1. How to use GuruFocus - Tutorials
  2. What Is in the GuruFocus Premium Membership?
  3. A DIY Guide on How to Invest Using Guru Strategies
John Engle
John Engle
Articles (345) 

Lyft Struggles With an Uncertain Path to Profitability

Scale may not be enough to bolster its core ride-sharing business

June 17, 2019 | About:

Lyft Inc. (NASDAQ:LYFT) had a rather rocky reception when it made its public market debut earlier this year. Reported financial results for the first quarter of 2019 have not done much to improve things for the disruptive ride-sharing company.

The company now faces a very serious question: Can it ever become sustainably profitable based on its core business?

Management and bullish analysts see a bright future ahead, but many other observers are far less certain.

The company's vision

Last week, John Zimmer, Lyft’s co-founder, appeared on Freakonomics Radio to lay out what he considers to be the company’s simple path to profitability:

“And so the path is quite simple, there's two main pieces. One is: Rides are profitable in most markets. And then obviously we have to cover our overhead. And so the more rides that we do, the more that it covers that which doesn't scale with the growth. And secondly, per-ride, variable costs, things like insurance, are coming down. And will continue to come down. And we have a very clear path to profitability, with $3.5 billion in the bank and we intend to invest that well to get a good return for our investors.”

In essence, Zimmer’s case - and that of the company’s other executives - is that Lyft will achieve profitability thanks to scale, which will allow it to reduce per-ride variable costs to a level that will make the business sustainable. Susquehanna analyst Shyam Patil has bought into the argument, raising his price target on the basis of future leverage improving insurance costs.

The issue of margins

There is certainly some evidence to support Lyft’s argument. Importantly, gross margins have improved as revenue has grown. Last quarter, the company reported a gross margin of 40.4% on gross profit of $313.2 million. If this margin can be improved further, profitability might become possible.

However, the 40.4% reported gross margin is a bit misleading. Incentives, which have made up substantial costs for Lyft, are often recorded on the revenue line. As a consequence, real gross margins are considerably lower than the top line report would suggest.

In any event, Lyft still has a long way to go if it is going to be able to expand margins, however it chooses to record incentives in its financial statements.

The issue of scale

Lyft’s argument that scale can deliver the promised margin improvements and, in turn, profitability is less certain - and less simple - than the company suggests. Ordinarily, when discussing a new and evolving industry, scale is assumed to be valuable, but the magnitude of its impact is an unknown. In the case of ride-sharing, we actually do have an example of another company that has achieved far greater scale: Uber Technologies Inc. (NYSE:UBER).

If scale is going to save Lyft’s core business, then we should be able to see significant margin improvement at Uber, which is already far larger. Yet, even a casual assessment of Uber’s finances reveal it to have seen lackluster benefits of scale. Indeed, the company reported a $1 billion net loss on a $1.4 billion gross profit. Hardly a ringing endorsement for the business model, irrespective of scale.

Verdict

Ride-sharing is an evolving business and much is likely to change as Lyft matures along with the industry. However, it currently does not look great. As analyst Evan Niu pointed out ahead of Lyft’s initial public offering, future profitability is far from certain:

“There is room in the model for profitability, but it's going to be a big question mark. Maybe the goal with these types of businesses is to own certain geographies and dominate those markets. Once you've really established yourself as the provider in a specific space, you can slowly creep prices up. That might be a way to do it. But in the meantime, there's going to be a lot of discounting along the way, and if you stop doing that discounting, you might have a bunch of people defecting and going to other apps.”

Investors expecting a triumphant turn to massive profitability in the course of just a few years may find themselves painfully disappointed. Moreover, even if some form of financial sustainability does materialize, the threat of competition will always keep profit levels within strictly limited bounds.

Disclosure: Author is short Uber.

Read more here:

Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.

About the author:

John Engle
John Engle is president of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

Rating: 0.0/5 (0 votes)

Comments

Please leave your comment:


Performances of the stocks mentioned by John Engle


User Generated Screeners


pjmason14Momentum
pascal.van.garsseHigh FCF-M2
kosalmmuse6
kosalmmuseBest one1
DBrizanall 2019Feb26
kosalmmuseBest one
DBrizanall 2019Feb25
kosalmmuseNice
kosalmmusehan
MsDale*52-Week Low
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)

GF Chat

{{numOfNotice}}
FEEDBACK