Hertz Stock: Continues to Get Worse and Worse (NASDAQ:HTZ)

It just keeps getting worse for Hertz Global Holdings (NASDAQ:HTZ) investors – share price continues to fall, unsecured debt downgraded to CCC-, lost a $300 million lawsuit, used car and truck prices continue to fall, revenue continues to fall, debt continues to rise and interest rates remain higher than some expected. At this point, only a contrarian investor would consider buying HTZ. This is an update to my previous HTZ articles.

HTZ’s total shareholder return since the company emerged from Ch.11 bankruptcy on June 30, 2021 has been terrible in absolute terms and compared to Avis Budget Group (NASDAQ:CAR).

Concerns about a “Ch.22” submission.

I want to start by discussing the elephant in the room – bankruptcy. While many feel that the talk of filing Ch.11 is premature and even irrational, the reality is that in June Fitch demoted their unsecured ratings to CCC-, which is just one notch above a default rating. This CCC- rating applies only to unsecured debt. It is not the default long-term issuer rating for Hertz Corp. which is B- with a “negative rating”. Fitch downgraded the unsecured debt based on “the expectation that following the recently concluded secured issues, recovery prospects for unsecured debt holders will be weak in a stress scenario, given the increased share of secured debt in the capital structure.” That was according to Hertz issue $750 million 12.625% 1 Lien and $250 million 8.0% 2 Lien PIK notes in June, both of which would have priority for recovery over unsecured debt in any future bankruptcy proceedings. (See below.)

Hertz would be in a strong financial position if they didn’t buy back shares, which is an issue I covered in my previous article, but I think it’s worth repeating. They repurchased $3.43 billion worth of shares at an average price of $19.62. Those buybacks were traded when Stephen Scherr, who was paid $182,136,137 in 2022, was still CEO. Without these buybacks, which my followers know I’m almost always against, it would be affirming how financially strong Hertz is compared to discussing a potential financial restructuring in my opinion. Now, Hertz is even restricted from making new share repurchases until April 1, 2025 under Amendment #8 to the credit agreement, and I wouldn’t be surprised if that restriction continues longer with future changes.

Hertz lost interest rate appeal case

Hertz shareholders in 2021 should have received a much smaller recovery under the Ch.11 reorganization plan because ticket holders were underpaid according to the Wells Fargo Bank, NA v The Hertz Corp. (In re The Hertz Corp.), No. 23-1169 submitted on September 10 (text of the decision). “The final total will exceed $300 million” that Hertz must pay former ticket holders, according to the law firm representing the ticket holders. That would be close to $1 per HTZ share, which is significant considering the stock is trading at $2.99.

The appeals court ruled that noteholders were actually entitled to coupon interest rates, which were 5.50%-7.125%, instead of the federal court rate, which was only 0.15% at the time, because interest rates were so low in 2020-2021. the bankruptcy process. These unpaid damages total approximately $125 million. The court also ruled that the “entire” payments of $135 million should have been allowed. These unpaid damages continue to accrue interest, bringing the total to over $300 million.

The decision was based in part on the fact that Hertz was actually solvent when it emerged from bankruptcy in 2021 and that the plan stated that ticket holders were not “impaired” because their claims were paid in full. The court ruled that, in fact, they were not paid in full for their rightful claims. The most interesting statement, in my opinion, from the decision was:

Can Hertz use the Bankruptcy Code to force noteholders to forgo nine figures in contractually valid interest and spend that money on a massive shareholder dividend? The answer is no.

It could be a while before Hertz has to pay, but the total will add up as interest continues to accrue. Shareholders who bought HTZ stock after Hertz emerged from bankruptcy are now indirectly stuck with a huge cash payout, and “old” Hertz shareholders have received a much larger recovery package than they actually should have received.

Used vehicle values ​​continue to drop

Many HTZ merchants have ignored the traditional consumer demand for car rentals, but for the past 2-3 years have focused primarily on the Hertz fleet only. I covered the various issues with their EV debacle in my previous article, and the used car price issue just keeps getting worse. The latest monthly price index for used cars and trucks fell to 178.192 from 198.768 a year earlier, which is down 10.4% and is down 0.8% from the previous month. The amount of the decrease in the last 12 months depends on the type of vehicle, as can be seen in the table below. Electric vehicles saw the biggest drop of 7.2% based on the Manheim Index, which uses a different methodology than the CPI, which also includes much older used cars/trucks, and shows a 3.9& drop for all vehicles.

The value index for used vehicles in Manheim is still much higher than a few years ago and has increased slightly in the last 6 weeks. I wonder if potential sellers are holding back and waiting for stronger prices after the Fed cut interest rates.

The decline in used vehicle prices is more pronounced for Hertz, as it purchased a large number of used vehicles near the peak of used car prices to add to its fleet, and now the market value of these used vehicles has fallen more in percentage terms than new vehicles they bought.

The reason the current estimated value of the vehicle fleet is so important is that this depreciation factor is one of the metrics used to determine their lease payments to HVF, the bankruptcy-remote special acquisition subsidiary that actually owns/finishes the vehicles. The specific value is depreciation per unit – DPU, and this increased to $600 in Q2’24 from $197 in Q2’23. Much of the increase was due to the decline in the value of electric vehicles. Current management is trying to bring the DPU below $325 by spinning old used vehicles, including EVs, into new ones, which of course requires a lot of capital.

Debt problems continue to worsen

Hertz is under financial pressure from having to issue additional debt to raise the necessary capital and by rolling over maturing debt at much higher interest rates on debt that was issued several years ago when interest rates were very low. Non-vehicle debt rose to $4.595 billion at the end of 2Q24, from $3.449 billion at the end of last year. In June, they sold $750 million in collateralized notes at 12.625% 7/15/29. This is a very high rate for secured debt. They also sold $250 million in PIK 2lien notes.

In order to issue this new secured debt, their credit agreement had to be amended to allow for 5 times the “consolidated leverage ratio of the first guarantee”. This ratio falls to 4.75x at the end of 4Q24 and continues to decline to 3.0x in 4Q25. I doubt they can stick to this deal as it would have to grow “Consolidated EBITDA” significantly as it is unlikely they will be able to reduce 1 Lien debt and I don’t expect a dramatic improvement in their results in the short term. (Consolidated EBITDA is defined in the agreement and is not the same as “Adjusted EBITDA” reported in quarterly/annual reports.) If not met, another amendment may be required. There is also a more restrictive liquidity requirement of $500M for 4Q’24 and 1Q’25, but that should most likely not be an issue.

Their debt vehicle faces $2.0 billion of HVF Series III 2021-1 debt maturities. Vehicle debt reporting in their quarterly and annual reports does not list rates for specific debt classes for a series. The reported interest rate for this series is 1.66%, but that’s the average – not the actual rate. Actual rates for this specific series range from 1.21% to 3.98%, depending on the class. Class A is first in line for payments until Class D, which has 3.98%. Based on the $750 million new vehicle debt issued in two series on July 26, we estimate that the annual incremental interest expense to roll over this $2.0 billion Series 21-1 debt could be approximately 85 up to $90 million unless there is a major drop in interest rates in the near future. This increase is approximately $0.29 per HTZ share. The interest range for these two 2024 Series is 5.44% to 9.41%, which is significantly higher than the 2021-1 Series due.

Hertz has some debt with variable interest rates that could have a positive impact on future interest expense if the Federal Reserve begins to lower rates, but there are also a number of future debt maturities that will most likely have to be rolled over to higher rates.

HTZ evaluation

Given the P&L below with very heavy losses, it is difficult, if not impossible, to estimate an appropriate value for HTZ based on revenue. The liquidation value of HTZ is close to zero because most of their assets are in the remote special purpose entity that owns their vehicles, and it is unclear whether the actual liquidation value of those vehicles is greater than the debt. The assets at the Hertz level are mostly intangible and I doubt they are worth more than the $4.6 billion non-vehicle debt.

Income statement for the 2nd quarter and six months 2024 and 2023

Conclusion

Talk of a potential future Hertz bankruptcy is fueled by the fact that the company has filed for bankruptcy in the past. While I seriously doubt there will be a “Ch.22” filing in the next 18 months, Hertz is in serious financial trouble as evidenced by Fitch’s CCC rating on their unsecured debt. While bankruptcy might be unlikely, I wouldn’t be surprised. if it were to attempt an out-of-court debt restructuring using some type of stock-for-debt exchange offer, which would dilute HTZ’s current shareholders.

While the short-term outlook for Hertz is not bright, they have well-known brands in the viable rental car industry, and used vehicle prices could improve in the future if interest rates fall significantly. Therefore, since there is long-term potential, I maintain my “hold” recommendation on HTZ stock.