Car and equipment rental company Hertz Global Holdings (NYSE: HTZ ) is under-performing its peers this so far this year. Hertz has gained just 4%, while the likes of United Rentals (NYSE: URI ) and Avis Budget (NASDAQ: CAR ) are up 20% and 28%, respectively.
Hertz's underperformance can be attributed to its weak fourth-quarter performance and its high debt burden. But, the company is undertaking some steps to fix its business. Will Hertz be able to turn its business around going forward, and more importantly, is it a good investment?
A weak performance
Hertz's fourth-quarter results fell short of analysts' estimates. Revenue for the fourth quarter rose 10.2% to $2.6 billion, but adjusted net income declined to $121.1 million from $139.1 million last year because of expenses related to maintaining extra fleet following the Dollar Thrifty acquisition. In addition, lower-than-expected pricing also hurt Hertz. For 2014, Hertz anticipates the U.S. and international rental car revenue to increase 6% to 8% and 5% to 7%, respectively, year over year.
Moreover, Hertz is planning to spin off its equipment rental business for $2.5 billion, which will help it reduce its massive debt. The proceeds will also be used to fund its proposed $1 billion share buyback.
Paring down the debt
Hertz has been working hard to fortify its balance sheet. It has successfully extended its corporate debt maturity profile and lowered its financing costs. It has also improved its funding in Europe.
However, the decision to spin off the equipment rental business is the one that should catch your eye. Hertz Equipment Rental Corporation, or HERC, has diversified over the years, with revenue from industrial and fragmented markets contributing around 62% of the total revenue. HERC has expanded into developing nations by franchising locations in South and Central America, the Middle East, and Asia.
According to CEO Mark Frissora in the company's fourth quarter earnings call:
[S]eparating the company now will unlock the greatest value for shareholders. And so today we announced our intent to split Hertz into two independent public companies, new equipment rental and Hertz rental car.
This separation will allow each company to pursue its distinct strategies, create greater financial flexibility, and benefit from a focused management team.
Hertz had applied to the IRS for a tax-free spinoff and recently received a ruling in its favor. This would benefit shareholders, as they would receive a tax-free distribution of shares at the time of the separation. The company expects this spinoff to be complete by 2015.
Hertz has a massive debt of $16.3 billion, with just $583 million in cash on the balance sheet. This is more than double United Rentals' debt of $7.17 billion. Although United Rentals has a weaker cash position of $175 million, it has got a stronger asset base. Consequently, United Rentals' debt-to-equity ratio of 392 is way lower than Hertz's 589, according to Yahoo! Finance .
Moreover, United Rentals is providing strong competition to Hertz in the equipment rental space. The company recently announced that it will acquire National Pump, the second-largest pump-rental business in North America, for $780 million. Hence, it looks like United Rentals' lower debt burden is giving it more flexibility to make acquisitions and fortify its position in equipment rental, as compared with Hertz.
Operations are improving, but so is the competition
Hertz's U.S. operations posted a double-digit volume increase in the off-airport market. Its airport operations also increased at a fast pace, with 22 Firefly locations at top leisure destinations across the country. Also, the addition of Dollar Thrifty to its corporate and commercial partnership agreements will further boost its revenue.
Hertz's car rental service saw significant expansion in emerging markets, with the company acquiring around a 19% stake in China Auto Rental, China's leading car rental service provider. Today, Hertz and China Auto Rental are co-branded at more than 300 rental car locations across the country. Its other international operations have also performed well, with 5.8% revenue growth compared with last year. This was led by an improvement in economic conditions in Europe, along with growth in New Zealand and Australia.
However, Hertz needs to watch out for competition from Avis Budget, which is now focusing on new ways to get customers into its cars in a quick manner. Avis' new "Express Lane" option will allow customers to pay in advance on both Avis.com and Budget.com. This new initiative is expected to speed up time, both while checking in and checking out, and address the needs of people who are short on time, especially at airports or on business trips.
The spinoff of HERC will provide some relief to Hertz, as it is looking to expand the core car rental business. The spinoff will give it much needed funds to pare down debt and improve the balance sheet. In addition, Hertz can focus on spending some money on bolstering its business and ward off competition from Avis. So while Hertz hasn't set the Street on fire this year, the company is no doubt making some positive moves that investors shouldn't ignore.
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