DBRS Comments on Hertz’s 2Q11 Results; Issuer Rating at BB, UR - Developing

DBRS Inc. (DBRS) has today commented that the ratings of Hertz Corporation (Hertz or the Company), including its Issuer Rating of BB, are unaffected following the Company’s announcement of 2Q11 financial results. The ratings remain Under Review Developing, where they were placed on May 16, 2011.

For the quarter, Hertz reported a pre-tax income, on a GAAP basis, of $94.6 million as compared to a pre-tax loss of $6.2 million a year ago. On an adjusted basis, excluding such items as restructuring charges, non-cash debt charges and acquisition related costs, Hertz reported pre-tax income of $184.4 million, a noteworthy 92.5% improvement over 2Q10. Importantly, adjusted pre-tax income was 17% higher than the pre-recession peak set in 2Q07. The quarter’s strong results reflect a solid 6% increase in worldwide revenues, excluding the effects of foreign currency movements, to $2.1 billion driven by strong growth in transaction volumes across all three business segments as rental demand continues to recover from recessionary lows. Indeed, worldwide transactions increased 5%, while worldwide transaction days grew 8% evidencing the strengthening recovery in commercial and leisure travel and the strength of the Hertz brand. Pricing, or revenue per day, in worldwide rental car, however, declined 4%, reflecting competitive pricing conditions, as the industry was over-fleeted as Hertz, similar to its competitors, held fleet to protect against potential vehicle supply disruptions stemming from events in Japan.

Moreover, the Company’s results benefited from lower fleet costs which were helped by the still healthy used vehicle market. As a result, worldwide rental car adjusted pre-tax margins improved by 280 basis points to 13.7%. DBRS views positively that the improvement in revenue generation and margins were achieved, while Hertz continues to invest in the expansion of its off-airport business and Advantage brand demonstrating that operating costs remain under control. Furthermore, DBRS considers Hertz’s results as evidencing solid underlying momentum across the franchise with revenues improving across all business segments and good underlying trends in industry fundamentals.

By operating segment, the positive trajectory continued. For the quarter, U.S. car rental revenue increased 4% year-on-year, while European car rental revenue improved 18%. Importantly, U.S. off-airport demand continues to demonstrate solid growth with volumes increasing a noteworthy 10% year-on-year. As a result, off-airport accounts for 26% of U.S. car rental revenue, illustrating the success of the Company in broadening its revenue base. For the quarter, Hertz Equipment Rental Corporation (HERC) generated $301.7 million of revenue, a 10.5% increase year-on-year, excluding the effects of foreign currency, on a solid 11.3% growth in transaction volumes and higher utilization rates. DBRS notes that 2Q11 was the fourth consecutive quarter of positive revenue growth for HERC. DBRS sees the results at HERC as indicating that the recovery in the equipment rental market is gathering pace as industrial demand driven by infrastructure projects rebounds from recessionary lows. Nevertheless, given the uncertainties as to the strength and sustainability of the economic recovery in the U.S. and Eurozone, DBRS remains cautious regarding the further improvement in the operating environment.

Hertz’s results continue to benefit from the Company’s solid fleet management acumen. To this end, fleet costs were at historically low levels despite a 9% increase year-on-year in the worldwide average fleet size in 2Q11. Fleet costs continue to benefit from the strong used-vehicle market and continuing development of more profitable remarketing channels. U.S. vehicle depreciation per unit for the quarter totaled $220 per month, 26% lower than a year ago.

Hertz’s liquidity and funding profile remain solid underpinned by good access to the capital markets. Following the successful refinancing of over $4.0 billion of corporate debt in 1Q11, Hertz completed a $598 million asset-backed note issuance and a EUR 100 million revolving credit facility to support peak season fleet growth. At June 30, 2011, corporate liquidity totaled a solid $1.6 billion.

During 2Q11, Hertz announced that it had reached a definitive agreement to acquire the Donlen Corporation (Donlen), a leading provider of fleet leasing and management services for corporate customers, for $930 million, including $250 million in cash and the assumption of approximately $680 million of Donlen’s outstanding fleet debt. Hertz expects the transaction to close in 3Q11 and be accretive to earnings immediately. While the acquisition increases Hertz’s debt stack, overall, DBRS views the acquisition positively as it will expand Hertz’s product offering to corporate customers offering yearly and multi-year transportation options and further diversifies the revenue stream. Moreover, Hertz anticipates refinancing Donlen’s fleet debt at improved financing terms benefiting from Hertz’s well-established presence in the asset-backed market.

The Under Review Developing reflects DBRS’s view that the potential acquisition of Dollar Thrifty Automotive Group, Inc. (DTAG) is a long-term positive for Hertz and will further strengthen the Company’s overall franchise. While DBRS notes that there are certain uncertainties regarding this potential transaction, including the lack of a signed definitive merger agreement between the companies, the transaction would combine two complementary businesses: Hertz with its strong presence in the premium and corporate travel segment, and DTAG, with its solid position in the value-oriented leisure travel segment. Conversely however, DBRS sees potential risks in this transaction especially should the purchase price increase resulting in increased leverage, which in turn would weaken the Company’s financial profile and be less accretive. Furthermore, the review status also considers DBRS’s view that the upside potential offered by the transaction may be muted should industry fundamentals deteriorate. Nonetheless, should the deal progress and the final purchase price and financing composition become more certain, DBRS will complete its review assessing the impact on Hertz’s franchise, risk profile, capital structure, and its earnings generation ability. Also, DBRS will continue to monitor the structure of the purchase, the actual level of net debt incurred, goodwill and the ultimate impact on leverage.

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

The principal applicable methodology is Rating Finance Companies Operating in the United States, which can be found on our website under methodologies.

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

Lead Analyst: Steve Picarillo
Approver: Alan G. Reid
Initial Rating Date: 16 May 2001
Most Recent Rating Update: 16 May 2011