Description

We think that Deliveroo represents a very compelling risk/reward from its current price of 83 pence with limited downside. In summary –  ROO sold off with the tech/growth meltdown despite continuing to post very solid numbers through end of COVID and subsequent UK consumer crisis. The stock trades nearly at cash value despite having clear line-of-sight to FCF generation and beating management’s profitability targets a year early.  On our expectations for 2023 ROO trades at ~7.9x EBITDA, ~2.8x 2024 EBITDA and ~1.0x 2026 EBITDA. We think +15x is a reasonable multiple on 2026 EBITDA which implies upside of +500% from here.

Setup and Valuation

ROO is ridiculously cheap. 2/3 of the market cap is cash. The setup here is that ROO has carved out an interesting niche. Despite not being the country-level GMV leader ROO is leading in the most attractive sub-markets and has carved out a niche as the premium brand which yields higher AOVs and better profitability despite lower scale. Also, massive food inflation in the UK has greatly benefitted ROO gross margins (ROO revenue is a % of total order value but ROO has kept control of cost inflation by increasing network efficiency through better routing and batching & the weak macro has improved supply of couriers). We think that ROO will hit the low end of their 2026 gross margin target range (10-11%) in 2023, which is not in consensus numbers. This implies that ROO will generate 2023 EBITDA of ~50-75m vs. consensus currently at EBITDA breakeven. Since we believe that restaurant-set food prices will be sticky, this structurally improves ROO unit economics and gives clear line-of-sight to beating management’s target of a 4% EBITDA margin in 2026. We think that ROO is able to his this 4% target (laid out in March 22) despite lower growth which is a big differentiation vs. consensus. We also pro forma for exits of loss-making markets (Australia) and announced corporate cuts (~25M benefit) which are not reflected in consensus numbers (PF for Australia alone ROO is B/E + corp cuts gets you to 2023 EBITDA of ~25M, ahead of consensus breakeven). From our 2023 EBITDA of ~68M we model modest growth in 2024 and EBITDA quickly rises to ~188M (because you are adding EBITDA at ~8% incremental margins vs. a base at ~1% overall margins in 2023). This operating leverage is key to understanding why consensus mis-models ROO. ROO also issues very little SBC and has minimal cash costs below EBITDA. Despite the UK going through a massive consumer crisis as a result of Russia invasion of UK (energy bills skyrocketing, crushing consumer confidence and discretionary income), ROO is still growing (+9% in UK in 4Q22 vs. JET declining -3%). As the consumer environment normalizes (nat gas / electricity prices back down post-winter) we think ROO is setup to get back to mid-teens growth (supported by strong cohort growth and modest customer additions).

Below are additional details on the company and industry for anyone new to the story. We’re happy to continue the discussion in the comments.

Company background

Deliveroo is a food delivery business founded in the UK that operates in: UK & Ireland (~1/2 of biz), France + Italy (combined ~1/4 of biz) and a few additional international markets that make up the rest (UAE, Singapore, Hong Kong, Kuwait, Qatar, Belgium). What is unique about Deliveroo is that they are focused on the most profitable segment of food delivery. They do this by:

1)      Focusing on independent restaurants instead of QSRs, which leads to higher average order values (AOVs). ROO revenue is a % commission, so higher AOV’s means unit economics benefit from higher dollars to work with.

2)      Targeting geographies that make sense for delivery. This is either 1) dense markets, like London/Milan/Paris (all ROO profit pools) where ROO can send 1 courier w/ 2+ orders at a time and generate scale benefits or 2) high net worth zip codes (i.e. Sevenoaks, a town in UK you may have never heard of but ROO’s highest gross margin in the UK).

Despite ROO being at a smaller scale than peers and having no significant marketplace business (i.e. you order Chinese food on Grubhub and an employee of the restaurant delivers your food, whereby Grubhub makes a $ commission and has no variable delivery cost – which benefits profitability), ROO has established industry-leading profitability from their combination of 1) better strategy and 2) better technology.

Food Delivery Industry

We believe that food delivery has a long runway of growth that is obscured in recent/upcoming quarterly trading from 1) the massive shift in accelerating adoption during COVID and 2) the weak consumer environment.

A question that often gets posed when discussing food delivery names is “how could these businesses lose money during COVID, which was the best event ever for this industry?” – we think it’s important to understand how early western markets are in the food delivery adoption curve and the massive shift in the demand curve that happened during COVID. We think that each industry participant saw the opportunity to massively grow their TAM by accelerating user adoption (& based on their knowledge of cohort patterns pre-COVID saw this is as a great customer acquisition opportunity – as it was). However this has resulted in difficult comps to lap today because 1) new customer acquisition is lower and 2) churn is higher.

Below is a graphic from JET that helps illustrate this dynamic: in any given period, your current period customer acquisition is offset by prior period churn. At a fixed % churn on a significantly higher # of new users, the churn in your “transition” period is abnormally high (because it is the result of abnormally high customer acquisition in a prior period but you are in a current period of normal customer acquisition, so the # of churn looks worse on this mismatch). This is the period that the food delivery is working through as we will finally lap Omicron-impacted comps in 1Q23 and then transition to “back to normal” patterns and has thus obscured normalized growth.

This issue has been compounded by the weak consumer environment in Europe. Russia’s invasion of Ukraine added inflationary pressure & energy security risks, killing consumer confidence and discretionary income. The UK + France/Italy represent ~75% of ROO GMV and the consumer environment is strengthening as we lap periods of high energy costs. We see this environment continuing to ease throughout the year from fundamental improvements (i.e. gas storage is much better than last year) + lapping easier comps.

We get confidence in the potential for food delivery industry growth by looking at adoption in significantly more mature markets like China and Korea, and which have continued to grow.

Competitive Positioning in UK

ROO has managed to continue to gain share in the UK while JET and Dominos have been share donors. ROO does this by having a better offering (higher quality food, not pizza and kebobs) and better technology (by JET’s own admission, ROO delivers food faster). The only time that JET was able to sustain a period of market share gains was the summer of 2021 when they spend hundreds of millions of pounds to voucher the UK, which decimated their EBITDA and caused them to massively miss numbers (see BBG EBITDA progression for 2021). Today we think competition is rationale in the UK.

Competitive Positioning ex. UK

For international markets we have less visibility than the UK but we are still comfortable with ROO’s competitive positioning. France is a two-player market w/ Uber #1 and ROO a close #2. Uber disclosed in their Feb 22 investor day that they made 6% EBITDA segment margins in France (4Q21) and we believe Uber is a very rationale competitor. In Italy ROO has a leading position after JET has stumbled by focusing on structurally unprofitable markets in southern Italy while ROO captured profit pools in Rome and Milan. Italy is a competitive 4-way market w/ Uber and Glovo as well however Uber a distant 4^th position and seems to be more focused on rideshare. Glovo is the strongest logistics competitor to ROO but is under pressure to cut losses so we think the competitive situation there will continue to improve (and ROO is already operating at about breakeven while gaining share based on Yipit data). ROO’s middle eastern markets target the expat community and are very solid (UAE earned a ~2% GMV margin in 2021). It’s also important to note that ROO has aggressively shut down markets where they do not find success such as Australia, Spain and the Netherlands. We believe that ROO is seeking to exit Singapore as well and is in an attractive position to sell to either Grab or DHER (and by doing so would give either buyer the #1 position). Lastly ROO’s situation in Hong Kong improved from Uber exiting in 2021 and it is now a 2-player market with DHER (tho there is some risk of Meituan entering).

Regulatory

We are very comfortable with the regulatory situation in ROOs markets. In the UK, ROO’s independent contractor model has been upheld by the supreme court. This is different than rideshare (where Uber runs a “worker” status that is similar to IC+ in the US). In France/Italy the governments are very supportive of the gig economy (notably France, which is the opposite of US progressive politics; ROO also reached an agreement with the GMB union in Italy). There is regulatory noise at the EU-level, which is currently in the process of updating guidelines for employment status of independent contractors. Importantly, these guidelines will be up to each member state to interpret and we do not think will result in any significant changes for ROO. The remaining 25% of ROO GMV are in markets w/out regulatory issues.

Catalyst

Street numbers too low for 2023-beyond