DBRS Downgrades The Hertz Corporation Issuer Rating to BB (low), Trend Stable

DBRS, Inc. (DBRS) has today downgraded the Issuer Rating of The Hertz Corporation (Hertz or the Company) to BB (low) from BB. Concurrently, the trend on the ratings was revised to Stable from Negative. The rating action follows the Company’s recent filing of restated financial statements for 2011-2013 and the filing of financials for 2014 and 1Q15.

The rating action takes into account the serious weakness in the Company’s internal controls and procedures over financial reporting uncovered during the internal investigation related to the accounting misstatements, which were beyond DBRS’s expectations. The rating action also considers the cumulative impact of the accounting restatement on previous profitability levels. Additionally, the rating action reflects the recent mismanagement of the U.S. vehicle fleet by the Company’s prior management team, which has negatively impacted the Company’s financial results as well as its on-airport market share. These negative factors were partially offset by the strength of Hertz’s global franchise and the diverse revenues generated from the franchise, which are key factors underpinning the ratings. DBRS also recognizes the Company’s successful efforts to maintain access to liquidity during the accounting review, which DBRS sees as demonstrating the strength of the franchise.

An internal investigation conducted under order of the Company’s Audit Committee found that there were four categories of material weakness in internal control over financial reporting at Hertz. From DBRS’s perspective the findings indicate failures in the Company’s risk management and that operational risk was significantly higher than previously perceived. Amongst the most significant weaknesses were that prior executive management set an inappropriate tone within the organization that at times resulted in non-adherence to U.S. GAAP accounting principles, and that significant deficiencies existed in the competency of the accounting staff, as well as the reporting lines within the organization. Moreover, the investigation found that the Company’s internal audit function was deficient. While DBRS recognizes the progress Hertz has made in strengthening its accounting and finance departments as well as its internal controls over financial reporting, DBRS sees the process of remediating the weakness in internal controls as taking a number of years.

The effect of the restatements on earnings were material in DBRS’s view and a negative for ratings even though no restated period resulted in a loss. Restatements resulted in U.S. GAAP pre-tax income being reduced by 11% in 2013, 20% in 2012, and 23% in 2011. Further, DBRS notes the breadth of accounting items requiring restatement exceeded DBRS’s expectations.

Mis-steps in fleet management by the Company’s prior management team was a large contributor to the Company’s $78 million net loss in 2014. Hertz had excess capacity from overestimating demand as well as Dollar Thrifty fleet integration issues. As a result, the Company reported a low utilization rate of 77% for 2014. Moreover, the age of the fleet had been extended to a length that resulted in lost competitiveness to peers, which have recently reduced the age of their fleets. As a result, Hertz lost market share in the key on-airport market. DBRS views these results as demonstrating that Hertz’s fleet management, which is a key rating consideration, was not as disciplined as previously considered. Positively, Hertz’s new management team has been proactive in undertaking a significant refresh of its U.S. vehicle fleet, which is nearly complete. Since late 2014, Hertz has purchased nearly 350,000 model year 2015 vehicles and disposed of higher mileage, older vehicles. As a result, the Company’s average age of the U.S. vehicle fleet is approximately 4 months lower than in September 2014.

Hertz continues to maintain appropriate levels of liquidity. At March 31, 2015, available liquidity (cash plus available capacity under various financing facilities) totaled $3.4 billion. DBRS notes that while corporate debt maturities are modest over the near-term horizon with no material maturities until 2018 at December 31, 2014, Hertz had $5.5 billion, or 58% of total vehicle fleet debt maturing in 2016. DBRS anticipates that over the coming quarters Hertz will look to ladder out the maturities of its vehicle-backed debt while also reducing its floating rate debt exposure.

The Stable trend reflects DBRS’s view that the operating environment will remain favorable over the near-term providing Hertz the necessary time required to complete the strengthening of its internal control procedures, the refresh of the U.S. fleet that began in 2H14 and the integration of Dollar Thrifty. Moreover, DBRS expects the environment to be supportive of the Company’s efforts to restart revenue growth, while removing excess costs. Although global economic growth remains uneven, economic expansion in the U.S. and other key markets should support expanding business and leisure travel volumes underpinning rental car demand. However, navigating the continuing moderation in used vehicle values to more normal levels and potentially rising interest rates will be near-term challenges for the Company. Over the medium-term, sustained improvement in financial results underpinned by revenue growth, and improved operating and fleet efficiency could have positive rating implications. Conversely, ratings could come under pressure should the Company be unable to execute management’s strategic initiatives to improve results evidenced by weak profitability, low utilization rates, and further erosion of the Company’s on-airport market share. Further, any additional issues related to the Company’s internal controls, risk management or corporate governance could lead to negative ratings pressure.

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

The principal applicable methodology is the Global Methodology for Rating Finance Companies (October 2014). Other applicable methodologies include the DBRS Criteria – Rating Holding Companies and Their Subsidiaries (January 2015). These can be found at: http://www.dbrs.com/about/methodologies.

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

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: David Laterza
Rating Committee Chair: Roger Lister
Initial Rating Date: 15 May 2001
Most Recent Rating Update: 13 June 2014

For additional information on this rating, please refer to the linking document under Related Research.