Back in May, I argued that Zipcar (ZIP) was a steal when it was trading near $10. While the stock touched highs near $12 in late June and July, investors who have continued to hold the stock (including myself) have seen Zipcar shares drop to a trading range near $8. Nevertheless, I think that Zipcar shares are a good buy at current levels, for investors willing to hold the stock for at least a year. For a few reasons that I outline below, I expect Zipcar to bounce back over the next several quarters.
The primary reason for Zipcar's drop was the company's poor earnings report last month. In the Q2 report, the company cut its full-year guidance for revenue, EBIDTA, and EPS. Many in the investment community have been concerned about Zipcar's ability to maintain a high growth rate. This has led to a severe contraction of Zipcar's revenue multiple since its post-IPO close at $28. The weak earnings and guidance probably reinforced the concerns of many Zipcar bears. I will briefly discuss the causes of the revenue/earnings shortfall and then explain why I am still bullish on the stock over the long term.
CEO Scott Griffith blamed the Q2 revenue shortfall on slower-than-expected membership growth and general weakness in the UK (where Zipcar runs a large London operation). On the Q2 conference call, management explained that the company's experiment with more-expensive radio advertising had been ineffective. This raised costs, without driving significant membership gains. Therefore, the company is going back to its "bread-and-butter" by focusing on social media, referrals, and improving the productivity of online advertising. However, the lower membership gains in Q2 will have a lingering effect on revenue (for the simple reason that Zipcar's revenue growth is primarily driven by member additions). Furthermore, as a result of the Q2 shortfall in membership growth, Zipcar essentially has too many cars relative to its membership base. Since the company's assets are not being leveraged optimally, earnings suffer disproportionately.
Ongoing macroeconomic weakness also contributed to Zipcar's slowing revenue growth in Q2. On the earnings call, management suggested that the weak economy may have led some members to cut down on discretionary day trips. However, while the current weak economy/high fuel price environment is challenging for Zipcar in the short term, I think it may be beneficial in the long run. Over the past few years, we have seen the U.S. vehicle base aging significantly. If we continue to see high fuel prices and weak growth, some current urban car owners may decide to try car-sharing as an alternative to replacing their vehicles. Similarly, potential first-time car owners might decide that Zipcar offers a better value proposition. The economic environment is thus more of a threat to mass-market automakers like Ford (NYSE:F) and General Motors (NYSE:GM) than it is to Zipcar. (That said, I think the effect will be small relative to the size of Ford and GM.)
Returning to Zipcar's earnings call, it was comforting to see management outline a wide variety of initiatives to reinvigorate growth in the near-term. Zipcar is still at the forefront of the car sharing world; engaging in some trial and error is not a bad thing. One promising growth initiative is the recently announced expansion of the Zipvan cargo van-sharing service. This service has performed well in its test markets and nicely complements Zipcar's existing car-sharing network.
The emergence of competition, primarily from traditional rental car companies, has lately been a standard argument for Zipcar bears. The recent news that Hertz Global Holdings, Inc. (NYSE:HTZ) has agreed to acquire smaller rival Dollar Thrifty Automotive Group Inc. (NYSE:DTG) is probably good news for Zipcar in that respect. Hertz is further along than Enterprise or Avis Budget Group, Inc. (NASDAQ:CAR) in building out a car sharing business to go along with its daily/weekly rentals. The Dollar Thrifty acquisition will likely divert Hertz's focus from the car sharing segment.
Furthermore, as I discussed in my previous article, I doubt that the traditional rental car companies constitute a long-term threat to Zipcar. Hertz, Avis, and Enterprise all have many more vehicles than Zipcar, but their placement is much worse from a car-sharing perspective. Traditional rental car agencies want to be at airports and in city centers, while car sharing demand is highest in residential neighborhoods and on college/university campuses. The synergies between the two businesses are thus much more modest than might appear to be the case.
To summarize, I think that Zipcar's weak Q2 performance was a hiccup caused by two main factors:
1) trial and error in advertising that failed, and
2) macroeconomic weakness.
However, the first is easy to fix, and the second may provide long-term benefits in driving people towards car-sharing, rather than car ownership. Meanwhile, Zipcar has been steadily improving margins over the past few years (see slide 14) and I expect this to continue for the foreseeable future. As some of Zipcar's current growth initiatives take hold, I think the stock will bounce back over the next year or so. Zipcar has upside as far as $15 if revenue growth picks up again in 2013.