Why We Believe In The Zipcar Story, Part I: The Bigger Picture

Zipcar‘s (NYSE:ZIP) stock has been at the receiving end of the market’s pessimism for quite sometime now and reached a new 52-week low of $10 this month amid fears of slowing growth and profitability prospects that prompted investors to shy away from the stock. The stock fell more than 20% after announcing its latest quarterly results in which the company posted a loss and weaker growth forecast. Notably, the same stock scaled a high of almost $30 in May last year, but since then, things have been downhill for the stock price.

However, we believe the pessimism around the young company’s stock is overdone and that the stock is undervalued at near $10. Zipcar’s revenues and membership have both grown at 20%+ over the last few quarters and serves 700K members with a fleet of over 9K vehicles in North America and Europe. Aside from competing with traditional rental companies and car-sharing services like Hertz On Demand, Enterprise’s WeCar, UHaul’s UCarShare and City Car Share, it also faces competition from new low-cost, peer-to-peer (P2P) car sharing services like RelayRidesand GetAround.

We have a $18 Trefis price estimate for Zipcar, at a 70% premium to the current market price.

See our complete analysis for Zipcar’s stock

Zipcar At a Glance

Zipcar’s fleet called “Zipcars” are parked at various reserved and convenient locations in the areas where it operates. Zipcar members, also called as “Zipsters”, pay an annual membership fee and can reserve cars by the hour (or day) with gas, parking, maintenance and insurance included. The members have automated access to Zipcars using an access card called “Zipcard,” which enables the Zipster to unlock the door where the keys are already inside. Gas cards and parking passes are also included if needed.

Stock Price Rose With Expectations But Slipped With Continued Losses

Zipcar grabbed investor attention last year with its IPO, as the leading market player with first-mover advantage and significant brand cache, in the global car sharing market that could exceed $10 billion by 2020 according to Frost & Sullivan estimates. During 2011, Zipcar’s membership grew by 25% in North America and Europe.

But car sharing is a highly capital intensive business and Zipcar is yet to turn in a profit. The market has reacted sharply to Zipcar’s continued losses in 2011 and the latest quarter. It faces several questions from its investors regarding its profitability, the long-term prospects and even viability of its business model. There have been major concerns around slower growth in core cities, slowing membership growth, delay in delivering profits and the entrance of a barrage of competitors like Hertz, Avis and Daimler. The stock has also stayed depressed since October-mid last year, when the six month lock-in period expired and the number of stocks available for trading increased four-fold.

Growing Competition Challenging Future Growth

Until now, Zipcar had been a dominant player in the niche car sharing segment, having grown amid few and scattered competitors. But the landscape is now much more hostile for the young car sharing company, with much stiffer competition from traditional car rental companies which have launched their car sharing arms like Hertz On Demand as well as the new peer-to-peer car sharing formats, which offer relaxed membership fee and other benefits to compete with Zipcar.

Growth Could Be Slower But Sell-off Seems Overdone

However, we believe this concern is overblown and the company commands a higher valuation than indicated by the recent disproportionate market reactions. While Zipcar’s membership growth could be slower than previously estimated, given the higher levels of competition and increased cost of customer acquisition, we still expect Zipcar Membership in North America could reach 1.4 million by 2018 with double digit sales growth. A bet on Zipcar right now is really a bet on the model for future transportation.

Given the capital intensive nature of the car sharing business and the fact that Zipcar is still a very young company making significant growth and expansion investments, the margins are likely to stay under pressure in the near future but that does not imply weakness of long-term profitability prospects. Zipcar’s mature markets (Boston, New York, Washington, and San Francisco) have consistently demonstrated the business’s profitability potential and that the profits are being held down due to growth investments, rather than a bad business model.

As the company’s new markets mature and penetration levels increase, the company should deliver good returns. We estimate that Zipcar’s EBITDA Profit Margin witnessed an increase from 5% in 2009 to 10% in 2010 and 19% in 2011 and expect it to gradually improve to about 26% over time as penetration and usage levels improve and Zipcar succeeds in its effort to bring down fleet costs as percentage of revenue.

This is the first of a three part series. Look for the subsequent note at Trefis under Zipcar.

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