Is This Promising Turnaround Moving Too Fast?

Summary

• Hertz’s bankruptcy took a turn for the better when the used car market became hot.
• The company was able to emerge from Chapter 11 with a growth plan focused on EVs and AI.
• Is Hertz moving too fast for the market to keep up?

Bankruptcy seemed almost impossible for most large publicly-traded companies in 2020 and 2021 as unprecedented easy money policies kept liquidity pouring in. Even the likes of cruise operator Carnival Corp. (CCL) and hydrocarbon exploration company Occidental PetroleumOXY
Corp. (OXY), both of which had balance sheets that were in shambles even before the pandemic abruptly cut into their operations, managed to survive.

Yet, one of the largest rental car companies in the U.S., Hertz Global Holdings Inc. (HTZ, Financial), somehow managed to find itself in Chapter 11, even as its major rivals Avis (CAR, Financial) and privately-owned Enterprise avoided the same fate thanks to better financial cushions.

Hertz emerged from bankruptcy court in mid-2021, and after an initial spike above the $30 mark, the market has been tepid on the stock.

However, while the current negativity is certainly merited, investors may be underestimating the company’s new lease on life following its great fall. It was not just back to business as usual; not only did Hertz learn a valuable lesson, it has also taken a new growth direction under CEO Stephen Scherr. Hertz is embracing electric vehicles and artificial intelligence, making it unique among American rental car companies. Could this make Hertz a promising turnaround opportunity, or will such aggressive investments lead it right back to insolvency?

From bankruptcy to 100,000 Teslas

In June 2021, the bankruptcy court approved Hertz’s reorganization plan, which included the elimination of over $5 billion in debt and provided more than $2.2 billion of liquidity for the reorganized company. Shareholders surprisingly received more than $1 billion in value, despite previously being in line to be completely wiped out. For comparison, Hertz had a market cap of $5.83 billion as of this writing.

Where did the money for such a solid restructuring plan come from? Thankfully for Hertz, while it was in the process of dealing with bankruptcy, the used car market suddenly became red-hot. The company has historically used the cash from selling its retired cars to pay off creditors, but when the pandemic initially hit, it found itself unable to get a good price for them, which was a contributing factor to its bankruptcy. The semiconductor shortage and easy money policies quickly turned things around, though, and suddenly, Hertz was getting top dollar for its used cars.

That is why the company was able to exit bankruptcy with a bang and even purchase 100,000 electric vehicles from Tesla (TSLA, Financial) for a whopping $4.22 billion, making EVs approximately 20% of its entire fleet.

A growth strategy focused on EVs and AI

Hertz’s electrification strategy does not end there. Under the leadership of Scherr, the former chief financial officer of Goldman Sachs (GS, Financial) who was brought on as the company’s new CEO in February 2022, Hertz is making EVs and artificial intelligence the cornerstones of its long-term plan.

According to Scherr, in addition to the Teslas, Hertz has also committed to adding 65,000 EVs from Polestar (PSNY, Financial) and 175,000 from General MotorsGM
(GM, Financial) to its fleet, with deliveries set to begin for model year 2023. The company aims to have 25% of its fleet electric by 2024.

In order to help facilitate EV adoption among customers, Hertz is also working with local governments when it comes to building out charging infrastructure. For example, Hertz recently announced a partnership with the city of Denver to build out its EV charging infrastructure (with a focus on lower-income, underserved areas) and offer tools and training around the city. These resources will also provide assistance for Hertz customers who may be driving an EV for the first time or need help locating a charger in an unfamiliar area. Hertz provides chargers through its partnership with BP Pulse, which is owned by oil giant BP (BP, Financial).

“Public private partnerships are very powerful vehicles,” Scherr said in a CNBC interview. “We see what’s happening in mobility, we see the direction of travel. And therefore we can be a force along with a very powerful city and mayor, to sort of move this forward in the way in which I think all of us would like to see, which is broad participation in electrification.”

The other part of Hertz’s technology transformation is artificial intelligence. Key advancements in artificial intelligence have made it incredibly valuable for certain parts of the car rental business. For example, there is no longer as much guesswork involved with the company trying to get its vehicles to different locations in order to meet demand, as the technology can help understand where demand is. Hertz is also testing artificial intelligence inspection technology that takes a 360-degree view of a car when you rent it and when you return it, which should help eliminate the debate (and associated costs) of who caused damage to a vehicle.

Valuation comparison

Hertz does seem to be on an attractive growth path as one of the first big movers in the EV rental space. Of course, it is not the first company to offer EV rentals, but it is the first household name that has a desk at nearly every airport in the country to do so on such a grand scale.

Hertz’s existing scale in renting gas-powered cars combined with its need to present a new growth story while emerging from bankruptcy has created a development that might have been much slower to come if the company had managed to survive Covid without going bankrupt.

In terms of valuation, Hertz trades at a price-earnings ratio of 9.91, which looks low when taken out of context but is higher than Avis’ price-earnings ratio of just 3.59. Thanks to keeping a stronger balance sheet, not only did Avis manage to survive the pandemic, it even achieved an incredible three-year earnings per share growth rate of 111%, while Hertz is just recovering to pre-pandemic levels.

While Avis is also in the process of adding more EVs to its fleet, it has been much slower in doing so when compared to Hertz, taking a “wait and see” approach. In fact, it was Hertz’s 100,000 Tesla purchase that spurred Avis to action on the EV front. CEO Joe Ferraro commented in the company’s third-quarter 2021 earnings call, “You’ll see us going forward be much more active in the electric scenarios as the situation develops over time.”

In the long run, I think whether Hertz or Avis is the better value will depend on how rapidly the automobile market transitions to EVs.

Takeaway

Hertz has done a stellar job of turning itself around following its bankruptcy. After getting a surprise boost from the stronger used car market, it managed to kick off its return to the public market with a bang by making huge investments in EVs and artificial intelligence, which promise to improve efficiency and position it for long-term growth.

As of 2022, only about 4% of North American car production is electric, which may make it seem like Avis’ slower EV adoption is the more efficient route. However, Hertz is not just aiming to mimic the overall market; it is aiming to capture the demand for experiencing an EV without buying one and partner with cities to help them build out charging infrastructure to improve drivability (and thus create demand).

As the EV transition accelerates and some states and companies make deadlines to go all-electric, Hertz looks poised to play a key role. Investors should keep a careful eye on its balance sheet, though, as balance sheet mismanagement could still become a major risk again.

Disclosures

I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours.