DBRS Confirms Hertz at BB (low), Revises Trend to Negative

DBRS, Inc. (DBRS) confirmed the Long-Term Issuer Rating of The Hertz Corporation (Hertz or the Company) at BB (low), as well as the Company’s Long-Term Senior Debt at B (high). Concurrently, DBRS has revised the trend on the ratings to Negative from Stable. Finally, DBRS assigned Hertz a Support Assessment of SA3, which results in the Company’s Intrinsic Assessment to be equalized with the Long-Term Issuer Rating at BB (low).

The change in trend to Negative from Stable reflects the significant challenges that Hertz faces in improving the efficiency of its operations, as well as its profitability. Earnings have been pressured by considerable headwinds, including miss-steps in fleet management, the intense competition for on-airport market share and a shift in customer mix from higher yielding corporate and retail rentals towards lower yielding domestic tour and ride hailing vehicle rentals. To improve its operating results, Hertz has focused on a number of initiatives, including strengthening its fleet management, enhancing its operational efficiencies and upgrading its operating platforms, including its e-commerce site. Although DBRS sees early progress in these initiatives, including the recent resizing and rebalancing of the U.S rental car fleet and capital initiatives, as well as positive pricing momentum coming out of June and into July, DBRS notes that the Company’s turnaround plan will take many quarters to complete and includes a layer of execution and operating risk.

The confirmation of the Company’s ratings reflects Hertz’s top tier global car rental franchise with strong market positions in both the on-airport and off-airport markets. Its solid off-airport business, which adds a layer of revenue diversity, is underpinned by an insurance replacement business that maintains good relationships with most of the top U.S. insurance companies. The confirmation also considers Hertz’s acceptable funding and liquidity profiles. Overall, the Company relies on a significant component of secured funding, which DBRS considers to be a constraint on Hertz’s ratings. Indeed, at June 30, 2017, approximately 66% of the Company’s $16.8 billion of outstanding funding was vehicle financing, which was overwhelmingly secured. Meanwhile, with the high level of confidence sensitive wholesale funding on Hertz’s balance sheet, DBRS views strong liquidity management as key to managing through capital market cycles. At June 30, 2017, corporate liquidity included $1.1 billion of unrestricted cash, $879 million of non-vehicle restricted cash for paying down corporate debt and a $1.55 billion revolving credit facility (RCF), of which $750 million was drawn, and $791 million of letters of credit were issued from the RCF. Importantly, the Company has a solid buffer over its financial maintenance covenant (consolidated first lien net leverage ratio) for its revolving credit facility. Specifically, at the end of 2Q17, Hertz’s first lien net leverage ratio was 2.56x, which is below the 3.25x threshold.

Overall, the Company has suffered net losses in five of the last six quarters. Softening used vehicle values in the U.S. and the Company’s overweight fleet mix to compact vehicles have negatively impacted Hertz’s bottom line. The decline in used vehicle values has resulted in a 16% increase in depreciation expense in 1H17 over 1H16. Within the U.S. segment, depreciation per vehicle increased to $351 per vehicle per month compared to $290 per vehicle per month in the comparable period a year ago. Moreover, Hertz’s U.S. fleet was under-weight larger vehicles, including SUVs that have been in demand. Through 1H17, Hertz has undergone a fleet refresh to better align the fleet composition with customer demand. However, this has come at a cost given that this repositioning was undertaken during a period of weakening used vehicle values; with compact cars and sedans most impacted. As a result, Hertz recorded a $145 million loss on fleet disposition activities during 1H17. Moreover, the Company’s bottom line has reflected impairment charges and asset write-downs. For 1H17, the Company recognized $116 million of intangible asset impairment charges, of which $86 million was related to the Dollar Thrifty trade name.

Total revenues for 1H17 were 3% lower YoY at $4.1 billion, reflecting lower transaction volumes at both the U.S. on-airport and off-airport markets and a reduction in pricing. U.S. off-airport volumes were lower due to a reduction in manufacturer recalls compared to 1H16. Indeed, as a result U.S. rental car segment fleet utilization declined to 78% for 1H17, from 80% for 1H16. Meanwhile, U.S. segment vehicle revenue per unit declined to $968 per month for 1H17, from $1,025 for 1H16, due to lower rental revenues and higher average vehicles.

Hertz’s International segment results improved YoY with International RAC reporting 1H17 pre-tax income of $37 million, up from $27 million. Overall, revenues decreased 2%, however, when the impact of foreign currency exchange rates is excluded, revenues increased by 1% due to an increase in transaction days spurred by volume growth in the Company’s value brands. Meanwhile, 1H17 direct operating expenses for the International segment declined YoY, due mostly to the non-recurrence of a $20 million charge in 2Q16 resulting from adverse experience and case development, mostly in the United Kingdom. Finally, 1H17 net vehicle depreciation expense for the International segment increased by 1%, YoY, or 4% excluding foreign currency exchange rates, driven by an increase in average vehicles.

DBRS notes that the sustained losses have negatively impacted the Company’s capital position. Indeed, Hertz’s equity base totaled $755 million at June 30, 2017, a 30% decline from December 31, 2016, and a 53% decline from June 30, 2016. Meanwhile, the Company’s high level of acquisition-related goodwill and intangible assets result in tangible equity being in a sizeable deficit position. Leverage continues to be elevated with debt (including fleet debt)-to-equity at a very high 22.2x at June 30, 2017, up from 12.6x at December 31, 2016. At June 30, 2017, DBRS calculated total debt-to-last twelve months (LTM) EBITDA was manageable at 6.1x.

RATINGS DRIVERS
Evidence of sustained improvement in profitability underpinned by strengthening revenue generation, improved fleet utilization, lower cost per vehicle, and higher revenues per vehicle per day could result in the trend returning to Stable. Conversely, sustained weak levels of profitability, material erosion of on-airport market share, declining levels of available liquidity, and execution and operational miss-steps, could have negative rating implications.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Global Methodology for Rating Finance Companies (October 2016) and Global Methodology for Rating Banks and Banking Organisations (May 2017), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Mark Nolan, CFA, Vice President, US Non-Bank FIG – Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG – Global FIG
Initial Rating Date: May 16, 2001
Most Recent Rating Update: July 1, 2016

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.