Deliveroo loses less by selling less

We have reached the stage of the reverse earnings warning of the impending recession. Deliveroo shares rose nearly 6% as it plans to subsidize less takeout.

An unscheduled courier shipping business update on Monday confirmed that order sizes had shrunk in a barely growing market. Growth in gross transaction value (GTV) slowed to 3% year-on-year in the second quarter, from 12% in the first quarter.

For the year as a whole, the GTV’s growth forecasts have risen from 4 to 12% against 15 to 25% previously; the consensus forecast was 16%.

But management is “confident in the company’s ability to adapt financially to a rapidly changing macroeconomic environment through gross margin improvements, more effective marketing spend and tight cost control,” apparently. therefore the adjusted EBITDA margin forecast was left alone at minus 1.5 to 1.8 percent of GTV.

Selling less with the same (negative) margin means profit expectations rise – RBC Capital Markets now expects a full-year loss of £118m, down from a previous forecast of £132m – and stocks too. Great!

The odd thing here is that defending margins shouldn’t matter much, at least to shareholders. Deliveroo is a stock concept. It’s a simple long-term bet that the food delivery economy will ever work.

The City expects Deliveroo to continue burning cash until the end of 2024. The company’s most absurd float means it’s still sitting on around £1.1bn (against a market capitalization of £1.5 billion) and so far only needs to burn pounds. 150-200k a year, so it’s relatively well positioned for both the take-out Hunger Games and another round of consolidation.

Added to this is the worry that if the positive free cash flow target is pushed back, all confidence in CEO William Shu is gone. Deliveroo has far more exposure than its peers to the UK market, which provides more than half of the revenue, and its relatively upmarket image means it is unlikely to squeeze its way into leading positions in the market. (Hong Kong is the only market of the 11 it operates in where Deliveroo is No. 1 by share.)

Here is a recent note from Barclays:

The path to positive FCF depends somewhat on 1) the consumer’s willingness to pay when Deliveroo sets up monetization, and 2) the competitive environment. The base case is that the competitive environment becomes easier as the industry as a whole becomes more rational (and we strongly believe this is happening). But, should this change, we think it is possible that either ROO will have to push back FCF b/even point to generate growth, or sacrifice some GMV and refocus activity on its core business. However, we believe this business is highly unlikely to run out of cash – there are parts of Deliveroo that are profitable on an Adjusted EBITDA basis (e.g. UK (especially London) and UAE united) and probably profitable core cohorts in central cities in other countries (e.g. Milan, Paris, HK). It would be quite simple to make the whole business profitable tomorrow – just raise the ordering fee dramatically – it would just cause a headwind on GMV. So we have a hard time envisioning a scenario where ROO actually runs out of money, even in a stressful case. However, this type of scenario is negative for the share price; if GMV began to decline as management focused on positive FCF, much of the “hope” in the story would vanish.

About Myra R.

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