Monday Winners: High-Flying Hertz Flying too High?

David Sterman's picture

Monday, April 26, 2010 - 12:25pm

by David Sterman

Shares of Hertz (NYSE: HTZ) rose roughly +20% this morning after the world’s largest car rental firm agreed to acquire rival Dollar Thrifty (NYSE: DTG) for a modest premium. Investors in Dollar Thrifty can’t complain: shares are now up twenty-fold since plummeting to $2 during the economic crisis. The deal, which reduces competition, should give Hertz additional pricing power. And that’s a plus for rival Avis Budget Group (NYSE: CAR) as well, which also rose more than +10% on the buyout news.

The spike in Hertz’s shares is unusual for two reasons. First, acquirers rarely see their stocks bid up when a deal is announced, and usually suffer a modest pullback. Also, the deal is likely to only modestly improve Hertz’s profits, probably well less than the +20% increase reflected in the share price.

In this bullish market environment, even “less bad” is good. Office Depot (NYSE: ODP) continues to lose market share to rivals such as Staples (Nasdaq: SPLS), but the retailer’s annual loss is set to shrink, according to Jefferies, which is talking up the stock ahead of Tuesday’s quarterly earnings release. Shares, which rose nearly +8% on Monday, now trade at an 18-month high.

Shares of Whirlpool (NYSE: WHR) also rose more than +10% in Monday trading and now trade close to an all-time high. The appliance maker saw first quarter sales rise +20% and expects to post banner results throughout the year. Rising demand in Asia and Latin America get much of the credit, while U.S. sales are expected to grow at a more moderate pace.

But it may be time to take profits. Whirlpool now expects to earn $8 or $9 a share this year, which would top the company’s record profits of $8.10 a share earned in 2007. But investors should note that profits throughout the past decade mostly ranged from $5 to $6 a share. The current strong run rate is surely attributable to a bounce back in global demand after a period of slack in 2008 and 2009. And since this is a cyclical earnings play, investors tend to seek the exit when the price-to-earnings ratio (P/E) gets too high. Shares of Whirlpool now trade for about 13.5 times the mid-point of management’s 2009 profit guidance. Peak-cycle profits on cyclical stocks typically merit a P/E ratio below 10.

Whirlpool could go on to post solid results next year as well, and per-share profits could rise yet higher to around $10. But that still can’t justify further gains in this current highflyer.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.