Description

Since we wrote up Deliveroo last year the stock is up +30% and we believe that ROO continues to be a very compelling investment opportunity. A few key components of our thesis are:

• We believe that 2024 EBITDA will exceed current consensus
• A strong ’24 result will position the company well to achieve recently re-iterated ’26 targets
• Expiry of CEO super voting shares in March presents potential near-term M&A catalyst and medium-term technical catalysts of index inclusion

Company overview

As a very brief reminder, Deliveroo is a food delivery business founded in the UK that operates in: UK & Ireland (~60% of biz), France + Italy (combined ~20% of biz) + Middle east (UAE, Kuwait, Qatar combine to ~10% of biz). Remaining ~10% is Hong Kong, Singapore and small Belgium biz. What is unique about Deliveroo is that they are focused on the most profitable segment of food delivery. They do this by:

• 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 on a fixed cost base (per order cost to courier the same regardless of AOV)
• 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).

What’s changed?

We’ll direct readers to our prior write up for more information on company background and competitive positioning and will focus here on what has changed and our updated views. Over the past year the main updates are:

• EU platform worker directive failed – ROO has ~20-25% exposure to the EU through operations in France, Italy and Belgium. We have believed (and continue to) that the EU platform workers directive would result in substantial autonomy provided to member states such that regulation would not change materially. Importantly, France is supportive of the gig model & ROO has already settled with Italian unions. So we see low risk in both markets currently. However, the directive has created regulatory noise & could potentially meaningful, so is worth watching. Two versions of the text were put forward in the last few months and both failed to gain support. The result is that the directive is dead unless picked up by a new parliament / council down the road. While this adds to potential uncertainty longer-term, we believe that this removes a ’24 regulatory overhang and hopefully reduces noisy newsflow. We’re happy to continue to the regulatory discussion in the comments if people are but we think that this issue is not a material risk for ROO.
• Completed tender offer – ROO successfully tendered for £250M worth of shares in October ’23 at a price of £1.30. We believe that this was an important step towards reducing ROO’s excessive cash balance and rewarded long-term shareholders by increasing our ownership in the company.
• There is potential for further capital returns as ROO’s cash balance is still excessive since the company has reached positive FCF. We think another tender of similar size is likely if the share price persists below the levels of the previously completed tender.
• November 2023 markets day – This was ROO’s first strategy update since FY21 results, where mid-term outlook and ’26 guidance were provided (a lot has changed in equity markets since then…). ROO maintained their ’26 margin target of 4% of GTV and reduced their medium-term growth outlook to double-digits from +20% (as expected). In the context of ‘22/’23 results that lapped COVID and included significant cost of living crisis in the UK / EU, we believe that this update was prudent. ROO also announced delivery services for retail items, which we think is a logical adjacency and should be modestly accretive to growth and profitability.

Why is this interesting?

• Consensus estimates for ’24 are too low – the sellside has been continually pessimistic on Deliveroo’s ability to generate EBITDA growth and ROO tends to guide conservative. We believe that ROO will earn ~£150M of EBITDA in ’24. We assume that GTV will grow ~9% in ’24 (~1/3 AOV inflation, ~2/3 order growth) and flow through at a ~9% incremental margin. Part of this growth will come from ROO accelerating their advertising business, a portion of which we believe will be reinvested to lower customer costs and drive growth.
• We remain confident in ROO’s ability to achieve ’26 targets – from the ‘24YE launchpad, ROO will have already achieved a ~10% gross margin and ~2% EBITDA margin. We believe that growth will continue at LDD rates (driven by increased penetration of food delivery) at ~9-10% contribution margins. The majority of margin expansion to get to ROO’s targets will come from operating leverage on a fixed overhead base and a portion will come from increasing advertising (guidance is for additional ~1% post YE24, which has ~+70% contribution margin but a portion of which will be reinvested for growth. For context, Delivery Hero is currently earning ~3% of GTV in advertising in their comparable markets [excluding Korea]). See below from ROO’s CMD presentation:

What is ROO worth?

We believe that ROO growth will re-accelerate in ’24 / ’25 as ROO laps easier comps and cost-of-living pressures subside as wages catch up to slowing inflation and European energy situation continues to improve. Below we highlight a range of outcomes that we underwrite and provide meaningful equity upside from current prices. It’s worth noting that even after ROO achieves their mid-term ’26 margin target of 4%, the business will continue to grow at incremental contribution margins of ~9%, +2x the average margin, resulting in substantial EBITDA growth and quickly buying down ROO’s multiple. As such, we believe that ROO could conceivably trade at much higher multiples but this is not necessary to underwrite to earn a great return on the stock from here.

Catalyst

• Beating '24 street est.
• Achieving '26 guidance
• M&A