Rising Star Buy: Go Hertz

This article is part of our Rising Star Portfolios series.

The Messed-Up Expectation methodology I'm following with my Rising Star portfolio is working. In that portfolio, I'm looking for companies at prices reflecting growth expectations that are lower than what they're likely capable of, and getting high returns when the market corrects its mistake.

I believe it will be helped by investing Hertz Global Holdings (NYSE: HTZ  ) .

O.J. Simpson loved this company
Hertz is the second largest U.S. car rental company, behind privately held Enterprise Holdings (which includes Alamo, Enterprise, and National) and ahead of Avis Budget Group (Nasdaq: CAR  ) and Dollar Thrifty Automotive Group (NYSE: DTG  ) .

Even before former football star O.J. Simpson dashed through airports for Hertz -- before being dropped in 1992 -- Hertz had an eventful history:

  • Founded in 1918.
  • Went public in the 1950s.
  • Taken private in the 1960s by RCA Corp.
  • Sold to Park Ridge Corp., a venture between Ford Motor (NYSE: F  ) , Hertz management, and, eventually, Volvo.
  • Made public again in 1997, before going private once more in 2001 when Ford bought all the outstanding shares.
  • Sold to a private equity group in a 2005 leveraged buyout, where the company was loaded up with debt.
  • Made public a third time in late 2006.

After reaching revenue and earnings highs in 2007, Hertz went through several tough years, but now seems to be pulling out and turning things around as the economy improves. But it's still priced as if it will never grow again (more on this shortly).

The story
Since becoming public again, Hertz has been cutting costs and refinancing its debt. At the end of 2006, its net debt position was $11.6 billion; it now stands at $8.9 billion. Also since the end of 2006, the company's cut $1.7 billion in costs and increased revenue per employee by 29%.

Hertz's two major divisions, Rent-a-Car (RAC) and Equipment Rental (HERC), have seen growth recently. Revenue for each was up last quarter, and HERC is on a five-quarter trend of year-over-year improvements.

The company is aggressively expanding its off-airport RAC presence as part of its growth strategy. This saves them on fees to airports, plus these locations typically get more insurance business. This part of the business is growing at a double-digit pace.

Depreciation expense for the rental car fleet, a major expense for RAC, is also going down. Partly this is because Hertz is buying more used cars, but recently it's also because of the Japanese tsunami. What it calls "residual value" (think of it as blue book value) for its Japanese cars -- 40% of the fleet -- has gone up because of the short supply of Japanese cars. Lower depreciation expenses allows Hertz to sell its cars into the used car market at higher prices, keeping its net fleet replacement costs down.

I expect these trends to continue, as Hertz moves further into the off-airport market and HERC sees increased demand for its fleet.

The risks
Two things could upset this.

First, a major slowdown in the economy affecting travel, which affects rentals. If this happens, though, it would come as a surprise to many. Priceline.com, the online travel agent, for instance, was predicting strong growth in both domestic and international travel in its last earnings release.

Second, higher gas prices. You'd think that this would mean less rental. However, Mark Frissora, Hertz chairman and CEO, responded to a question on this in last quarter's conference call this way:

[P]eople don't cancel their vacations because the price of gas goes up $1 a gallon, and that's just been our history. That's been our experience. ... [T]hey're not going to say, oh dear, I've got to cancel my vacation because I'm going to rent a car and it's going to cost me [more in gas]. ... I'm not saying it's positive, but it isn't a negative to the extent that people may think it is. ...[W]e think that right now ... the press is overtrumping and overplaying this entire thing.

The move
I agree, as it often seems at times that the media and market focus too much on one thing. On the other hand, this gives me an opportunity to buy this company for the MUE port.

Using last night's closing price of $17 per share, the market is expecting less than no growth for the next 10 years and then no more forever, from the company's trailing level of $1.1 billion in free cash flow (using my usual 15% hurdle rate to discount). Given its moves into more off-airport locations, its continued cost and debt reductions, and more travel expected as the world's economy improves, I believe this priced-in expectation is messed up.

Tomorrow, the MUE port will purchase an initial 2% position, roughly $350 worth, with an eye toward increasing it in the future.

Add Hertz to My Watchlist and then come tell me what you think over on the MUE discussion board, or follow me on Twitter.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).

Fool analyst Jim Mueller owns no positions in any of the companies mentioned in the article. He works for the Motley Fool Stock Advisor newsletter service, where Priceline is a recommendation. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool's disclosure policy is never messed up.


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