It's the Fuel Economy, Stupid
By Lawrence Carrel
April 28, 2006
Here's our weekly look at small-capitalization stocks that are making waves on Wall Street.
SOARING GASOLINE PRICES are playing right into the hands of Steven Schneider. The chief executive of ZAP (ZP1) is counting on growing pain at the pump to convince drivers to fork over $25,000 for a Smart car2, the fuel-efficient vehicle that can squeeze out 40-plus miles from a gallon of unleaded. Popular in Europe, Smart cars only recently started selling in the U.S.
Environmentally conscious — not to mention gas-price conscious — Americans have ZAP to thank for making the diminutive ride available at all. DaimlerChrysler (DCX3), the manufacturer of Smart cars, doesn't sell them here. The German-American automobile maker felt it wasn't economically feasible to modify Smart cars to meet more stringent U.S. standards. Much to Daimler's chagrin, ZAP found a way to do it. As a result the Santa Rosa, Calif.-based company has a lock on the nascent market — at least for now.
"I think market sentiment is shifting to smaller, more fuel-efficient vehicles," says Dennis Virag, president of the Automotive Consulting Group, a strategic consultant to the automotive industry based in Ann Arbor, Mich. "And the Smart car is an extremely well-executed vehicle for urban areas. I think it will do well among both the younger and older generations."
Investors seem to agree. ZAP's stock has surged more than sevenfold in 2006. Granted, the shares started off the year at 28 cents apiece, but indications the 12-year-old company is finally ready to mass-market Americanized versions of Smart cars in the U.S. are fueling confidence in the business plan. ZAP's market capitalization sits at about $67 million.
ZAP, short for "zero air pollution," helped pioneer the electric-scooter and motorbike industry and eventually moved into electric-powered all-terrain vehicles. Yet, its goal was always to sell environmentally friendly, advanced-technology cars. While Smart cars are neither electric nor hybrid, their internal-combustion engines use unleaded gas — and, some models, diesel — more efficiently. ZAP claims its modified Smart cars can accelerate up to 85 miles per hour.
It hasn't been an easy road for ZAP, which spent the past four years working to make the Smart car compliant with U.S. regulations. It received an initial stamp of approval from the Environmental Protection Agency in November 2004. On Dec. 6, 2004, ZAP's shares hit $5.03. By February 2005, ZAP began setting up its distribution network. CEO Schneider says ZAP quickly garnered $2 million worth of orders for the Americanized Smart cars.
The euphoria was short-lived. Since the orders exceeded ZAP's capacity at the time, Schneider says he approached DaimlerChrysler about working together to bring the cars to market. ZAP had been purchasing Smart cars from third-party suppliers and making the modifications itself. Daimler, which recall had already declared the business plan unfeasible, balked at the partnership offer. As word of Daimler's rejection spread, ZAP's stock price tanked.
According to Joe DeMatio, senior editor of Automobile magazine, Daimler wasn't going to admit it was wrong about the ability to get the cars up to U.S. standards profitably. "This was a bit of an embarrassment for Daimler," he says.
In October, ZAP sued DaimlerChrysler, claiming the auto giant employed anticompetitive tactics to discredit ZAP. The company is seeking $4 billion in damages. The case is pending.
"We don't actively prevent them from selling the Smart car," says Daimler spokesman Han Tjan. "Anyone is free to sell what they want."
"No one paid attention to the fact that the relationship [with Daimler] wasn't part of the business plan," says CEO Schneider. "We delivered 11 cars in 2005. But the perception became that we couldn't deliver. So, the EPA started running its tests again, and we got caught up in bureaucratic red tape. The delay was out of ZAP's control, but we got the reputation of overpromising and underdelivering."
Even though ZAP again received EPA approval to sell modified Smart cars in November, the damage was done. Shares hit an all-time low of 26 cents on Dec. 31, triggering a delisting notice from the Pacific Stock Exchange. But the stock started turning around in the new year. In January, the Pacific Exchange accepted a plan giving the company six months to bring the share price above $1. Then in February, ZAP received government certification to sell Smart cars in 45 states; five states including California and New York were excluded because their emissions standards were too tough. As of Thursday, ZAP has sold 122 Smart cars to dealers. It's in the process of getting 200 more vehicles up to U.S. standards. An additional 313 cars, purchased from third-party importers unaffiliated with Daimler, are ready to enter the country after passing customs inspections.
For 2005, ZAP posted a net loss of $23.5 million, or 75 cents a share, narrower than the 2004 loss of $27.8 million, or $1.67 a share. Revenue sank 25% to $3.6 million last year. As of Dec. 31, the company had $1.5 million in cash and $1.9 million in long-term debt.
"By the end of the second quarter, we will have sold more than 600 cars," says Max Scheder, ZAP's president. "That will bring in sales between $12 million and $15 million, and break-even for us is between $10 million and $12 million a year. Consumer-products sales for 2006 will be another $2.5 million."
Scheder says because of the overhang from noncash expenses, ZAP needs more than $35 million in revenue to become profitable. For 2006, the goal is to become cash-flow positive. The company says it has the capacity to Americanize 600 cars a month. In addition to the Smart car, ZAP will begin selling in two weeks the only fully electric car approved for sale in the U.S. The Xebra4, which plugs into a regular electric socket, gets about 40 miles per battery. The car, which sells for $9,000, comes with just one battery, but more can be added. The profit margins on the Xebra are much higher than the Smart car, management says.
ZAP isn't the only company offering gas-sipping cars. Last month, Toyota Motor (TM5) began selling the Yaris. It gets 34 miles per gallon in the city and 40 on the highway. Compared to the eight-foot-long Smart car, which can only hold two passengers, the Yaris hatchback is 12.5 feet long, holds five passengers and sells for $11,000 — less than half the Smart car's price tag. The Yaris sedan is 14 feet long and sells for $12,000. After selling 1,300 in March, Toyota expects to sell 50,000 Yaris vehicles in the U.S. this year. And last week, Honda Motor (HMC6) started marketing the Fit car. It gets 33 miles to the gallon in the city and 38 miles on the highway. At 13 feet long, the Fit also holds five passengers and is priced at $13,850. Honda expects to sell at least 35,000 Fit cars this year. In addition, Daimler says it's considering selling Smart cars in the U.S. when it brings out the next generation in Europe next year. A decision is due by year's end.
"I don't see [the Smart car] as a competitor of the Fit or Yaris," says Automobile magazine's DeMatio. "I think this will be purchased as a lifestyle accessory by affluent urbanites. It's perfect for Manhattan, Chicago or San Francisco. It's easy to park and easy to get around in. It might be a second car, but not a primary car for people who want to leave the city. Fit and Yaris will be the economy cars. Still, the Smart car is kind of adorable, so it will garner a lot of fans."
ZAP shareholders are hoping there are enough fans to drive the company into the black.
Links in this article:
1http://www.smartmoney.com/cfscripts/Director.cfm?searchString=ZP
2http://www.ZAPworld.com/cars/smartCar.asp
3http://www.smartmoney.com/cfscripts/Director.cfm?searchString=DCX
4http://www.ZAPworld.com/cars/xebra.asp
5http://www.smartmoney.com/cfscripts/Director.cfm?searchString=TM
6http://www.smartmoney.com/cfscripts/Director.cfm?searchString=HMC
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