Deliveroo loses less by selling less

We’ve reached the reverse profit warning stage of the incoming recession. Deliveroo shares are up nearly 6 per cent because it expects to subsidise fewer takeaways.

An unscheduled trading update from the courier dispatch service on Monday confirmed that because consumers are sentient, order sizes have shrunk in a barely growing market. Gross transaction value (GTV) growth decelerated to 3 per cent year-on-year in Q2, versus 12 per cent in Q1.

For the full year, GTV growth guidance went to 4-12 per cent from 15-25 per cent previously; consensus forecasts had centred on 16 per cent, so it’s a massive miss.

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

Selling less at the same (negative) margin means earnings forecasts go up — RBC Capital markets now expects a £118mn full-year loss, versus a previous forecast of £132mn — and so do the shares. Super!

What’s odd here is that defending margins really shouldn’t matter much, at least to shareholders. Deliveroo is a concept stock. It’s a simple long-term bet on whether food delivery economics can ever work.

The City forecasts Deliveroo to keep burning cash until the end of 2024. The company’s top-of-the-nonsense float means it’s still sitting on around £1.1bn (versus a £1.5bn market cap) and for now only needs to keep burning £150-200mn a year, so is relatively well placed both for takeaway Hunger Games and another round of consolidation.

In counterpoint is the worry that, if the target for positive free cash flow gets pushed any further back, all confidence in CEO William Shu goes. Deliveroo’s much more exposed than peers to the UK market, which provides more than half of revenues, and its relatively upscale image means it probably can’t acquire its way into any market-leading positions. (Hong Kong is the only market of the 11 in which it operates where Deliveroo is #1 by share.)

In that context, an up to 21 percentage point downgrade to sales growth guidance doesn’t look great news? Based on price elasticity and stuff?

Here’s a recent note from Barclays:

The path to FCF positive is somewhat predicated on 1) the consumer’s willingness to pay as Deliveroo puts through monetisation, and 2) the competitive environment. The base case is that the competitive environment is getting easier as the whole industry gets more rational (and we quite strongly believe this is happening). But, should that change, we think it is possible that either ROO would need to push back the FCF b/even point to deliver growth or sacrifice some GMV and refocus the business on its core. However, we think it is very unlikely that this business would run out of money – there are profitable parts of Deliveroo on an adj EBITDA basis (eg the UK (particularly London) and the UAE) and likely profitable core cohorts in core cities in other countries (e.g. Milan, Paris, HK). It would be quite simple to make the whole business profitable tomorrow – just increase order fees materially – it would just carry with it a headwind on GMV. So we struggle to envisage a scenario where ROO actually runs out of money, even in a stress case. However, this kind of scenario is a negative for the share price; if GMV were to start declining as management focuses moving to FCF positive, a lot of the ‘hope’ in the story dies away.