Cindy Ord
Rental car companies like Hertz (NASDAQ:HTZ) have several different factors going for and against them, and both are for the near term as well as the longer term.
When it comes to Hertz, which recently re-emerged from bankruptcy after the COVID-19 pandemic devastated the car rental company, these factors contribute to a rather volatile thesis for a company which may do extremely well in the long run, but only if they play their car(d)s right.
Will they? We can only speculate at this point, just like everything else in the stock market, but there are a set of facts which may help us better understand how the company may cope with these headwinds and leverage the tailwinds.
Near Term Pains Are Many
There are several near term pains the company will face over the next 18 to 24 months, which I believe will severely limit any share price appreciation potential:
Recessionary Fears
On the macroeconomic news, a recession is caused by and lead to, people spending far less on not necessities like luxury travel and is also when businesses spend less on internal travel as well. These are the two main factors when it comes to how a recession, which I believe is likely to take place over the next year or two, will shape Hertz’s ability to grow their business.
The first is that business travel will likely decline. As a major driver of global car rentals, business travel has been somewhat slow to re-emerge after the pandemic all but brought it to a halt. The reason for this is that over the pandemic, companies have adapted to virtual meetings and assessments, project follow ups and the likes, through platforms like Zoom (ZM) and Slack, a Salesforce (CRM) company. This means that if a recession, in whatever form, does indeed occur, companies will be well equipped to perform these activities online in order to save money – potentially lowering demand for car rentals.
The second and more talked-about one is consumer travel by individuals. This factor is two-fold, but I’ll talk about the second part right after this. The main consumer angle of this is that when money is tight, people travel less and with less discretionary travel – less car rentals occur. There isn’t much more to elaborate on this, as we can see in any previous recession – the effects on rental car companies is profound when personal and discretionary spending is lower or stops altogether by certain consumer groups.
Used Car Prices And Appetite
As I mentioned in the last paragraph, there’s another thing about rental car companies which is affected by a general economic downturn and something we’ve seen exacerbated in the last few quarters with raging inflation – and that is used car prices and sales.
Rental car companies operate through 2 separate avenues to maximize their profits. Generally speaking, rental car companies keep their newly purchased fleets for about a year or two and then either a) auction them off to the highest bidder, which mostly consist of private consumers, used car dealerships and the likes and b) have an agreement with the vehicle manufacturer about terms where they would re-purchase the vehicle at a lower rate.
This is the main reason why you don’t see such a high depreciation with car rental companies anymore – they rarely have vehicles in their fleet beyond a year or two, so the value only depreciates by a small portion than a normal car does, given the lower price point they buy the cars in the first place.
After the pandemic inflation fueled higher used car prices, consumers have put a pause on purchasing used cars and as a result, prices have begun coming down in a drastic way – leading to both lower near-term appetite for car rental companies to sell their slightly-used vehicles and when they do – it’s at a lower price point than previous sold for. This one is a double whammy of sorts since, for the most part, rental car companies purchased these cars at the height of the inflation surge, meaning their re-sale margins are likely to be smaller.
Lotta Spending on EVs
As I mentioned in my article on Tesla (TSLA) a few days ago, Hertz has made a 100,000 vehicle order for the company’s fleets around the United States and the world and intend to purchase a further 175,000 all-electric and plug-in hybrid vehicles from General Motors (GM) over the next couple of years.
While the appetite I mentioned earlier for car rental in the case of a recession may be lower, these costs will be realized by the company no matter what, and with there being potentially lower demand for the used vehicles once their time with the rental company is done – these can lead to a serious surge in inventory and potential depreciation increases as the fleet grows older.
But as I’ve said before, these negative catalysts are somewhat limited to the near term, since a recession won’t last forever and business travel has ways to go before it reaches full capacity – meaning that the company’s longer term prospects are rosier than the near term ones I just laid out.
Long(er) Term Prospects Are Quite… Better!
There are 2 different timelines to think about when it comes to Hertz’s business – the first is that once, or if, a recession does happen, it will ultimately lead to a larger growth environment as people and businesses emerge from it and return to normalcy, something which has happened in every single recession or economic slowdown in our history.
This means that increased spending on rental cars will lead the company’s revenues and profits higher. But there’s also something else which contributes to my longer-term prospects of the company, and that is autonomous driving.
Autonomous Driving Potential Is Huge
As I’ve talked about in my previous article on Uber (UBER), it’s unclear who exactly will be the largest beneficiaries once any form of autonomous driving becomes more of a reality than a thing we enjoy just a little more than cruise control. While I think that companies like Uber may face regulatory burdens and union votes, it’s hard to see how giant rental companies like Hertz won’t be enormously benefitted by this given their potential fleets.
If a company like Uber wants to buy one million autonomous vehicles and fire all of its drivers, there are countless hurdles they would need to work through for that to happen, and you can read more about that in my linked article.
But for a company like Hertz, it’s quite simple. If their 100,000 Tesla models have the hardware to drive themselves, whenever various hurdles like regulations and technological ones are worked through – they’ll simply do that. And for business travel in particular, and for personal travel as well, that can be a huge boon for Hertz’s revenues and profits.
No Need For Taxis Or Ubers
This is mostly due to the fact that business travelers won’t need as many taxis and ride sharing in order to get to their destinations. While this does not mean that all taxis and ride sharing services will become obsolete, they most certainly won’t, it’s hard to make an argument against a business partnering with Hertz to provide a self-driving car service for their traveling employees, which can not only boost the company’s clientele but also create a more steady stream of revenue like a subscription service type business.
Don’t Buy Just Yet, But Be Ready
Hertz has done plenty to make investors happy with the direction they are going. They lowered their debt right ahead of interest rates skyrocketing, a move which deleveraged the company and saved them hundreds of millions of dollars in interest expense over the past and future years.
They also used their re-emergence from bankruptcy to boost their cash position to over $1 billion and are making the necessary investments to move the needled on future revenue and profit growth.
While there are short term headwinds the company will face over the next few years, like a possible economic slowdown, competitive pressures and more – their long term prospects are quite good and have me on alert for a good purchasing price for a longer term investment.
Over the next few years, the car rental market is projected to grow at a 4.6% CAGR (compound annual growth rate), while analysts currently project a slightly slower growth rate over that time period. The company’s profits are projected to decline as well, with the company’s EPS projected to decline by 16%, 35% and 29% in 2022, 2023 and 2024, respectively.
Therefore, I don’t believe that Hertz is currently a strong long term investment but as their longer term prospects remain strong given the aforementioned factors, I’m keeping an eye out for an entry point.
As multiples are set to reach about 10x forward earnings in the coming years, I’m looking for the company’s share price to reach around $15.00 for an entry point and will hold for a period of roughly 5 years, as I believe at that point, we’re likely to see a strong rebound in demand for rental cars and used car auctions and sales.
While I remain bearish on the company’s near-term prospects, I am turning increasingly bullish on their longer term ones and am keeping an eye out for an appropriate entry point.
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