3 Reasons to Avoid HRI and 1 Stock to Buy Instead

Herc has had an impressive run over the past six months as its shares have beaten the S&P 500 by 6.9%. The stock now trades at $143.35, marking a 13.4% gain. This performance may have investors wondering how to approach the situation.

Is now the time to buy Herc, or should you be careful about including it in your portfolio? Get the full breakdown from our expert analysts, it’s free.

Why Is Herc Not Exciting?

Despite the momentum, we're cautious about Herc. Here are three reasons you should be careful with HRI and a stock we'd rather own.

1. Shrinking Operating Margin

Operating margin is a key measure of profitability. Think of it as net income - the bottom line - excluding the impact of taxes and interest on debt, which are less connected to business fundamentals.

Looking at the trend in its profitability, Herc’s operating margin decreased by 7.3 percentage points over the last five years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its operating margin for the trailing 12 months was 10.8%.

2. EPS Took a Dip Over the Last Two Years

While long-term earnings trends give us the big picture, we also track EPS over a shorter period because it can provide insight into an emerging theme or development for the business.

Sadly for Herc, its EPS declined by 22.1% annually over the last two years while its revenue grew by 15.5%. This tells us the company became less profitable on a per-share basis as it expanded.

3. High Debt Levels Increase Risk

Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.

Herc’s $9.59 billion of debt exceeds the $52 million of cash on its balance sheet. Furthermore, its 5× net-debt-to-EBITDA ratio (based on its EBITDA of $1.82 billion over the last 12 months) shows the company is overleveraged.

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Herc could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope Herc can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.

Final Judgment

Herc’s business quality ultimately falls short of our standards. With its shares beating the market recently, the stock trades at 19.3× forward P/E (or $143.35 per share). While this valuation is reasonable, we don’t really see a big opportunity at the moment. We're pretty confident there are more exciting stocks to buy at the moment. Let us point you toward an all-weather company that owns household favorite Taco Bell.

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