Zipcar Is A Steal Near $10

| About: Avis Budget (CAR)
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Car-sharing pioneer Zipcar (ZIP) has seen its stock swoon since reporting earnings on April 25. Zipcar reported a loss of $3 million, or 8 cents per share, on revenue growth of 20%. While this topped Wall Street estimates, analysts and other stock-watchers were apparently worried about Zipcar's forecast, which implied slowing revenue growth. Zipcar stock has dropped from nearly $14 before the earnings report to $10.20 at Monday's close, even enduring brief drops below $10. The strange thing about this price action is that management increased the company's earnings forecast. Typically, an earnings beat and raise does not lead to a 25%+ drop in stock price.

The problem, it seems, is that Zipcar is a growth company, and has been marketed to investors as such. Thus, revenue and user growth are more important to many investors at this point than earnings. However, this concern is overblown, as the company's valuation does not assume more than 15-20% revenue growth (as explained below). While Zipcar had never had a profitable quarter prior to its IPO last spring, it has posted a profit in two of the five quarters since then. Furthermore, the company expects 2012 to be its first profitable year.

In a recent investor presentation, Zipcar showed that income before tax in its first four cities (Boston, New York, Washington, and San Francisco) has risen steadily from 13% of revenue in 2008 to 23% of revenue in 2011. In these cities (which Zipcar refers to as its "established markets") Zipcar posted a 21% margin in the seasonally weak Q1 2012. As Jeremy Bowman writes, this indicates that profits are being held back by growth initiatives rather than a bad business model.

This means that, while overall revenue growth is nice, the key for Zipcar is to grow into its "less established" markets in order to get them up to (or near) the profitability level of the established markets. Since the company has managed this process well in the established markets, there's no reason to doubt its ability to transfer this success to other cities. In a worst case scenario, the company could pull out of underperforming markets and redeploy those vehicles elsewhere. In the Jefferies presentation noted earlier, Zipcar stated that EBIDTA margin has improved steadily from -1% to 2% to 5% over the past three fiscal years. The company's long-term financial model projects a 19% EBIDTA margin, implying that there is lots of room for profit growth even if revenue growth does slow somewhat. Zipcar now trades for less than 1.5 times projected 2012 sales. This is a very modest figure, indicating that the company's valuation does not necessitate rapid revenue growth.

Some pundits and industry-watchers have doubted Zipcar's ability to survive and maintain a competitive advantage against established daily car rental agencies such as Hertz (NYSE:HTZ) and Avis Budget (NASDAQ:CAR). In part this is due to a misunderstanding of Zipcar's business model: while members can rent Zipcars by the day, the company focuses on the hourly market. For short outings and errand trips under 5 hours, renting a Zipcar is almost always more cost effective than renting from a traditional agency. By contrast, Zipcar's daily prices are far above those of traditional car rental agencies. However, this simply pushes the mix towards the more profitable hourly market, while still allowing customers to rent Zipcars by the day if they are willing to pay a premium.

Furthermore, while Hertz has already made a small push into the hourly rental business, and Avis Budget is interested in doing the same, Zipcar has a substantial first mover advantage. First, Zipcar already has secured parking spaces for its 9000 car (and growing) fleet. Since the company focuses on markets with high parking costs (i.e. limited supply), competitors will have difficulty finding equally good parking real estate. Second, Zipcar has over 700,000 members, who are quite loyal to the company. As a Zipcar member myself, I have a hard time imagining how a competitor would induce me to switch. Zipcar's rates are fair and its cars are convenient; competitors could at best provide marginal improvements, which would not be worth the hassle of switching.

Zipcar's improving profitability picture and modest valuation make the company a worthwhile investment opportunity. Additionally, in the short term, Zipcar will benefit from lower gas prices during the peak summer driving season. While Zipcar's prospects are not tied as tightly to oil prices as airlines, for instance, gasoline still constitutes one of the company's largest expenses (unlike traditional rental car agencies, Zipcar pays for fuel rather than requiring customers to do so). Gas prices have already dropped roughly 17 cents in the past month, and gasoline futures price action suggests that prices are likely to continue declining. This provides additional upside to the company's projected profit for 2012. With all of these positive drivers, Zipcar is a steal at its current trading level near $10.

Disclosure: I am long ZIP.