Earlier this summer, the ink on the Hertz post-mortem began to dry.
The company, and its underlying assets, were in freefall, prompting analysts, speculators, and carrion collectors to wonder whether it would live beyond Chapter 11—and triggering the share price yo-yo we’ve seen throughout June and July.
Bloomberg’s David Welch even wrote an epitaph:
“Global pandemic obliterates the travel business and lands an iconic 102-year-old company in court to seek protection from creditors.” [Note: Mr. Welch goes on to give an excellently incisive (and longer) explanation on Hertz’s changing-of-the-guard difficulties along with its myriad accounting gymnastics.]
But even as markets rallied strong(ishly) this week, our analysis indicates that the fundamental financial challenges Hertz faced pre-crisis are still in play—and COVID-19 didn’t have a major impact on revenue until March. While the fuse was shortened by the pandemic—it was already well-lit by a low Financial Health Rating and a mediocre Q4.
A little context.
Generally, bankruptcy happens in two ways—either at the creditors’ behest or by the company’s choice.
The former is pretty straightforward: creditors can push for bankruptcy after the company misses an interest payment or triggers a covenant (viz. interest coverage level or debt to assets ratio) and cannot cure within a defined timeframe (typically 30 days).
The latter is less straightforward: while a company can run regular scenarios on their business (through-to evaluating revenue expectations, competitive forces, cash-flow scenarios, capital access possibilities, et al)—forecasting remains part art and part science. Rarely does a company want to go bankrupt, but there are times a company may choose to file for bankruptcy for strategic purposes.
In a volatile and uncertain time—read: the last 120 days—a company’s timeframe to forecast its forward prospects, ability to make decisions, and line-of-sight into operating runway are all seriously truncated.
And as the levers for solvency are suddenly flipped, the choice to file becomes increasingly binary.
Some Brief Analysis.
Shortly before Hertz’s bankruptcy filing, RapidRatings conducted two stress tests using year-end (12-31-2019) financials as a basis. Hertz was benchmarked with a RapidRatings’ FHR® of 49 (on RapidRatings’ 0-100 scale), indicating medium risk. If you were placing bets solely on January and February of this year, you’d see that narrative play out with 6% revenue growth.
On the other (comparing) hand, Avis had a leg up with an FHR of 58, and out-classed Hertz among core health measures, as signaled by RapidRatings’ CHS of 62—or strong health—against Hertz’s CHS of 51—or medium health.
After hitting Hertz with an industry-weighted 12.95% decline in revenue in our second stress test (deeper into the pandemic), we saw a projected 15-point FHR drop (down to a 34 FHR aka high risk).
By the end of the quarter, projection for the coming year became reality: Hertz had lost 10% in worldwide revenue compared to the previous year and the company’s Probability of Default tripled.
The pandemic had accelerated the calculus considerably.
The New Entropy.
In a massively volatile market, deterioration happens faster, decision-making is more consequential, and accordingly, some companies will file for bankruptcy earlier.
With no end in sight for current volatility, we anticipate more companies with FHR ratings of 40+ to slide into higher risk zones.
Hertz is an example of how black swan events can drastically exacerbate cracks in the raw fundamentals of financial health—even when they are rated medium or low risk. Companies who proactively monitor the financial health of their counterparties and/or suppliers, can proactively manage those risks—while taking advantage of new opportunities for stronger collaboration.