Hertz and Avis Bonds Slide as Used-Car Prices Come Down

Rental-car company bonds are turning into lemons.

Debt issued by Hertz Global Holdings Inc. and Avis Budget Group Inc., which had traded at or above par in recent years, tumbled to new lows earlier this month amid signs that used-vehicle prices are dropping twice as much as expected. That’s bad news for companies that collectively have to dispose of about 400,000 vehicles a year, and especially for Hertz, whose junk-rated debt is teetering close to a downgrade.

“Historically the biggest problem that has hit the industry is when they get over-fleeted and bought too many cars; that isn’t the case this time,” said Bruce Clark, an analyst at Moody’s Investors Service. “Prices are coming down and they’re coming down faster than they had anticipated.”

Hertz and Avis are getting squeezed as the U.S. auto industry comes off a record-high year for new car sales that was propelled by cheap credit and easy leases. That’s now feeding a glut of used cars as leases end, while heavy discounting on new models has narrowed the price gap with used cars, putting more pressure on resales for Hertz and Avis. The concern has spread from equity investors to creditors, because lower “residual” prices on used cars translate into less value for the assets backing their loans and bonds.

“You don’t know how long this thing will take to settle,” said Arun Kumar, an automotive consultant at AlixPartners LLP. If the manufacturers discount further, the rental car companies “need to be primed to go toe-to-toe in that market.”

Avis’s 2024 bonds traded at a record low of 95.6 cents on the dollar early this month before retracing some of the lost ground, and its 2023 debt has lost almost 1 percent since June, trailing the 11 percent gain for the Bloomberg Barclays U.S. Corporate High Yield Total Return Index. Hertz’s 2022 notes hit a record low of 89.9 cents last week, and the cost of buying protection against default soared to the most since 2009 during the Great Recession. Collectively, Hertz’s $4.8 billion of corporate bonds and loans were the second-worst performers so far this year among similarly rated peers in the Bank of America Merrill Lynch U.S. High-Yield Index.

Hertz’s net debt stood at 5.6 times adjusted earnings at year-end, and Moody’s said in November it would cut its B1 rating if the metric approached five times. With analysts now expecting Hertz to bring in a third of the income it did a year ago, the ratio could only worsen if the company doesn’t reduce its debt load.

Trying Harder

By contrast, Parsippany, New Jersey-based Avis, with about $4.1 billion of corporate bonds and loans, has kept net leverage within its goal of 3 to 4 times. Hertz needs to improve its technology, rates and execution, according to a Bloomberg Intelligence report by Joel Levington, and Moody’s said Hertz needs to more effectively manage risks tied to resale prices.

That won’t be easy. Prices have already fallen in five of the last six months, according to car auctioneer Manheim. While Avis and Hertz were counting on price declines of no more than 3 percent for 2017, a national index of used-car prices fell 3.8 percent in February. General Motors Co. expects prices to drop 7 percent this year and auto lender Ally Financial Inc. reported last month that prices fell that much during its first quarter. The latter disclosure weighed on Hertz and Avis, whose shares have each declined more than 20 percent this year.

Karen Drake, a spokeswoman for Estero, Florida-based Hertz, declined to comment on used-car prices and Avis representatives didn’t respond to messages seeking comment.

Hertz and Avis typically buy the cars outright from manufacturers or get them on a contract with a buyback agreement. The latter, called program cars, cost more because manufacturers assume the resale price risk. Vehicles that Avis and Hertz buy outright are called risk cars because rental companies make their own assumptions about what the cars will be worth when it’s time to sell. Combined with closely held Enterprise Holdings Inc., the three companies control more than 95 percent of the U.S. rental fleet, according to Manheim.

Program cars made up only 20 percent of Hertz’s U.S. fleet last year, according to a company filing, less than half the 44 percent for Avis’s total fleet. Hertz will try to buy more of those this year, Chief Financial Officer Tom Kennedy told investors during a February earnings call.

There aren’t any plans to “shore up the balance sheet,” Kennedy said, “but we do acknowledge that we’re at elevated leverage levels and we’re going to be working to bring that down.” Hertz’s biggest investors include billionaire Carl Icahn, who’s known for shareholder activism.

Holding Period

Hertz typically holds risk cars for about 20 months and program cars for eight months, Drake said in an email. They are then usually sold through an auction or to a used-car dealership. Hertz also started to rent the cars out to ride-sharing services like Uber and Lyft -- once seen as a threat to growth -- as a potentially more profitable alternative to selling. Avis’s website is trying to entice buyers with discounts of as much as $500 off all vehicles.

“Getting something is better than getting nothing,” said Deutsche Bank AG analyst Chris Woronka. “It’s another outlet for otherwise perishable inventory.”

Resales could also be hindered by the heavy discounting on run-of-the-mill models favored by Avis and Hertz, such as Ford Fusions and Chrysler 200s, which may not be the first choice for potential buyers. Hertz had been trying to bring down the average age of its fleet by buying cheaper, smaller cars, but it’s now trying to fix its lopsided assortment as Americans tend to prefer bigger cars, said Evan Mann, a senior analyst at bond-research firm Gimme Credit.

The missteps led to a costly earnings miss, prompting Hertz to replace its chief executive earlier this year.

“It could get worrisome very quickly,” Mann said. “Has the fleet situation corrected itself -- that could be very telling.”