In this question-and-answer session, Professors Jesse Chan and Lynn Li sat down to discuss the recent news of Hertz’s decision to sell electric vehicles.
Question: What is the business of Hertz?
Answer: Most people think of Hertz as a rental car company with its three largest brands being Hertz (premium), Dollar (value brand), and Thrifty (deep value brand). However, Hertz also operates as a used car company. After all, they typically hold their cars for about 6 to 36 months, which means that Hertz is constantly selling used cars through a variety of channels, including its own used car lots, labeled Hertz Car Sales, and through a partnership with online used car retailer Carvana. Finally, in January 2023, Hertz also partnered with Uber, providing them with mostly electric vehicles (EVs) for their drivers.
Question: How many cars does Hertz own?
Answer: As of December 2022, Hertz operated with approximately 428,700 vehicles domestically and 118,700 vehicles internationally. This represented growth over the 389,300 vehicles Hertz operated domestically and 78,400 vehicles operated internationally in 2021. In October 2021, Hertz announced its plans to expand its EV rental fleet in North America. In the December 2021 annual report, Tesla did not appear to be a major contributor to the fleet composition, but by December 2022, Tesla accounted for 11% of the vehicles domestically. Importantly, Hertz had previously committed to buying almost 100,000 Teslas and an additional 175,000 EVs from General Motors1. According to CNBC, however, Hertz only had about 50,000 EVs in its fleet as of October 2023, including around 35,000 Teslas, suggesting Hertz was already beginning to slow its pace of EV acquisitions. Previously, Hertz had indicated they wanted nearly a quarter of its cars to be EVs.
Question: Why was Hertz so interested in electric vehicles?
Answer: Hertz cited a number of goals with its large EV commitments in 2021. First, Car and Driver noted that Hertz planned for the Teslas to command rental rates “similar to our premium and luxury vehicles,” indicating that Hertz was attempting to differentiate its product against competitors Enterprise and Avis Budget Group with Tesla vehicles, which were in short supply at the time. By locking up such a large supply of Teslas, Hertz could theoretically limit the number of Teslas that Avis and Enterprise could purchase given production was constrained at the time.
In addition, another motivation for Hertz to move aggressively into adding electric vehicles to its fleet is that a lot of its rental business, particularly at its flagship Hertz brand, is targeted towards business travelers. As more firms began expressing goals of reducing their carbon footprint, Hertz surmised that business travelers switching from gasoline to electric rental cars could play a role in helping their employers reduce their Scope 3 emissions and overall carbon footprint. Hertz itself also faced a shareholder resolution in December 2019 questioning the firm’s approach to managing its climate risks. Rapidly growing the proportion of electric cars in its rental fleet, while commanding a revenue premium for the cars, seemed like a good way to achieve multiple objectives simultaneously: grow revenues, differentiate their product in a highly commoditized industry, make its product more attractive to business travelers reducing their carbon footprint, and help lower its own carbon footprint.
Question: Where are the sources of revenue for Hertz?
Answer: As a car rental company, a portion of its revenue comes from car rentals to both business and leisure travelers. Additionally, they receive revenue from their used car sales business. Typically, Hertz bulk orders cars directly from manufacturers such as GM and receives a significant discount on the purchase price. When they sell their used cars later, Hertz records revenue from these sales. The business model requires accurately predicting resale values of its acquired cars and then obtaining enough rental revenue to cover the depreciation of its fleet during the period it owns the cars. In 2021, electric vehicles appeared to be holding their value more strongly than gasoline cars, and this added an additional dimension of appeal to ordering many electric cars. This made Teslas particularly attractive: not only could they secure a revenue premium by offering a differentiated product, but they could also benefit from the strong resale values.
Question: You mentioned that GM gives Hertz a discount. Did Tesla give Hertz a discount?
Answer: If Elon Musk’s post on X (the platform formerly known as Twitter) on November 1, 2021, is true, then Hertz did not receive any discounts on their Tesla purchases. As Musk noted, “Tesla has far more demand than production, therefore we will only sell cars to Hertz for the same margin as to consumers.” This made the cars somewhat less attractive to Hertz, who as mentioned previously, typically gets extremely large discounts from the traditional automakers.
Question: Why was Hertz willing to purchase Tesla at the same margins as a regular consumer like you and me?
Answer: After the pandemic, due to the global supply chain, used car prices skyrocketed. You could buy a vehicle, drive it for a year, and sell it for close to your original purchase price. Hertz may have believed that it would buy Teslas and sell it for an amount close to the original purchase price after using it as a rental vehicle. In fact, lots of individual Tesla owners did exactly this—buy a Tesla, drive it for a year, sell it for about what you paid for it because prices for new Teslas had gone up, and repeat. In addition, the resale value data for Teslas supported this assertion. Teslas up until 2021 or 2022 actually held their value quite well as they aged, providing Hertz with confidence that it could resell its used Teslas after its traditional 6 to 36 month ownership period for a substantial amount.
Question: Is the Hertz announcement of its sales of EVs unusual? Why did it want to unload a lot of EVs all at once?
Answer: On January 11, 2024, Hertz announced that it had started selling about one-third, or approximately 20,000, of its EVs and purchase more internal combustion engine vehicles. On January 26, 2024, Hertz’s used car website showed 25,812 vehicles for sale, which would be approximately 6% of its fleet. Remember, Hertz is also a used car company that sells cars that are between 6-36 months old, so the sheer volume of cars being sold is not particularly unusual, but the composition of the sale is—of the EVs that Hertz is selling off, the vast majority are Teslas. Hertz Car Sales’ website has very few EVs from other manufacturers (GM, Ford, Volvo, Hyundai) listed for sale, even though these cars form part of Hertz’s fleet
Hertz discovered that the rental demand for Teslas was not nearly as strong as it anticipated, with the company unable to command the rental revenue premiums it anticipated when it ordered the cars. The company shifted to place the Teslas into its rideshare rental business, but then quickly discovered the vehicles were incurring overly high damage repair costs — body panels, interior trim pieces, etc. — as rideshare usage is much more taxing on the vehicle than traditional rental. And as 2023 started, there was substantially greater volatility in used EV prices, with Tesla values being particularly volatile as Tesla began adjusting its pricing for new cars.
Question: Do the Tesla price cuts affect Hertz’s profitability?
Answer: Absolutely. In December 2022, Tesla began offering discounts on its cars. Since then, prices of new Tesla vehicles have come down dramatically. Hertz probably purchased the majority of its Tesla fleet throughout 2022 at peak prices. The price of a new Tesla influences what consumers are willing to pay for a used Tesla, because if someone can order a new Tesla for $35,000 online, it is unlikely they will be willing to pay $40,000 for a two-year-old used Tesla. This illustrates how new vehicle pricing changes can affect the value of similar existing cars on the road, like existing Model 3 and Model Y cars.
On January 26, 2024, Hertz’s used car website showed 538 Model 3’s and 180 Model Y’s for sale. If we were to extrapolate this ratio, it means that Hertz probably purchased approximately 35,200 Model 3 and 11,800 Model Y vehicles. The prices of Model 3 came down by approximately 17%, and the Y by 26%2.
On the cost side, that means for fiscal year 2023, without even thinking about depreciation, Hertz should take an impairment charge, meaning that it needs to write down the value of these Tesla vehicles to the new lower price. If we assume that 35,200 Model 3 were purchased at approximately $45,000 and 11,800 Model Y were purchased at approximately $66,000, then the value of its Tesla fleet should decrease by approximately $472 million, just based on the price cuts alone. To put that into perspective, the depreciation expense for all 427,800 vehicles for the fiscal year 2022 is $701 million. When Hertz announced it was selling approximately 20,000 EVs throughout 2024, they noted in an 8-K filing on January 11, 2024 that they will have to take a $245 million incremental depreciation expense on their income statement- in line with our rough estimates above, at least for the pool of vehicles that Hertz has identified it plans to sell in 2024.
With the recent announcement, it looks like Hertz is going to be recording some very large one-time charges related to its EV fleet as a result of recent changes in market conditions and used car values. It’ll be interesting to watch the February 6th earnings announcement and see what the annual report looks like.
