When investors see stock from a well-known company such as Hertz (HTZG.Q) plunge, it's tempting to pick up shares at a low price while awaiting a rebound -- after all, buy low and sell high, right?
Hertz, however, finds itself in a bit of an unusual situation, as the company has filed for Chapter 11 bankruptcy protection and is in the process of being delisted from the New York Stock Exchange. Let's try to remove the confusion surrounding the rental company and take a look at three reasons investors should not buy Hertz stock, no matter how tempting the shares appear.
1. When financing goes wrong
To understand why it's unfavorable to own shares of Hertz in its current form, we first must understand how Hertz got to this point. For a vehicle rental company it's obviously important to have a fresh, maintained, and extensive vehicle fleet. Doing that is an expensive operation.
Essentially, Hertz financed a hefty chunk of its vehicle fleet and tied those assets to its lenders in the form of asset-backed securities. The end result is that almost $15 billion of the company's total $19 billion in debt is linked to its vehicle fleet. The agreement between Hertz and its lenders is that if the value of those vehicle assets falls to a certain degree, it is obligated to make cash payments to satisfy the difference with lenders.
Image source: Getty Images.
That agreement is risky, but maintainable as long as revenue continues to flow per usual and the value of the vehicle fleet doesn't drop dramatically. Unfortunately, the COVID-19 pandemic had a staggeringly negative impact on the company's ability to generate revenue -- Hertz generates a vast majority of its revenue from people traveling to and from airports. And COVID-19 also disrupted the used-car market, as the supply of used and off-lease vehicles stacked up with no auctions and less retail demand, so the values of used cars dropped quickly, and Hertz was unable to make cash payments to satisfy its lenders.
Now, this all matters because in bankruptcy proceedings, a company must satisfy its lenders (among other entities) before any liquidated or other value is spread to remaining common shareholders (like you if you buy the stock). However, Hertz's pile of debt is more akin to a mountain, and there is little likelihood with such a debt burden that any value will be left for common shareholders.
2. Liquidity could fade with delisting
Another reason potential investors should shy away from buying what are likely to be worthless shares of Hertz is that the New York Stock Exchange notified the company it would be delisted. But what does that mean for common shareholders, exactly? It's important to note that the delisting of Hertz won't affect the shares already purchased or how much of the company those shareholders own. However, it could make selling those shares more difficult, as the company would be traded "over the counter" (OTC), which is a different exchange with fewer regulations.
Being delisted from the NYSE and resuming trading on OTC exchanges is generally viewed as a negative, as the shares will become less liquid, with fewer institutional and individual investors able to trade the stock. Hertz has appealed the NYSE's decision to delist its stock, but the rental company also admitted in an SEC filing, "There can be no assurance that the NYSE will grant the Company's request for continued listing at the hearing and whether there will be equity value in the Company's common stock." Ultimately, if you're playing the dangerous game of buying and selling Hertz stock right now, you could get stuck with a far less movable stock sooner rather than later.
3. Know when to follow
In one of the more crazy developments in the markets recently, after one of the world's top investors, Carl Icahn, sold his nearly 40% position at a staggering loss, shares of Hertz soared from May 26 lows of $0.41 per share to a June 8 close of $5.53. The move was absolutely baffling, and CNBC's Jim Cramer put it bluntly when warning investors, "You may think a stock like Hertz or Chesapeake Energy (CHKA.Q) looks like a steal at these levels, but the only people being robbed here are you the buyers." Cramer continued, "Believe me, if there was a real chance the common stock would be worth anything, Icahn would've stuck around. He didn't." Further, you can see in the graphic below how investors have opted to own shares of Avis Budget Group (CAR 0.52%), as its share price puts distance between itself and the stock price of its competitor.
Icahn saw the handwriting on the wall, and while he left the door open to possibly returning as an investor in a newly restructured Hertz company, he sold what was once a $1.88 billion aggregate stake in the company for a total of just under $40 million. When someone with far more power, influence, experience, and skin in the game throws in the towel on owning common shares, you should consider pressing the sell button as well.
Bottom line
There are a number of possible reasons people were buying Hertz post-bankruptcy. It could be algorithms and day traders playing a dangerous game of buy and sell. It could be individual investors not fully understanding the bankruptcy process and that if and when a restructured Hertz emerges and issues shares, the current shares will be worthless and canceled. It could be bears closing short positions that provided a short squeeze. Or it could be some combination of all three possibilities. But what investors need to understand is that only in a very unusual scenario will current Hertz shares be of any value to common shareholders when the dust settles. Period.
