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Goldman Sachs

Credit Outlook

Services: Komal Patel

Sector View:

We have a Neutral coverage view on HY Services; we view the auto rentals space as an area of caution given the late stages of the economic cycle and secular disruption, while we are more constructive on equipment rental names given their more defensive cash flow profiles.

Auto rentals. While macroeconomic conditions and consumer confidence have recently been supportive of business/leisure travel and recent favorable used car market dynamics buoyed the latest earnings results, we have concerns around secular risk and changes in the underlying environment/cycle risk. We are cautious about the industry long-term for several reasons, including commoditization and disruption from new and growing entrants. Over the near to medium term, we believe residual value challenges will return as off-lease vehicles increase used supply in the market and rising interest rates add pressure to financial profiles. These headwinds are similar at Hertz and Avis, with neither company immune to larger trends at play in the industry and often reacting comparably (from a trading standpoint) on industry and competitor commentary. While there is more idiosyncratic risk at Hertz compared to Avis as the success of its business turnaround remains in question and spending will remain elevated through 2019, we believe this is reflected in the divergent trading levels. We see downside risk across multiple factors including cyclical, secular, execution and financial risks.

Equipment rentals. We see strength in the U.S. economy and favorable economic indicators such as industrial production driving top-line growth with some room to run still. Equipment rental operators also benefit from diverse end market exposures, allowing them to capitalize on different growth trends across various verticals. Compared to other pockets within HY Services, we think equipment rentals are a more favorable end market in this late-stage cycle. We value the counter-cyclical cash flows that these businesses can generate by selling equipment and the fact that this business is not experiencing the same disruption auto rental companies are facing. The financial profiles of the equipment rental names are considerably better than those of the rental car names, but we see tighter trading levels reflecting this balanced end market view.

4 December 2018

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Goldman Sachs

Credit Outlook

Exhibit 117: Rental car market share is concentrated to the top 3

Exhibit 118: On-airport rentals represent ~70% of revenue

players
100%	9%	8%	8%	7%	7%	6%	5%	5%	6%	6%	6%	5%	5%	5%	5%	5%	45%	100%
90%	9%	9%	6%	6%	7%	7%	7%	7%	7%	7%	7%	20%	21%	20%	20%	17%	40%	90%		30%
			4%	4%	8%	7%	8%												33%
80%	3%	3%	6%	5%				19%	19%	18%	19%						35%	80%
	5%	5%			14%	14%	15%
70%	12%	14%	13%	13%												21%	30%	70%
												26%	25%	23%	21%
60%				10%	11%			16%
			11%			13%	13%		20%	19%	20%							60%
	16%	14%															25%
50%
																		50%
40%			20%	20%	19%	18%	18%										20%
	20%	17%
																		40%
																	15%
30%																57%			67%	70%
								52%						51%	54%
20%									48%	50%	49%	49%	49%				10%	30%
					35%		34%
			33%	34%		33%
	27%	29%															5%	20%
10%
0%	2001	2002	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017	0%	10%
																		0%
																			HTZ	CAR
			Enterprise				Hertz					National							Airport	Off-Airport
			Avis				Dollar					Thrifty
			Budget				Everyone else					Industry HHI [RHS]

Source: Auto Rental News, Goldman Sachs Global Investment Research		Source: Goldman Sachs Global Investment Research, Company data
Exhibit 119: US enplanements are growing in mid-single digits, yoy		Exhibit 120: Manheim and NADA performance has been strong in

%														2018
40,000													15%	10.0%
														8.0%
35,000													10%	6.0%
													5%	4.0%
30,000														2.0%
													0%
														0.0%
25,000
														-2.0%
													-5%
20,000													-10%	-4.0%
														-6.0%
15,000	Jul-05	Jan-06	Jul-06	Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13	Jul-13	Jan-14	Jul-14	Jan-15 Jul-15 Jan-16	Jul-16	Jan-17	Jul-17	Jan-18	-15%	-8.0%
Jan-05														-10.0%
				Enplanements (’000s) [LHS]				% yoy						NADA	Manheim

Source: Haver Analytics, Air Travel Authority, Goldman Sachs Global Investment Research		Source: NADA, Manheim
Exhibit 121: Pricing has been elusive at both Avis and Hertz in the		Exhibit 122: U.S. RAC Fleet and Growth %

US

U.S. RAC Revenue per Day (RPD)

	3%							600,000						8.0%
			2.0%											7.0%
	2%
								500,000
														6.0%
	1%		0.1%	0.1%		0.3%	0.3%							5.0%
								400,000						4.0%
	0%
					-0.3%			300,000						3.0%
	-1%
						-0.9%								2.0%
				-1.0%	-1.0%
	-2%	-2.0%						200,000						1.0%
														0.0%
	-3%
														-1.0%
	-3.0%							100,000
	-4%	-3.6%												-2.0%
	-3.9%							0						-3.0%
	-5%
								1Q17	2Q17	3Q17	4Q17	1Q18	2Q18	3Q18
	1Q17	2Q17	3Q17	4Q17	1Q18	2Q18	3Q18
		HTZ			CAR				HTZ	CAR	HTZ yoy%			CAR yoy%

Source: Goldman Sachs Global Investment Research, Company data

Source: Goldman Sachs Global Investment Research, Company data

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Goldman Sachs

Credit Outlook

Exhibit 123: Non-Residential Construction spending has grown																																							Exhibit 124: URI is the market share leader in North America
steadily in recent years
$6.0																																								HRI
$5.0																																							URI	3%
																																					11%
$4.0																																								AHTLN
																																								7%
																																								HEES
$3.0																																								2%
$2.0																																							Other
$1.0																																					77%
$0.0
200020012002200320042005200620072008200920102011201220132014201520162017
Source: Goldman Sachs Global Investment Research, Census Bureau																																							Source: Goldman Sachs Global Investment Research, Company data

Exhibit 125: URI has generally generated free cash flow through the cycle

$1,400 $1,200 $1,000 $800 $600 $400 $200

$0 -$200

-$400

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E

Source: Goldman Sachs Global Investment Research, Company data

4 December 2018

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Goldman Sachs

Best ideas

Credit Outlook

Trade Idea #1: Sell the HTZ 7.625% 2L notes due 2022. The HTZ 2nd liens have tightened since October, driven by favorable NADA and Manheim data as well as positive momentum from Q3 results. We are skeptical about the actual strength of 2019 and expect tougher yoy comparisons on fleet costs. We see potential for underperformance if Q4 does not echo a favorable Q3. Furthermore, Hertz said it is considering refinancing options for the 2020 and 2021 bonds and we think potential issuance of a 1.5/2nd lien bond(s) would drive up leverage through second liens, and add pressure to an already weak collateral coverage on the 7.625s of 2022, with an asset base that relies heavily on intangibles. We believe a sequential slowdown through Q4, weak collateral coverage on elevated secured leverage and potential layering/diluting effects of a 1.5/2nd lien bond issuance should weigh on trading levels.

Risks to our view: Hertz (Underperform): Upside: residual environment remains favorable, business turnaround benefits are greater and more quickly realized than expected, pricing power and cash generation better than expected.

Exhibit 126: HTZ 2nd liens have tightened in recent months

700

650

600

550

500

450

400

350

300

250

200

Exhibit 127: Trading levels of the 2nd liens vs the unsecureds due 2022 suggest similar collateral coverage

1000

900

800

700

600

500

400

300

200

100

0

Oct-17

Nov-17

Dec-17

Mar-18

May-18

Oct-18

Nov-18

Jun-17

Jul-17

Aug-17

Sep-17

Jan-18

Feb-18

Apr-18

Jun-18

Jul-18

Aug-18

Sep-18

HTZ 2nd lien 7.625s due 2022		HTZ Unsecured 6.25s due 2022

Source: Bloomberg, Goldman Sachs Global Investment Research

Source: Goldman Sachs Global Investment Research, Bloomberg

4 December 2018

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Goldman Sachs

Credit Outlook

Trade Idea #2: Swap out of the CAR 5.5s due ‘23 and into the URI 4.625s due ‘23 as

a defensive trade. We see URI as better positioned than CAR in the near-term, as it generates ~$1.3bn of free cash flow (FY18E) versus ~$300mn at CAR, and is a full turn lower on a net leverage basis. In the longer term, as we expect challenges in the rental car industry driven by elusive pricing, volatile residual value trends, and heightened competition from mobility options, we think Avis will see its financial and cash flow profile stressed. In comparison, we think the higher margins and counter-cyclical cash flows from potential equipment sales and reduced capex of the equipment rental end market leave United Rentals as much better positioned. Looking at the 5-year point, a potential inflection point in the cyclical and secular riskst, we believe CAR 2023s trading at 5.8% does not adequately compensate investors. We recommend that investors seeking long-term capital preservation in the HY Services sector sell the CAR 2023s and swap into the URI 2023s. We also believe the URI 2026 new issue notes, used to fund the BlueLine acquisition, offer attractive yield relative to the rest of the complex.

Risks to our view: Avis: Upside: residual environment remains favorable, market share gains lead to better pricing power, needle-moving partnerships in mobility. United Rentals: Downside: integration challenges impact underlying business, synergies not realized, more than expected debt-funded M&A.

Exhibit 128: HY Services Bond Comparables

			Coupon	Maturity	Rating	Z-Spread	YTW	Price
		HTZ	7.625%	6/1/2022	B1/B+/NR	472	8.042%	$98.75
		HTZ	5.500%	10/15/2024	B3/B-/NR	680	10.036%	$80.25
		CAR	5.500%	4/1/2023	B1/BB/NR	258	5.829%	$98.75
		CAR	5.250%	3/15/2025	B1/BB/WD	407	7.259%	$90.00
		URI	5.750%	11/15/2024	Ba3/BB/NR	252	5.749%	$100.00
		URI	4.625%	10/15/2025	Ba3/BB/NR	273	5.855%	$93.13
		URI	6.500%	12/15/2026	Ba3/BB/NR	319	6.318%	$100.88
		HERCRE	7.750%	6/1/2024	B3/B+/NR	137	5.702%	$106.38
		Yield Book HY Services					6.755%
		Yield Book BB Index					5.251%
		Yield Book HY Broad Market					6.307%

Source: Goldman Sachs Global Investment Research, The Yield Book, FTSE Index

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