TKAYF - Deliveroo: Near-Term Uncertainty Still Present

2023-04-25 09:06:55 ET

Summary

• Deliveroo's international orders fell by 15% in Q1 2023, which is a cause for concern, and contributes to the discussion surrounding the outlook for future growth.
• Deliveroo's UK growth was better than Just Eat Takeaway, but I believe the swing in growth was mainly due to grocery orders, which is not a key metric.
• If Deliveroo's grocery delivery starts to slow and food order growth is not strong as expected, it would cast a very negative narrative on DROOF when TKWY starts growing positively.

Thesis

The 1Q23 results for Deliveroo ( OTCPK:DROOF ) support my hypothesis that the near-term risk is materializing. DROOF disclosed 1Q23 results with group orders that were 2% below consensus. Orders fell by 15% internationally, but fell by only 3% in the UK, so international weakness was the main factor. To be clear, I want to emphasize that the comparison is not like-for-like because DROOF orders include groceries and others while Just Eat Takeaway ( OTCPK:JTKWY ) orders were down 11% for 1Q. Management has previously stated that FY23 will see low to mid-single digit growth in constant currency and £20-50 million in adjusted EBITDA, indicating that the DROOF will be EBITDA positive. Management based this forecast on the fact that GTV trends had been improving throughout the quarter and revenues had increased by more than 4%. I still believe the rather sizable drop in international orders is cause for concern, and that it contributes to the discussion surrounding the outlook for future growth. Until at least the end of FY23, I do not anticipate the near-term uncertainties to be resolved. When JTKWY starts to print faster growth against easy comp, this could be a major catalyst for a positive share price derating as the company emerges from its tough comp. This could reverse the widespread belief that TKWF is gaining market share at the expense of DROOF. All in all, I remain neutral on DROOF stock.

UK growth was way better than Just Eat Takeaway

On a segment level UK&I performed well with GTV growing 6%. As I mentioned above about DROOF taking marketing share from JTKWY, commentary made by JTKWY management supports that idea that grocery has been a major swing here. JTKWY mentioned on their earnings call that their market share based on the various external data piece that they look at depicts a pretty flat picture overall. More importantly, JTKWY mentioned that it is challenging quarter for all players in the UK&I. As such, I believe the major swing here is groceries, which is not a key metric to look at when evaluating the food delivery players. One evidence that suggest my theory is right is that DROFF now sees more grocery shopping frequency . My take is while this has help DROOF show a “better” growth in this period, it has set itself up for a tougher comp against JTKWY moving forward when JTKWY starts to grow against easy comps last year. One must also note that grocery delivery in UK is extremely competitive with many players competing for that thin margin. If DROOF grocery deliver starts to show weakness + food order growth (that is unknown today) is not strong as expected, it would cast a very negative narrative on DROOF when JTKWY shows strong positive growth.

Guidance

In terms of guidance, DROOF issued their full year guidance a month ago, as a result, I am not surprised the guidance is reiterated with GTV growth guided low-mid single digit growth and adj. EBITDA of £20-50m in 2023, equating to 0.5% of GTV. The “going profit” narrative has been pushed by all food delivery players in the industry, most notably with JTKWY starting the ball and now guiding to FCF positive next year. However, unlike JTKWY that has structural profitable regions in Germany and Netherlands, I believe the risk for DROOF is higher given its concentration in the UK. We all know that UK inflation remains high, and that cannot stay for long. If the reversal in AOV (due to inflation tapering down) is sharp, I fear that DROOF might see periods of negative profits (turning from positive to negative) if the cost base is not managed well. While this unlikely to happen as I believe there is room for management to flex the cost base easily, this is a risk we need to take note off, especially as DROOF has not proven to be able to turn profit, yet.

Valuation

Lastly, I like to talk about the valuation disparity between JTKWY and DROOF. DROOF is currently trading at 0.5x forward revenue while JTKWY is trading at 0.64x forward revenue. I believe the valuation difference between the two suggest either JTKWY is extremely undervalued or DROOF being extreme overvalued, or both. Just by looking at the market size each player is presence in and profitability, JTKWY is clearer in a better position. For JTKWY, the key areas include UK, Netherlands, Germany, and Canada, the collective GDP of these regions are multiple times the size of UK GDP, which suggest a longer runway of growth and of course profit pool. In contract, DROOF is mostly in the UK which should limit how much it can grow. Secondly, JTKWY has the market place model in Netherlands, Germany, and the UK which has structurally higher profit margins than DROOF logistical model. As such, JTKWY should deserve a premium in this aspect as well. The fact that the valuation gap between the two is little to none is an interesting point to note.

Conclusion

In conclusion, the 1Q23 results for Deliveroo support the hypothesis that the near-term risk is materializing, with orders falling by 15% internationally. While UK growth was better than JTKWY, the swing in growth was mainly due to grocery orders, which is not a key metric to evaluate the food delivery players. Deliveroo's guidance for full year GTV growth and adjusted EBITDA is low-mid single digit growth and £20-50 million, respectively. However, the risk for Deliveroo is higher given its concentration in the UK and the potential reversal of AOV due to inflation tapering down. In summary, the rather sizable drop in international orders is cause for concern, and until at least the end of FY23, the near-term uncertainties are unlikely to be resolved. I reiterate my hold rating.

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