How to Survive Upheaval? New Lessons from the Hertz Fiasco

Once the top US car rental company, Hertz declared bankruptcy in May 2020. Hertz had a mountain of debt it couldn’t pay and couldn’t get refinance.

You may think Hertz is still on the stock market, the company is just OK. Actually, Hertz went bankrupt in 2020 but revived immediately after that. It reduced a significant amount of debt by negotiating with its creditors when it was under restructuring. In this case, bankruptcy is not the end of the company, but for the former executives and investors, it is the end. Their stock became just a piece of paper. Investors got almost no compensation for that.

When the pandemic hit, Hertz’s sales plummeted. Cash from sales was crucial for them, primarily because they had borrowed a significant amount of money and were continuously rolling it over. If you check their cash flow statement, you’ll see that they borrowed and repaid almost the same amount each year.

Now, if a company like this suddenly encounters irregular happenings and loses cash from sales, repaying the bank becomes a challenge. Normally, in this situation, it would use a repay-and-borrow-almost-the-same-amount strategy, just as it used to do.

However, at the beginning of the COVID era, several factors made banks hesitant to lend:

1. The uncertainty surrounding COVID made banks more conservative about lending.

2. With COVID keeping people indoors, the car rental industry was supposed to take a hit.

3. Hertz’s existing debt was already substantial relative to its profits and available cash. Banks seemed reluctant to lend more, doubting the company’s repayment capability.

4. Early in the pandemic, used car prices dropped, meaning banks couldn’t rely on Hertz’s car fleet as sufficient collateral.

Unable to secure new loans, Hertz’s financial crisis deepened, leading to bankruptcy.

Why Did the “Worse” Ones Get the Money!?

I’ve noticed that while other car rental companies avoided bankruptcy, Hertz alone sunk. But why? Avis, for instance, is also a major car rental company. Both have similar business structures.

Let’s see the accounting safety indicators for these two companies:

1. Quick Ratio ((cash + receivables) ÷ current liabilities)

This metric essentially gauges a company’s ability to pay its short-term debts using assets that can be quickly converted into cash. Apparently, a higher number is better because it means they have more cash. Safer!

As of December 2019: Hertz stood at 20% while Avis was at 8.3%.

Though both ratios seem very bad, they aren’t quite as alarming as they seem. Both companies routinely roll over (when they pay the debt, borrow the same amount of money) short-term debt, you can treat it more like long-term debt. Because they repeat rolling over effectively never pay back the money. If we treat the short-term debt as long-term debt, the figures become much better.

Avis appears riskier than Hertz.

2. Debt Equity Ratio (debt ÷ equity)

This indicates the balance between the equity and debt a company uses to finance its assets. Lesser debt is generally safer as there’s no obligation to pay back equity. So, a higher number is worse.

December 2019 figures: Hertz was at 12.1 times, whereas Avis was at a staggering 34.3 times(huge debt). This makes Hertz seem considerably safer on paper.

Yet, puzzlingly, it was Avis that successfully borrowed new funds at the beginning of the COVID era, sidestepping a crisis.

Why OJ Simpson Was “Oh Jeez Symptom” of the Bankruptcy

I found a key to the puzzling situation when I examined the credit ratings of both companies.

From Moody’s, as of April 26, 2020, Avis had a B2 rating while Hertz was rated Caa3. Though B2 is risky, it’s considerably better than Caa3. The reasons are:

1. Hertz made a loss two years (2019,2018) in a row before COVID started. while Avis constantly made a profit.

2. Naturally, Hertz had a negative ROA (return on asset. Calculated by net profit / total assets. This is because it was making a loss) while Avis had 1.3%… well, at least in the positive range.

3. Avis had fewer car assets. In a downturn, having huge assets can be an obstacle.

Car rental companies usually buy new cars, rent them out, and then sell the older ones. If a company has a lot of cars, and something unexpected happens, like not being able to sell the old cars (which happened at the beginning of COVID), it can be a big surprise and they can run out of money fast.

4. Hertz once featured OJ Simpson in their TV commercials. In these iconic commercials, OJ emerged from an airplane and seamlessly transitioned into a Hertz rental car. That is very important. Hertz’s business is more tied to airports. When air travel was dead in the COVID era, those rating guys thought Hertz couldn’t get business anymore. And this can’t be seen only from accounting indicators.

Thus, these factors contributed to Hertz receiving a lower rating than Avis. While ROA is typically seen as a profitability indicator, in certain scenarios, it emerges as the most important safety barometer.

How can a company be more profitable by reducing costs and avoid bankruptcy?

What’s the core reason behind Hertz’s bankruptcy? Hertz sucked at predicting demand. It’s clear they never saw COVID coming, but their issues began before that.

What could Hertz have done differently to enhance finances? While Hertz had more assets than Avis, their sales figures were remarkably similar. This implies that Hertz had too many cars that weren’t rented. With better demand forecasting, Hertz could have only the necessary vehicles, and distribute them to their shops based on customer demand, reducing depreciation costs. This would not only reduce the pressure on profits but also save cash.

ROA is calculated as profit / total assets. By improving its demand predictions, Hertz could trim its unnecessary assets and reduce depreciation costs. A combination of increased profits and reduced assets would significantly improve ROA.

With a healthy ROA, banks would have a more favorable impression, making them more inclined to offer loans.