Deliveroo: appetite for cash back is bigger than required

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Deliveroo has had a rough ride since its London listing in March 2021. A chunk of the roughly £1bn cash that the food delivery service raised in its initial public offering sits, keeping warm, on the company’s balance sheet.

Chief executive Will Shu is promising to hand back more than a quarter of this £948mn to shareholders. That cheered the market, but it sends an odd message.

Companies typically allocate capital based on how much cash flows through their accounts. After making investment decisions, CEOs can send any cash surfeit to a number of places. One option is to give the cash to shareholders via dividends and buybacks. Banks and other financial groups tend to do this by utilising any excess capital on their balance sheets.

But Deliveroo has not created any free cash flow. In the interim period to June it burnt through £27.7mn. Yes, the business is improving. In the last two years, Deliveroo had averaged annual free-cash-flow-burn of £241mn. First-half results published on Wednesday also showed that gross margins are looking more healthy at 10.4 per cent, up 170 basis points in the past 18 months.

This steadying explains why the group’s shares have climbed 48 per cent this year, but also why they trade at just 0.6 times revenues.

Shu’s apparent generosity hands back excess but unearned capital. Rather than a store of retained earnings, shareholders are in effect getting their deposits back. How that capital is returned, share buybacks or dividends, the company will confirm later.

Potential investors may well be asking why Deliveroo holds so much rainy day cash, thinks Bernstein Research. It makes for an inefficient balance sheet. Net of the promised £250mn handout, the company will still have some £700mn of cash. That is a lot against a market capitalisation of just £2.2bn.

Shu is apparently comfortable with both future cash flow and any investment requirements. Deliveroo has pulled in its horns of late, cutting exposure to markets such as Spain. The irrational expansionary bent of delivery companies has tempered, for now.

An investor day in November should offer more insights into Shu’s ability to balance the desire for growth and the need for profitability. It will take more than a capital return to prove that this conundrum has been solved.

*This note has been changed to reflect that Deliveroo raised roughly £1bn in cash at its IPO.