Looking at Hertz, it seems like they are buying back stock and claiming huge FCF at the Corporate level. This is interesting for a couple of reasons. One it seems like the stock is down a lot, and its rare for companies to buy back stock when the price is down. Second, the company very clearly delineates between corporate debt and fleet debt. Also it guides to Corporate EBIDA.
What confuses me though is that the market cap is for the entire company. In other words, the company is responsible for fleet debt and takes credit for EBITDA generated off the fleet too. So while fleet debt is non-recourse, operationally it is part of the company.
My preference is to value the company including fleet debt and using the entirety of the income statement. What makes Hertz interesting is that it has financial leverage (which it can dial up or down) but operating leverage is relatively low.
Business model: Cyclical. Commodity. Financial leverage is significant. Economically sensitive. Competition from Uber. Thin net margins, although Gross Margins are healthy at 45%. The buy cars on debt and hope to rent them out to make up for interest costs and depreciation. This kind of business does well during market up cycles and gets destroyed during down cycles. 2008 there were huge impairment charge as they sell cars into a soft economy due to overfleeting. At it's low market cap was $1.6b.
Valuation: Market cap $3.9b. Debt $15.9b. EV $19.3b. Corporate debt at $6b, Fleet debt at $10b.
Gross margins are stable, SG&A is between 9-10% (somewhat scales with revenues), D&A expense varies depending on fleet size. So net income margins are volatile. Operating income margins hit a low of 7.4% in 2008 and a high of 16.5% in 2013.
The big positive is there aren't big factories that would lead to huge negative Gross or Operating Margins. The negative is it's a cyclical commodity levered (financially) carry trade on the transportation sector.
So, in a downturn, this can fall to very low market cap levels and potentially go bankrupt given their corporate debt. It's unlikely because they can sell off cars and equipment at HERC to shore up liquidity. So they can probably ride through recessions.
Airport vs. off airport and leisure vs. business
Hertz provides a nice split of revenues between on and off airport locations by dollars and volumes. The 10K also shows the split between leisure and business.
Leisure is 66% of the travel, business is 34%. Airport is 74% and off airport is 26%. By profitability, I wouldn't be surprised if Airport was 90% of profitability. By transactions, airport is even higher.
This is important for a couple of reasons. 1. Airport traffic can be very cyclical and so there will be a correlation between economic growth and Hertz' profitability. This will get crushed during period of slow travel air travel since 90% of profits come from airports 2. Uber doesn't really disrupt the airport business at present since airports tend to be far from city centers, where Uber dominates.
Since 66% of the travel is leisure, the stock will also be driven by consumer spending. Airport + Leisure means car rentals are going to be volatile and cyclical.
When to buy?
Watch for impairment charges after recession. That's when you start nibbling. No way to determine fair value given sensitivity to economy but sub $2b market cap, you should start accumulating.
Right now because of cheap debt, fleet capacity is too high and pricing is showing weakness. Wait for either rock bottom stock price or improving pricing environment.
HERC Corporate presentation
Herc just released a corporate presentation, presumably pre spin to provide more clarity on their business and financials. Non deal presentation as its termed.
HERC is generally a small part of HERTZ's overall business. Approx. 14% of $10.5 revenues in 2015 came from equipment rental. 82% of revenue earning equipment is rental cars.So approx. $1.47b of 2015 revenues are equipment rental. EBITDA margins are similar to RAC at 36%. It's hard to say what the market cap of HERC should be when it is listed, since much depends on how much debt (Corporate and fleet) gets moved over. It doesn't much matter, unless you're trying to do some kind of SOTPs analysis, which is not my preferred approach to investing.
Again these guys focus on Corporate EBITDA, which is weird and I prefer to look at the whole company. The argument for the spinoff is that the RAC business is very valuable but the valuation is obscured by the very cyclical HERC business. I don't buy it. The two are very similar in terms of how they make money. Of course, they fundamentally operate in different markets, so perhaps there's an argument for separation there. But the main business in both cases is rentals.
Oil & Gas is experiencing a brutal downturn, so business is down a lot there. 33% on some counts. What is interesting is the strength in the non-O&G segment, which is showing growth in the double digits. That's interesting.
HERC claims to have $2.94b in Tangible Book Value. That's fair but it is probably backed by a fair bit of debt too (they haven't specified yet but it will be substantial since the parent has something close to $17b of debt, $6b corporate).
Like RAC, this is a very levered cyclical market. Equipment rental is probably here to stay but I can't help but think this business is basically a levered carry trade on the equipment rental business. Since it is so scalable, and cheap debt has lead to high levels of fleet levels, there needs to be some capacity rationalization before pricing firms again.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.