd quarter which most likely reflects consumer spending on summer vacations. Investors and traders should be aware of this pattern, and not extrapolate one quarter's earnings as a change in trend.

Some investors care more about cash flows than earnings, so I also decided to look at Hertz's cash flows.

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Source: I-Metrix data and author's calculations

One finds that from 2005-2014, the Hertz had more cash outflows from investing than it had cash inflows from operations. The difference was just over $3.53 billion. Most of this difference was made up by increasing cash flows from financing by $3.35 billion.

How do the cash flows from financing break down?

From 2005-2014, net debt increased by just over $3 billion. Net equity also increased by just over $3.5 billion, i.e. Hertz was issuing more shares. Hertz, also paid out over $2.5 billion in dividends, most of it in 2005, while it was still a private corporation. Hertz also had a financing outflow of $.7 billion from the "other" line item. Overall, this created a net cash inflow to help Hertz cover the net negative cash flows from operations and investing. However, this still sits on the balance sheet today.

Some might say "That's fine. It's in the past. Now, Hertz is reporting again." Okay. Let's look at the figures which are available in 2015 after Hertz started reporting again.

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Source: I-Metrix data and author's calculations

Well, It looks very much the same. Investing outflows are still greater than operating inflows, and Hertz is again using financing inflows to cover the difference.

"What's the big deal? Cash flows from operations are positive! We only need to worry about that."

I would beg to differ. See operating and investing cash flows are strict categories for accountants, but the analyst, or portfolio manager, has to see how the company's business model actually operates. A large part of Hertz's business is buying new cars, or equipment, to rent and then selling off the older part of its fleet. I would argue the difference between what price it buys new cars for and the price it sells its old cars for functions like an operating cash outflow in practice. Have a look at this snip from Hertz's Q3 statement of cash flows.

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Source: SEC (Data from 2015 and 2014 for 9 months in millions)

Reported in that document are Hertz's cash from operations. It shows during the 9 months ending in 2015, there was a $2,683 million cash inflow from operations. Again, this is less than the $3,114 million cash outflow from investing. Cash flows from financing again made up the difference.

Very simply, Hertz's operating cash flows do not cover its capital expenditures; it has to sell the old cars for more money.

I also came across this financing arrangement which I found odd.

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Source: SEC filing, author's graphic

I think I get it straight, when I say that Hertz is the guarantor of the lessor and also a lessee. Rental Car Finance Corp. is owned by Dollar Thrifty Automotive Group (Link), and recall from above that Hertz bought Dollar back in 2012. The same executive, R. Scott Massengil, also signed the document for all four entities.

Here is what Hertz has to say about their financing from its' last quarterly report:

"Fleet Debt

HVF II

In October 2015, HVF II issued the Series 2015-2 Rental Car Asset Backed Notes, Class A, Class B, Class C and Class D (the "HVF II Series 2015-2 Notes") and Series 2015-3 Rental Car Asset Backed Notes, Class A, Class B, Class C and Class D (the "HVF II Series 2015-3 Notes") in an aggregate principal amount of $636 million. The expected maturities of the HVF II Series 2015-2 Notes and the HVF II Series 2015-3 Notes are September 2018 and September 2020, respectively. The HVF II Series 2015-2 Notes are comprised of approximately $190 million aggregate principal amount of 2.02% Rental Car Asset Backed Notes, Class A, $46 million aggregate principal amount of 2.96% Rental Car Asset Backed Notes, Class B, $14 million aggregate principal amount of 3.95% Rental Car Asset Backed Notes, Class C and $15 million aggregate principal amount of 4.93% Rental Car Asset Backed Notes, Class D. The HVF II Series 2015-3 Notes are comprised of approximately $265 million aggregate principal amount of 2.67% Rental Car Asset Backed Notes, Class A, $65 million aggregate principal amount of 3.71% Rental Car Asset Backed Notes, Class B, $20 million aggregate principal amount of 4.44% Rental Car Asset Backed Notes, Class C and $21 million aggregate principal amount of 5.33% Rental Car Asset Backed Notes, Class D. An affiliate of HVF II purchased the Class D Notes of each such series, therefore, $36 million of the obligation is eliminated in consolidation. The net proceeds from the sale of the HVF II Series 2015-2 Notes and HVF II Series 2015-3 Notes were used (NYSE:I) to repay a portion of the outstanding principal amount of HVF II's Series 2013-A Notes and HVF II's Series 2014-A Notes and (ii) to make loans to Hertz Vehicle Financing LLC, a wholly owned special purpose subsidiary of the Company, to acquire or refinance vehicles. "

Source: Hertz Sec footnote

If you are wondering what "HVF" stands for, it is:

"Hertz Vehicle Financing II LP ("HVF II"), a bankruptcy remote, indirect, wholly-owned, special purpose subsidiary of The Hertz Corporation" Source: Sec 8-K filled on Dec 12, 2015

Investors and traders should also note that Carl Ichan owns a large stake in Hertz. So far this investment has not proved fruitful. Until Hertz can have its' operating cash flow consistently above its' investing cash flow, it will not be something I would invest in. Hertz has had 10 years to "fix" its business and the numbers say that has not happened.

I have done some preliminary research into Hertz's FCFE and FCFF. I'll try and write a follow up article shortly, but so far it does not look good for the equity holders.

Too bad I did not find this stock to short sooner. With it hovering around $10 there is not much further to fall. Hertz, is even planning a spinning off its equipment business (SA article). However, if I was a manager of an "enhanced" index fund, in which Hertz was in the benchmark, I would definitely underweight this stock. Hertz bulls, your hope is in someone not looking under the hood, and buying it out. I'll not be making that bet.

Disclosure: I/we 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.