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Thesis
I hold a strong long-term view of the Food Delivery industry, because I believe that the younger generation values conveniencethan previous generations and is willing to spend money on it. This behavior should be further included in the consumer mind during the covid lock-down as well, revealing to non-users the benefits of food delivery. About Deliveroo (OTCPK: DROOF), I believe that its 1P model is doing well, especially in London – DROOF’s stronghold – but there is an overhanging risk of regulation literally making this business model illegal. On top of this, the looming risk of a recession that will change consumer spending behavior in the near-term future in Europe could put a damper on DROOF’s growth. DROOF is also not immune to any competitive threat, especially UberEats (UBER) and Just Eat Takeaway (OTCPK:TKAYF) which pursues its parts. I noticed that market share is difficult to analyze across platforms, especially since DROOF does not reveal the number of food orders. Overall, while the industry is set for long-term growth, I believe DROOF has a lot of risk going forward and, as such, recommend a hold rating.
2H22 results
In the grand scheme of things, DROOF’s results were satisfactory, with 2H22 gross profit coming in at 8% above consensus and 2H22 EBITDA being on target. 2H22 losses were much lower than I expected. Since most of the 4Q22 results were released in January, the focus of the 2H22 results is on FY23 guidance, where management is forecasting low to mid-single digit growth in GTV ex-FX and £ 20-50 million in adjusted EBITDA. As I said above, it is difficult to properly evaluate the results of DROOF because it does not reveal the most important metric for a food delivery company – the number of food orders (not the total -the orders). There are 2 ways to view the GTV guide:
- Food delivery orders have dropped significantly because food inflation is high. It doesn’t sound good
- Food delivery order growth is common, but it is unlikely given that we know food inflation is high
That being said, based on the results, I would say that the number of orders will fall sharply, which raises the question of how much DROOF is missing here? Food delivery is a game of who has the most profitable market share. If DROOF has a small share of the profitable market, it will have less money to protect its market position. That said, I would also argue that brand awareness is something that money can effectively “buy”, as seen in TKAYF’s failure to gain much traction in London.
Upside from advertising and other businesses?
In 4Q22, advertising accounted for 0.6% of GTV, or an annual £40 million revenue. While small, I think it will help DROOF in terms of revenue. Given that this is mostly due to the advertising of restaurants and that the FMCG proposition was only released in 2H22, the probability of its success seems high. If we take the management guide at face value, it appears that they are very optimistic about the development of this market niche. In the call, management stated that they expect revenue growth in 2023 to be strong and margin-accretive. Next, in grocery and dark shops, it seems to be progressing well as well. In addition to the supply side metrics and the percentage of gross transaction volume, it is important to note that Hop has made significant progress towards profitability and that it has probably achieved a significant cost advantage. against operators of pure play stores. An obvious contributor to this growth is the investment in products across the board in the grocery store selection.
Overall, progress appears to be rapid; however, as I mentioned before, there is not enough information to make an accurate assessment of actual performance. I don’t think anyone will be able to make a strong opinion about how important it is unless management starts to disclose more information. That being said, these are all question marks that could potentially lead to DROOF improvements if properly investigated.
Will we see a stop to burning money?
Cash flow is expected to improve along with EBITDA and the reduction of extraordinary expenses. Investors now have a better understanding of the difference between EBTIDA and FCF thanks to the disclosed cash bridge (something TKAYF does not do). More specifically, it appears that the two biggest items in FY22 were -£80m spent on capex and CapDev and the £85m spent on exceptional items. A significant portion of the latter, about $40 million, is a one-time inflow of working capital due to the tax on vested options that are not expected to recur, while the remainder is comprised of a one-time expense due to to close operations in Spain, Australia, and the Netherlands. What is noteworthy is that the new CFO indicated a potential break-even in the run-rate FCF in 2023. (most likely 2H23 or 4Q23 I believe). However, DROOF’s business model (hiring riders as independent contractors rather than full-time employees) still carries the risk of a heavy fine from regulators, with damaging effect on cash flow. In my opinion, the regulatory risk is the biggest overhang of the stock, because it is a walking time bomb that can effectively change the entire unit economics and operations of DROOF.
Conclusion
While the Food Delivery industry is set for long-term growth, DROOF faces many risks in the form of looming regulation, a potential recession, and intense competition. The recently released 2H22 results were satisfactory, with gross profit and EBITDA coming in above consensus and losses lower than expected. However, the lack of disclosure of the number of food orders makes it difficult to assess the true performance of the company. The upside may come from advertising and other businesses, such as grocery and dark stores, but more information is needed to accurately assess their potential. While cash flow is expected to improve, the risk of heavy fines from regulators for hiring riders as independent contractors remains a significant overhang on the stock. Based on these factors, I recommend a stop rating on DROOF.
Editor’s Note: This article discusses one or more securities that do not trade on a major US exchange. Please be aware of the risks associated with these stocks.
