Zipcar’s Cash Management Is A Key Driver To Its Outlook

Zipcar (NYSE:ZIP) is scheduled to announce its third quarter earnings on November 8. Zipcar’s third quarter was an eventful one as well. The company announced the acquisition of Carsharing.at, an Austrian car sharing service and continued the expansion of car sharing services and the new Zipvan cargo van sharing service across North America. While these developments bode well for the company’s long term prospects with regards to growth in its membership base and revenues, we are wary of a cash shortfall which may inhibit the company’s ability to carry out its ambitious plans.

Zipcar serves 730K members with a fleet of over 11K 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.

See our full analysis for Zipcar

The car sharing company had a difficult second quarter – revenues rose 15% y-o-y, the membership base grew 21%, and net loss declined over 92% to $422,000. However, the growth in membership base was lower than expected, and the company’s long term outlook is now shrouded in uncertainty due to increased competition from local services such as City Car Share and well established car rental companies such as Hertz. This resulted in a generally bearish outlook, and the stock tanked 20% in after-hours trading following the earnings release.

Expansion into new markets through acquisitions and new services

Early in the third quarter, Zipcar acquired leading Austrian company Carsharing.at, a leading car sharing service with over 10,000 members and a fleet of 200 vehicles. This acquisition is in line with Zipcar’s goal of expanding its car sharing network in Europe. The company’s management is especially bullish about its prospects in Austria, and plans to complete the integration of its services and technology with the Austrian company by mid-2013.

The company expected a recovery in Europe during the second half of this year, but that has not been the case. However, the market has strong growth potential in the long term, particularly due to government support. We believe that, in spite of increased competition from services such as Daimler’s car2go, Zipcar is well positioned to retain and capture market share in the region.

European operations currently make up around 11% of our valuation for the company. We project the average number of members for Zipcar Europe to show robust growth going forward, reaching almost 300,000 members by the end of our forecast period.

Zipvan, launched in 2011, is an innovative cargo van sharing service. The service targets a completely different customer base from Zipcar, and currently dominates what is a nascent market. It gives Zipcar an opportunity to diversify its revenue base amid increased competition in the car sharing space, and can also help boost overall margins due to the service’s higher net pricing.

Zipcar has shown steadily improving EBITDA margins since inception, and we believe that the Zipvan service can help the company boost margins even further. North American EBITDA margins stood at around 19% in 2011. We project this to gradually increase to over 23.5% by the end of our forecast period.

Effective cash management required to support growth

Although we are bullish on the company’s prospects based on its expansion plans and market positioning, a quick look at Zipcar’s financials paints a very different picture. The company managed to raise over $170 million from its IPO in early 2011, and cash reserves stood at $90 million at the end of Q2 that year.  However, these figures have gradually declined since, and as of last quarter, cash reserves are at $42 million. The company’s current ratio (a good measure of liquidity) has declined steadily from 1.95 in Q2 2012 to 1.35 last quarter.

However, this kind of deterioration in liquidity is typical of a small company with aggressive expansion plans. In such a case, it is worthwhile to consider whether cash flows from operations (CFO) can support growing net purchases of property, plant and equipment (PPE). Since the beginning of the second quarter of 2011, the quarterly ratio of CFO to net PPE purchases has grown from around 31% to almost 72%. If the company is able to sustain this kind of growth in CFO relative to net PPE purchases, and assuming that net PPE purchases will gradually decline in the long term due to an eventual slowdown in expansion, we can expect that the company will eventually improve its liquidity and remain a going concern.

We currently have a Trefis price estimate of $11 for Zipcar, which is about 60% above the market price.

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