Why Hertz Stock Could Become the Top Penny Stock of 2021


When Hertz (OTCMKTS:HTZGQ) declared bankruptcy last May, investors might have initially wondered if things could get any worse. Hertz stock had already lost 86% of its value since the start of the coronavirus pandemic.

Hertz (HTZGQ) sign in Montevrain, France on May 8, 2016.

Source: aureliefrance / Shutterstock.com

Any lingering questions regarding the indebted rental car company were soon answered. That day, Hertz shares would sink another 81% to 56 cents. Only foolhardy retail investors seemed willing to defy Wall Street logic and buy in.

Yet, these so-called “dumb money” investors might have the last laugh. This week, shares in rival Avis Budget (NASDAQ:CAR) hit an all-time high of $90, driven by a combination of consumer pent-up-demand and vehicle scarcity. An equivalent valuation on Hertz would have priced shares at $720 million (or $4.60 per share) before its bankruptcy reorganization. With its remaining rental fleet of almost 300,000 vehicles, Hertz’s value could grow even higher.

Things won’t be smooth sailing. Bankruptcy court rulings are often unpredictable, particularly when multiple debts are involved. And another economic slowdown — whether self-inflicted or exogenous — would almost guarantee that Hertz equity holders will receive nothing.

But given the sub-$3 price of Hertz stock, it’s a one-way gamble that could be worth taking. Because if a stock has a potential 200% to 1,000% upside, investors only need a slight chance for the bet to pay off.

Don’t bet your house on it. But if you have some “vacation money” to spare, Hertz looks like a gamble worth taking.

Hertz Stock: A Lesson From American Airlines

Corporate bankruptcies typically signal the end for owners of common stock. Banks and bondholders have priority in recouping losses, while shareholders get whatever scraps remain. In short, when a firm’s enterprise value plus cash drops below the value of its total debt, the resulting negative market cap means shares are worthless.

For years, Hertz stock has teetered on this same knife’s edge. Its abnormally large $15 billion debt burden — a byproduct of its private equity days — meant that Hertz has struggled to pay down debt. (Analysts have labeled the root cause, an ill-advised $1 billion dividend recap, as “one of that era’s most-criticized transactions“). The decade before the Covid-19 pandemic, Hertz spent more on interest payments ($6.85 billion) than it earned from operations ($6.71 billion).

Still, bankruptcies can occasionally end in success. In 2013, American Airlines (NASDAQ:AAL) shareholders emerged victorious from a high-profile bankruptcy.

When the airline filed for bankruptcy in 2011, Shares sank to pennies on the expectation that AAL’s $17.8 billion of liabilities outweighed its enterprise value. American Airlines would get delisted from major exchanges, leaving its pink-sheet listings available for 36 cents apiece.

But then something interesting happened. When U.S. Airways CEO Doug Parker approached American Airlines with a buyout offer, American’s Chairman, Tom Horton, managed to negotiate a 72-28 equity split. As an added twist, the ownership escalator was based on stock performance 120 days after the IPO.

In other words, creditors could get paid off with equity in the new company. At the time, neither side knew whether that would leave American Airlines shareholders with anything.

The gamble worked. As shares in the merged airline surged to $36 by 2014, those who bought American Airlines as an OTC penny stock at 36 cents would have walked away happy.

Hertz and the Used Car Market

Today, Hertz finds itself in a similar situation. In early March, the car rental company accepted an offer that valued the aggregate firm at $4.8 billion — a steep discount to its $20 billion pre-coronavirus valuation. By mid-April, two more bids had raised the value of Hertz’s debt alone to $6.2 billion.

Core to this rise is a simple problem of supply and demand. At the start of the pandemic, car manufacturers decreased production in anticipation of lower demand. The cuts, however, proved too steep. When sales shrank by a less-than-expected 15%, carmakers proved unable to keep up. Used car prices rose 20% for the year.

Then came the computer chip shortage. Driven by unprecedented demand for personal electronics, the world’s chip makers reduced allocation to car manufacturers. As firms from Tesla (NASDAQ:TSLA) to Peugeot (NYSE:STLA) have idled production, used car prices have risen further. The Manheim Used Vehicle Value Index is now up 52% year-on-year. Had Hertz held onto its entire fleet (assuming it had the means), they might have earned $8 billion in paper gains.

The legacy firm’s slimmed-down 300,000 vehicle fleet could become its greatest asset. As used car prices continue to rise, Hertz will find itself able to borrow more (and at lower interest rates) against each vehicle. That might not eliminate the firm’s total debts, but refinancing will lower interest payments and create a road to solvency.

What Is Hertz Worth?

Even American Airlines’ bosses didn’t know what their company was worth in bankruptcy. When you have $19 billion in debt, the difference between $18 billion and $20 billion enterprise value is negative versus positive $1 billion equity value.

Hertz shareholders have found themselves equally in the dark. In late March, Hertz’s management agreed to a plan that would repay 70 cents per dollar for unsecured creditors. Shareholders would presumably receive zero. Since then, shares in the industry have risen on investor optimism. Junior Hertz bonds now trade at 100 cents to the dollar.

That means a bankruptcy judge will now likely reject Hertz’s original proposition. If other entities are willing to buy Hertz’s debt for fuller valuations, there’s little reason to settle for a lower price that would eliminate shareholders and penalize unsecured debt holders.

HTZGQ Stock Could Be the Top Penny Stock of 2021

Investors in over-the-counter pink sheets often face a bewildering choice of low-revenue, opaque firms. Most of these bets go on to disappoint. In fact, the average penny stock “returns” -32%. Bankrupt companies fall even further — the average stock in bankruptcy drops 70% during their proceedings, according to a study by professors at UMass and Philadelphia University. More than half of bankrupt firms go straight to zero.

Yet Hertz is a strange standout among its unlisted penny stock peers. Its global brand — which includes Hertz, Dollar and Thrifty — has 12,000 locations around the world. That makes the firm larger than 10,600-location Avis and twice as big as 6,000-location Enterprise. The industry is also riding a surge of Covid-19 reopening demand.

Rental car prices have increased 30% nationally, with some tourist destinations reporting 300% increases. Meanwhile, rental car companies have delayed replacing their fleet. Avis sold 250,000 vehicles in 2020, joining Hertz and others in shrinking available inventory. Demand for rental cars may outpace supply for years.

Hertz bondholders have wasted no time. Today, the firm’s unsecured bonds are trading at par, signaling that investors believe full repayment is forthcoming. If that’s the case, Hertz’s equity value might be worth anywhere between $800 million to $3 billion, depending on the speed of the coronavirus recovery.

That makes Hertz stock a bet worth taking. Because, strangely enough, the longer Hertz spends in bankruptcy court, the better its chance of survival. Investors take note: the Hertz saga isn’t quite finished yet.

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Read More:Penny Stocks — How to Profit Without Getting Scammed

On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.

Article printed from InvestorPlace Media, https://investorplace.com/2021/05/why-hertz-stock-could-become-the-top-penny-stock/.

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