DBRS Confirms Hertz at BB (low), Trend Remains Negative

DBRS, Inc. (DBRS) confirmed the Long-Term Issuer Rating of The Hertz Corporation (Hertz or the Company) at BB (low), and the Long-Term Senior Debt Rating at B (high). The trend for all ratings remains Negative. Additionally, DBRS maintained Hertz’s Support Assessment of SA3, which results in the Company’s Intrinsic Assessment to be equalized with the Long-Term Issuer Rating at BB (low).

KEY RATING CONSIDERATIONS
The confirmation of Hertz’s ratings reflects the Company’s top-tier global rental car franchise including strong market positions in the U.S. on-airport and international markets. The ratings also consider the Company’s weak earnings generation capacity, highly leveraged balance sheet, and satisfactory funding and liquidity positions. Additionally, Hertz maintains a high level of encumbered assets, which limits its financial flexibility. Overall, DBRS views Hertz’s funding and leverage profiles as constraints to its ratings. The Negative trend considers the continuing challenges the Company faces in attaining sustained improvement in its earnings generation.

RATING DRIVERS
Sustained improvement in the trajectory of earnings, underpinned by higher revenues, improved efficiencies, and sound fleet utilization could result in Hertz’s ratings returning to a Stable trend. Conversely, a return to a negative trajectory in the Company’s earnings, a notable decline in the U.S. on-airport market share, or a weakening liquidity profile could result in the ratings being lowered.

RATING RATIONALE
The ratings reflect Hertz’s strong rental car franchise including its top-tier positions in both the U.S. on-airport and international markets. The Company, which is one of the largest rental car companies in the world, provides vehicle rental services through approximately 10,200 corporate and franchise locations. Importantly, the Hertz, Dollar, and Thrifty brands are well-established in the industry and have significant market recognition in their segments. Although a moderately sized component of the overall franchise, the Company’s Donlen business has a solid market position within the commercial fleet management sector.

The Company continues its transformation initiatives to strengthen its operating platforms and regain profitability. Importantly, Hertz has made solid progress on several fronts, including augmenting its senior management team, including the recent hiring of a new CFO and a CIO, and strengthening its fleet management through new processes and strategies. Solid industry fundamentals including sound global economies and strong airline passenger volumes also provide a tailwind for Hertz. DBRS notes that Hertz’s transformation is expected to continue over the medium term.

The Company has achieved some early progress in improving earnings generation. Sustaining the favorable trajectory in earnings is key to the trend returning to Stable. For 1H18, Hertz reported a net loss of $263 million, down from a net loss of $380 million for 1H17, reflecting higher total revenues, spurred by increases across all business segments. Higher U.S. segment revenues reflected improved volumes, driven by a 14% increase in the off-airport business and a 3% increase in the on-airport business. Meanwhile, excluding the impact from foreign currency exchange rates, International segment revenues improved 2%, year-over-year (YoY). Nonetheless, transformation initiatives continue to pressure expenses. Partially offsetting were lower vehicle depreciation costs driven by the sound used vehicle market in the U.S. segment. Overall, total expenses for 1H18, which also reflect the nonrecurrence of 1H17 intangible asset impairments, increased 2% YoY.

The Company’s risk profile is sound. Risks associated with residual values and fleet management remain manageable, especially given the Company’s enhanced fleet profile and improving used vehicle values. Meanwhile, credit risk, which is primarily related to payments made by manufacturers to the Company related to program vehicles, continues to be moderate. DBRS notes that the percentage of program vehicles in the U.S. segment totaled a modest 13%, and in the international segment totaled 51%.

Funding is acceptable, consisting of a large component of secured debt. With the high level of encumbered assets on its balance sheet, the Company’s financial flexibility is limited. Given its substantial level of wholesale funding, DBRS notes that robust liquidity management is essential to managing through capital market cycles. At the end of 1H18, the Company maintained approximately $1.2 billion of corporate liquidity, including $685 million of unrestricted cash and $502 million of availability under Hertz’s revolving credit facility. Positively, Hertz maintains a sound cushion over its financial maintenance covenant (consolidated first lien net leverage ratio) for its revolving credit facility. Indeed, at June 30, 2018, the Company’s first lien leverage ratio was 1.60x, which is below the 3.00x threshold.

Capitalization is adequate, but leverage remains high. Hertz’s capital position has been negatively impacted by recent net losses. Equity totaled $1.1 billion at June 30, 2018, down 30% from YE17. Hertz’s tangible equity was in a sizable deficit position, given its high level of acquisition-related goodwill and intangible assets. DBRS notes that the Company’s leverage is a constraining factor for the ratings. At June 30, 2018, balance sheet leverage (debt/equity) was 16.3x, up from 9.8x at YE17, and cashflow leverage (debt to last twelve months EBITDA) was 5.3x, up moderately from 4.8x at YE17.

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

The applicable methodology is the Global Methodology for Rating Finance Companies (November 2017), which can be found on our website under 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.

Lead Analyst: Mark Nolan, CFA, Vice President, US Non-Bank FIG – Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG – Global FIG
Initial Rating Date: May 16, 2001
Most Recent Rating Update: September 29, 2017

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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