This Top-Notch Car Rental Business Is Selling Cheap

Hertz (NYSE: HTZ  ) may be offering investors a sweet deal on its massive fleet of rental cars -- the second largest in the nation. In the company's recent earnings report, top- and bottom-line numbers came in ahead of Wall Street estimates, yet the stock sold off due to a deal gone sour with a divested asset -- Advantage Rent A Car. The latter business had acquired 24,000 vehicles from Hertz, and it's no longer able to pay for the leases -- leaving Hertz in the hole and a waiting line of creditors. In the long term, though, this is an easily absorbed cost for the nearly $9 billion company that will no doubt benefit from the increasingly hot rental car industry in the U.S. and abroad.

Earnings take a back seat
Sales climbed 22% for Hertz in the recently ended quarter. The revenue figure, more than $3 billion, represented a record amount for the company. Unprecedented earnings continued on down the income statement, with a record adjusted EPS of $0.73, a 15.9% premium to the prior year's quarter.

Driving the big jump in earnings was the company's more than $2 billion acquisition of Dollar Thrifty.

U.S. car rental sales gained 33%, international bumped up by nearly 10% to $768 million, and equipment rental gained nearly 11%.

This was the ninth quarter in a row that the company achieved record pre-tax income.

The bullish thesis behind Hertz is similar to the one put forth by a group of Columbia Business School students who won a Pershing Square investment competition. Now that the land-grab is quieting down following the company's Dollar Thrifty purchase (leaving just three big players in the industry), Hertz is allowing for some price increases, which obviously is a boost to margins. In the most recent quarter, management noted price increases as the profit driver for the U.S. business, despite lower-than-expected traffic and excess fleet. Hertz is also finding success in its hourly business -- Hertz on Demand.

So what's keeping pressure on the stock? A bad seed and some lingering issues from a year of change.

Advantage: bankruptcy court
Part of Hertz's acquisition included divestiture of its Advantage Rent A Car business, as mandated by the FTC. The company then leased 24,000 vehicles to Advantage, which is run by Franchise Services of North America. In the wake of industry consolidation, Advantage simply hasn't been able to make ends meet, and the company recently missed a lease payment to Hertz for the vehicles.

In all likelihood, Hertz is going to take a hit on the faulty deal, as the bankruptcy court isn't likely to award the initial asset sale to Hertz. The thing is, we are talking about a company that is set to do more than $500 million in cash flow this year and billions upon billions in sales. Investors have overreacted to this issue, as it will be little more than a blip in the long term.

Other issues some may have with Hertz include the resignation of its CFO earlier this year, and previously lowered guidance. This year has been tough for a wide variety of businesses -- many of them with strong fundamentals. Fifty million dollars less in net income for 2013 does not equate to a failing long-term business. In fact, car rentals are going to expand impressively, benefiting the three big companies tremendously. With the stock at less than 10 times forward earnings, investors are getting a deal on a wide-moat, well-managed company in an appealing growth industry.

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