Description

HTZ Value Investors Club Write Up February 2022                                                                                  

Hertz is a compelling and undervalued post reorg equity story with meaningful catalysts and a compelling short and long term investment case.

Rental cars have fully exited a painful period plagued by a broken oligopoly pressured by market share losses to ride hail and mismanagement at HTZ. The industry has entered a golden period of extremely tight supply / strong demand, structurally higher margins (and eventually multiples), and positive optionality around the future of mobility.

HTZ has exited Ch. 11 totally deleveraged with a much stronger management team and sponsorship vs pre covid which along with a very favorable operating environment gives opportunity to fully turnaround HTZ to be a best-in-class franchise.

·         Stock scenarios (% change from $18.35/sh):

o   Bear case: $16.60 (-10%) – Assumes 7.5x a $1bn EBITDA figure which gives HTZ zero credit for improvement vs pre covid levels (other than on costs)

o   Base case: $26 (+44%) – 7.5x normalized $1.6bn of EBITDA 

o   High Base case: $34 (+84%) – 9.8x our base case normalized of $1.6bn of EBITDA (~12.8x p/e) or 8x sponsor EBITDA of $2bn

o   Bull case: $40 (+125%) – 10x sponsor EBITDA of $2bn

o   Future of Mobility: $70/sh (+280%): 10x sponsor $2bn EBITDA + 5x multiple on $2bn revenue for autonomous fleet servicing by 2030

·         Catalysts:

o   2022 results / execution

o   Buyback execution / upsizing

o   Equity index inclusions

o   Potential M&A target (longer term)

Summary

·         HTZ and the car rental sector broadly are positioned to perform extraordinarily well in the coming years and it is a far better industry than investors realize

o   Oligopoly market structure can finally get sustainable pricing power with vehicles likely constrained for the foreseeable future

o   HTZ’s management / sponsorship has seen significant upgrades that are crucial to our confidence in the company

o   New partnerships with Carvana, Uber, Tesla, and Amex Global Travel position the company to execute at a much greater level

·         We project 2022 EBITDA at $2.9bn vs ~$2.1bn consensus as we expect very strong demand, limited supply of new vehicles for rental car companies, and continued elevated used car prices

o   We believe Supply / demand imbalance only going to get more favorable for car rental companies in 2022 and 2023 headwinds will be very manageable

o   Used rental car prices per Blackbook on a mix and mileage adjusted basis are up ~70% vs pre covid levels – providing massive gains that will flow through in lower depreciation than the street models which will flow through to FCF / share buybacks

·         Cash flow generation and the deployment of that capital in the near term will far exceed expectations

o   We believe HTZ will generate enough cash through operations and a very modest amount of leverage to be able to buy back the equivalent of 90% of the current float (~54% of total shares) in 2yrs

o   Our sense is that the sponsor may view the shares as undervalued at current levels and look to deploy excess cash into share repurchases

Further Details                                                                                                                                                           

 Tighter Vehicle Supply in 2022 vs 2021 – Supply Picture Won’t Materially Improve in 2023 Either

·         We believe the market is materially underestimating just how massive the deficit is in total vehicles today and how that will drive an extremely tight rental car supply picture at least through 2024

·         We project sales into daily rental in 2022 will be 75% below 2019 levels and down 43% vs an already depressed 2021 (was -61% y/y In Jan ’22), and we expect much lower than trend sales into daily rental for the foreseeable future

·         New vehicle production is running strong enough today only to supply a SAAR of ~14.5mm vs ~16-17mm underlying demand --- we believe OEMs will greatly prioritize vehicles to consumers before rental companies given much higher ASPs

·         New retail vehicle inventory on dealer lots are down ~2.5mm units vs pre covid levels – and much of this inventory will be rebuilt before rental companies get meaningful supply

·         Supply into rental car companies in 2021 was 726k vehicles (-58% vs 2019), which we believe was far more than OEMs would have supplied had they known about the chip shortages and surging consumer demand

o   OEMs made agreements with rental car companies to supply vehicles for 2021 (in particular Avis) in ~ August/Sept 2020 when there was uncertain retail demand and no known chip shortage issues (IHS only started revise down production forecasts starting in March 2021, with most material reductions to production forecasts occurring in the summer/fall of 2021)

o   By the fourth quarter 2021, new deliveries into daily rental were down 88% vs 2019 levels – we believe this is how 2022 will look as OEMs look to prioritize retail customers

·         Rental car companies need to replace existing aging fleet as 2022 progresses, leaving minimal capacity for vehicle purchases to expand fleets (in 2020 and early 2021 vehicle age by month was less relevant given very low utilization)

o   Fleet dispositions stepped down materially in 2020-2021 vs historical levels, meaning existing fleet increasingly needs to be replaced rather than having fleet purchases add to fleet

·         We expect even to hit our targets for total rental fleets that rental car companies will need to significantly increase their purchases of used vehicles (to expand fleet and refresh from very old vehicles). Purchasing used vehicles is much more operationally complex given reconditioning requirements – rental companies will only endeavor to do so because of the extraordinary pricing environment that we expect to continue

·         Given the ability today to add fleet with used vehicles, we believe current industry pricing is more reflective of pricing when new supply frees up than many investor realize

https://www.autorentalnews.com/10159278/rental-fleet-sales-for-2021-the-final-tally?utm_source=email&utm_medium=enewsletter&utm_campaign=20220112-NL-ARN-Reporter-BOBCD220106003&omdt=NL-ARN-Reporter&omid=1102367043&utm_content=01&tracking_number=BOBCD220106003&oly_enc_id=7465D4075934G6R

Higher Demand 2022

·         We see overall rental car demand returning to 2019 levels in 2022 while fleets will only be at 85% of 2019 levels – this supply/demand deficit appears unlikely to close meaningfully over the next few years

·         For the full year 2021 TSA volumes reached only 71% of 2019 levels and hit peak seasonal rental demand period of the summer months at just ~75% – we expect this to hit 96% in full year 2022 which compares to recent pre-Omicron peak of ~90% and today’s level of ~85% today

·         The very quick, and very widespread Omicron wave will accelerate growth in travel demand as the wave subside (we estimate 60% of US population will have been infected in just this past winter’s wave assuming 1/6 ascertainment ratio)

·         Prior to the start of the Omicron wave TSA volumes were tracking at 85% of 2019 levels and headed higher. Forward airline bookings data came down materially during Omicron wave but has been rapidly accelerating recently and we expect TSA throughput to approach pre covid levels for the full year

As we look at 2023 and 2024 we project volumes will well exceed 2019 (due to trend growth) but that rental fleet growth cannot pick up, leading to significant supply deficits vs underlying rental demand persisting  

Risk To Pricing for 2022 is Higher y/y – Current Peak Pricing Concerns Misguided

·         Given the supply demand picture we expect in 2022, we expect there’s significant upside risk to our flat y/y pricing – while consensus has pricing down 6% y/y

·         The market has been concerned that Avis’ 4Q’21 pricing miss as a sign that pricing has peaked, but we disagree as we believe the seasonal weakness in volumes typical of 4Q (Avis normally down 18% q/q in 4Q volumes) combined with rental cars inability to re-fleet (so didn’t de-fleet as much as normal seasonality) meant that there was a very short term negative shift in supply / demand that will reverse starting in the 2^nd half of 1Q as demand ramps (we have TSA in 1Q volumes ramp

·         Further most models (including ours, for illustrative purposes to represent a more normal environment) have pricing correcting significantly in 2023 – but we expect the supply / actual demand imbalance to be just as favorable – meaning pricing could remain at current elevated levels in 2023 and beyond

·         While large corporate volumes will rebound in ’22 and come in at contractually lower prices, this will just push down vehicle availability and raise prices for the remaining renters (leisure and small business)

Used Car Prices Are Still an Upside Driver – Not a Risk

·         Throughout the restructuring of HTZ investors have materially underestimated the impact of that trailing movements in used car prices would have on HTZ and we believe they continue to underestimate this

·         New and used cars prices have structurally inflated given elevated input costs – this should feed through to a permanent uplift in the value of HTZ’s existing used fleet that’s very meaningful – we model an additional ~$960mm of value flow through in 2022 from lower than normal depreciation despite assuming a ~18% reduction in used car prices (vs Ally predicting 15-20% decline over 2 years and Cox at -3% for Manheim index overall at YE ’22)

·         Elevated used car prices in our view our a misguided concern as there is ~$3bn imbedded gains today in the fleet value vs book value that can offset expected price depreciation

o   In the US fleet ABS disclosure you can see that there are $8.3bn of used vehicles by book value compared to a market value (assessed monthly by Blackbook and NADA) of $11.3bn. We believe that book value in the ABS approximates the GAAP book value as well. 

·         Higher purchase prices for new and used vehicles going forward will be offset by stronger used car prices than historical and are built into the significant cushion we imbed in our model (-17% reduction in values vs current prices)

·         Our free cash flow already incorporates incremental fleet equity required to rebuild their fleet

Industry Structural Oligopoly to Maintain Pricing Power Regardless of Vehicle Shortage Issue

·         We expect pricing power realized post covid to be maintained

o   Car rental industry is an attractive and consolidated industry with three major players dominating the market (industry consolidated through M&A over time – completed in early 2012)

§  HTZ, Avis and Enterprise fairly evenly split the on airport car rental market with no other scaled players (while Enterprise dominates the insurance replacement market)

o   Despite a very consolidated industry there had been no meaningful price gains over time (vs other travel industry with material price gains)

§  Rental car pricing per day from 2010-2019 was flat

§  As comparison, from 2010-2019 average hotel room night as measured by Bloomberg and STR was up over 30% and airline pricing was up 40%

o   We blame the historical lack of pricing power on (1) incremental volumes moving to ride hail in the 2015-2017 period when enplanement volumes exceeded industry rental volumes and (2) historical mismanagement at Hertz

§  Ride Hail had meaningful impact on volumes at first, but as Uber/Lyft expanded to new locations the incremental impact on rental demand from ride hail usage at airport has decreased meaningful (no discernible impact on industry in two years prior to covid)

§  Historical mismanagement at HTZ is too long of a story to tell here, but we believe poor tech systems + incompetence by several mgmt. teams led to market share losses and continuous over-fleeting situation at HTZ  which they tried to make up for buy buying unprofitable business (State Farm contract, discount opaque channels, small vehicles)

o   As you can see in the chart below, pricing on average was much worse in the 2015-2017 period when rental volumes meaningfully underperformed TSA enplanements – by 2017 the volume deficit had reached approximately ~10% - which is incidentally is in line with our rough estimate of the amount of volume that would leave rental for ride hail

o   Modest US pricing power returned to positive in 2018/2019 when volumes overall tracked in line with air traffic volume

o   Coming out of Covid we have a set-up of demand likely exceeding mgmt. planning expectations for the next few years driven by strong rebound in travel, particularly leisure

o   See chart in Appendix for data from a corporate expense mgmt. company that showed mkt share losses in ’15-17 in particular to ride hail 

Hertz Profitability to Reset Structurally Higher Post Reorg

·         HTZ and Avis have meaningfully under-earned their biggest peer historically and we see room for HTZ to close the gap

o   We believe Enterprise has historically operated in the ~20-24% EBITDA margin range, far higher than peers HTZ and Avis

§  Enterprise has had decentralized business model incentivized regional performance with a very strong management team

§  Enterprise has also viewed rental car industry as used car manufacturing with a very strong focus on driving profits through the buying and selling of vehicles (vs HTZ and Avis which have historically just viewed vehicles as a cost center)

·         Coming out of past structural demand shock crisis + consolidation many other related industries have gone on to be much more disciplined and reset to structurally higher margins

o   Airlines coming out of 9/11 and ’09 financial crisis

o   Auto OEMs + suppliers coming out of 2009

·         Over time we expect HTZ EBITDA margins will approach Enterprise’s historical margins will be structurally higher than pre covid

o   Operating cost saves of $200mm net achieved already, with a further ~200mm of opportunities from improved tech systems (and reduced labor from counter-less renting) 

o   Lower fleet leverage / interest rates

o   Operational price efficiencies (already implemented) including $30/month of contract exits, $15/month of mix shifts, and $50/month of revamped counter agent incentive programs

o   Partnerships (improved volumes through Uber, lower depr through Carvana, and more utilization / better pricing mix through Amex GBT)

Industry pricing power would be on top of our 2023 estimates Over time we believe HTZ can approach Enterprise’s historical margin range on a normalized basis

Multiple Expansion, Mgmt, and Partnerships Opportunities

·         Multiple expansion warranted

o   Historically Avis (more stable of the two) has traded at ~7.5x EBITDA which we believe is reflective of the poor industry dynamics, low margins, and very high leverage

o   With the industry delivering higher margins and cash flow generation with strong pricing power they will deserve at least low teens p/e multiples (translating into 8-10x EBITDA)

o   Past multiples compressed around concerns of disintermediation, and we believe they now deserve a small premium given positioning for growing along side new forms of mobility

·         Sponsors + Mgmt upgrades

o   One former GS exec who worked with Scherr noted to us that he was one of the best executives he worked at in his career and would be a terrific asset to Hertz

o   We have received extremely favorable views on Certares ability to operate in the travel space and execute on turnarounds 

o   In our deep dive of HTZ over the last two years we have been increasingly convinced that what HTZ needs is very intelligent leadership that can recruit a strong team around them – we think Certares/Knighthead and Scherr put Hertz in a fantastic position

·         Partnerships can help transform this business over time

o   We are big believers in Carvana offering a superior used vehicle distribution platform than any alternative and that with Carvana’s brand and technology Hertz can much more profitably buy and sell vehicles to structurally bring down vehicle depreciation

o   Deal with Tesla sets HTZ to be the only scaled provider of EVs in the mobility space for the next two years

o   Amex GBT partnership allows HTZ to access much more profitable small business rentals to improve mid-week utilization at better rates than large corporate

Strategic Assets / M&A And the Future of Mobility

·         On top of being fundamentally undervalued on today’s rental car opportunity set, we believe HTZ also offers a meaningful option on the future of mobility

·         With HTZ’s exclusive Uber deal and very large Tesla order book we expect they will be well positioned as the first mover at any material scale in offering an electric vehicle ride hail service network – no other provider will be able to off

·         While we can debate the timing and likelihood of autonomous taxi services, the TAM can be extraordinary large – at $1/mile and assuming just 3% of miles traveled by 2030 are in autonomous taxis would imply a top line market in the US of ~$113bn – assuming HTZ offered a 20% share of servicing this network of vehicles and 10% service fee would imply future revenue of ~$2bn p.a. for HTZ which would be growing rapidly (at 15% of miles traveled and 0.50/mile the TAM will increase 3x by 2035)

·         VW purchase of Europcar shows OEMs believe these are strategic assets

o   We believe VW has great ambitions for the US and would be interested in purchasing HTZ down the road as well

o   From VW’s investor day prior to announcing the acquisition of Europcar:  "We believe that the car rental business is a cornerstone for a scalable and profitable mobility business. In order to further accelerate our growth in this field, we're evaluating make buy, or partner options."

o   There are over 10 meaningful OEMs in the US today and only 3 rental car companies – it only takes one OEM believer to see HTZ sold to a strategic investor on this theme 

Appendix Charts                                                                                                                                                        

Historical Consolidation Chart

Certify Business Travel Expenditures Mix [Old Chart- Illustrates Mkt Share Losses in ~2015-2016 time frame]

Certify market share losses shown here likely exaggerate the actual share loss for Rental car as rideshare was likely

expanding the market in absolute terms, not just gaining share. But still we think its illustrative of some of the share losses

that occurred in 2015-2016. Not shown here but by 2017 the mix for uber had shifted to 68% of their receipts (up from

56% in ’15) and car rental declined to 25% (down 8pts y/y). Certify appears to have stopped providing data this clearly

after 2017, which we think is partially because this trend share changes slowed down dramatically

The party making this post currently has, in the aggregate, a long position in the securities of Hertz. It is possible that there may be developments that cause such

party to change its position. It may buy, sell, cover or otherwise change the form of its investment in, or take other actions with respect to, Hertz at any time and for

any reason, without notice

Catalyst

o   2022 results / execution

o   Buyback execution / upsizing

o   Equity index inclusions

o   Potential M&A target (longer term)