GrubHub continues to have difficulty maintaining profitability due to the high cost of delivery, which is becoming an increasingly important part of their business.
The decline in GrubHub’s growth rate is not surprising given that most attractive cities and consumer segments are likely already near saturation.
Competition remains a concern given data that indicates DoorDash continues to take market share.
Investors should look to Uber’s third-quarter results to gain insight into whether GrubHub’s problems are industrywide or company-specific.
GrubHub’s valuation is now more realistic given the company’s prospects, but the share price could decline further if the profitability and growth problems are not resolved.
After GrubHub’s (GRUB) weak Q3 results and negative guidance, the narrative around the company has shifted: Before, it was an undervalued company with bright prospects, and now it is a company with a questionable business model and future. In my previous article (GrubHub: Delivering Underperformance) I covered the problems with GrubHub’s business model and gave a conservative price target for Grubhub of $39 per share, believing the stock could potentially have significantly more downside. Investors should not be fooled into thinking this is an attractive entry point for a quality company’ Grubhub still needs to prove they can profitably manage a company based around a delivery network and that it can create sustainable organic growth.
Deteriorating Growth
GrubHub’s revenue growth has decelerated sharply in recent quarters, with GrubHub’s management citing industry headwinds and not any company-specific issues. Grubhub is referencing third-party data to support this belief even though they have previously said third-party data cannot be trusted. I believe it is likely that deteriorating growth is a result of both GrubHub-specific and industrywide issues, although Uber’s (NYSE:UBER) upcoming earnings should give some insight into whether this is the case. Investors should be concerned if there is an industrywide slowdown as the investment thesis for food-delivery companies has largely been based on the huge addressable market and the potential for economies of scale.
Figure 1: GrubHub Estimate of Total Addressable Market
(source: GrubHub)
As we highlighted in our last earnings call, high fees and total overall cost to diners will be an impediment to growth in this industry, as the average diner in the United States will not consistently pay over $25 in total cost for a quick service restaurant cheeseburger meal.
(source: GrubHub Shareholder Letter)
It appears likely that there is currently a relatively small group of consumers who value the convenience of food delivery enough to pay the high cost, and this is limiting the market size. Delivery platforms must figure out how to reduce delivery costs or their potential for growth and profitability will be limited.
There were a number of trends in GrubHub’s past data that signaled a slowdown in growth was likely. In particular, gross revenue per diner has been declining, indicating that new users to the platform have significantly lower value.
Figure 2: GrubHub Diner Revenue
(source: Created by author using data from GrubHub)
A similar dynamic can be seen in GrubHub’s orders-per-user data aggregated by geographic market, where there is a significant difference between New York and other large cities in the United States. As GrubHub expanded their service beyond the largest and most attractive markets, it was inevitable that growth would become more difficult to achieve. In the most recent quarter 40% of GrubHub’s new diners came from their newest markets, 25% came from markets launched in 2012, and the balance came from the oldest markets.
Figure 3: GrubHub Orders per Diner Aggregated by Geographic Market
(source: GrubHub)
In the past GrubHub has relied on acquisitions to generate much of their growth, but with a lack of viable targets remaining they no longer have the ability to do this. Growth must come by taking consumers from competitors or continuing to attract new consumers to the market, both of which are likely to be difficult.
Figure 4: GrubHub Estimated Organic Growth
(source: Created by author using data from GrubHub)
Market Share Loss
Despite GrubHub’s continued refutation of third-party data, it is clear that they have been rapidly losing market share to Uber Eats and DoorDash (DOORD), and this has likely contributed to their declining revenue growth.
Figure 5: Food Delivery Monthly Sales
(source: Second Measure)
GrubHub investors should be asking how the company has given up such a dominant position in such a short amount of time and management needs to provide a coherent strategy for stabilizing their market share. GrubHub believes they offer diner the lowest fees and yet they continue to lose market share, which indicates that consumers have a preference for the user experience of other services. Unlike competitors, GrubHub has exclusively placed partnered restaurants on their platform, as they believe it significantly improves the user experience. However, this does not show in user retention data. Most consumers now use more than one food-delivery service which I believe will make price the basis for competition.
Figure 6: Consumer Use of Multiple Food Delivery Services
(source: Created by author using data from Second Measure)
Declining Profitability
I believe GrubHub’s recent profitability problems are a result of competition being largely based on price and loss-making delivery services making up a larger proportion of total revenue. Since 2015 as the delivery network has grown relative to the marketplace, GrubHub’s profitability has declined.
Figure 7: GrubHub Expenses as a % of Revenue
(source: Created by author using data from GrubHub)
GrubHub can be viewed as a marketplace for ordering food and a food-delivery network. The marketplace for ordering food is highly profitable and the food-delivery network loses money. Adding delivery services allowed GrubHub to expand their addressable market as well as generate more revenue per order, but at much lower margins.
Figure 8: Example of GrubHub Fees
(source: GrubHub)
Delivery
Delivery/logistics is valuable to us because it increases potential restaurant inventory and order volume, not because it improves per order economics.
(source: GrubHub Shareholder Letter)
Even though delivery is destroying the economics of GrubHub’s business it is not a service they can afford to abandon. It drives a significant amount of volume and allows a much large range of restaurants to be offered on the platform.
Figure 9: GrubHub Order Volume Growth After the Introduction of Delivery
(source: GrubHub)
I believe success in the food-delivery space is dependent on the efficiency of the company’s logistics network. GrubHub believes that delivery is a commodity service that does not improve with scale and did not even mention strategies to improve delivery on the Q3 earnings call. GrubHub now delivers approximately 35% of daily active grubs and I believe this number will only grow over time, increasing the importance of delivery.
In 2015, we added delivery capabilities to enable restaurants that didn’t have delivery to join our platform. We did this as a means to an end – we knew it would be valuable to have those restaurants on the platform. But, we didn’t then, and still don’t believe now, that a company can generate significant profits on just the logistics component of the business. It is a commodity and there are significant variable costs that are hard to leverage even with technology and scale. Extremely large delivery/logistics companies can generate slim margins, but only because of the hub and spoke efficiencies they gain at substantial scale. The point-to-point nature of our business mostly eliminates that aspect of operating leverage.
(source: GrubHub Shareholder Letter)
It is concerning that GrubHub believes there is no viable strategy for improving their delivery operations. Other companies have raised the possibility of economies of density, drones, artificial intelligence and ghost kitchens as means to reduce the cost of delivery. It is not clear to what extent these strategies could work but it would be reassuring for GrubHub to address their growing operations and support costs and present a long term vision for reducing them.
Strategy
The strategy GrubHub presented to turnaround their business consists primarily of increasing restaurant inventory and increasing diner loyalty. GrubHub has had 15 years to build consumer loyalty, so it is not clear what they can change now or why they haven’t implemented those ideas in the past. GrubHub has a diner-focused strategy: They believe the winning service has to offer diners a differentiated service. I believe they offer a commodity service, leading consumers to use the lowest-cost service, and given this I do not understand the focus on diners.
GrubHub currently has over 140,000 restaurants on the platform already and plans to add non-partnered restaurants to the platform in an aim to double inventory in 2020.
We know from experience the single biggest determinant of diners usage on marketplaces is whether it has the restaurants that the diner wants.
(source: GrubHub Shareholder Letter)
While I believe adding restaurants to the platform will help to generate additional revenue, there appears to be diminishing returns to adding more restaurants at this point. Growth in restaurants on the platform is already outpacing growth in diners on the platform and gross orders per restaurant are declining.
Figure 10: GrubHub Restaurants and Monthly Active Diners
(source: Created by author using data from GrubHub)
Figure 11: GrubHub Gross Orders per Restaurant
(source: Created by author using data from GrubHub)
Significant space in GrubHub’s letter to investors was dedicated to discussing the value GrubHub provides to restaurants and how they can drive incremental traffic, but this is essentially the same value proposition as every other food delivery platform. With so many restaurants on the platform there is likely to be little benefit to the average restaurant joining and yet they cannot afford not to, as they risk losing business to competitors.
| 2014 | 2020 | |
| Avg Restaurant Revenue | $1,344,000 | $1,344,000 |
| Avg Revenue Generated by GrubHub | $60,000 | $20,000 |
| Cannibalization Rate (estimated) | 12.5% | 25% |
| Restaurant Gross Profit Margin | 70% | 70% |
| GrubHub Fees (% Revenue) | 15% | 36.7% |
| Restaurant Gross Profit Margin with GrubHub | 69.5% | 69.6% |
| Increase in Revenue (%) | 3.3% | 0.7% |
| Increase in Gross Profit (%) | 2.7% | 0.2% |
Figure 12: Example of GrubHub’s Impact on a Restaurant
(source: Created by author)
Regulation
In addition to its other problems GrubHub is facing the specter of regulation in its largest market, New York. The state liquor authority is considering a policy that would cap the fees food-delivery services can charge restaurants with a liquor license at 10%. This is due to a state policy that requires any entity that shares in a restaurant’s profits to be listed on its liquor license, with exceptions for vendors taking less than 10%. To continue charging higher fees, GrubHub would need to join thousands of individual liquor licenses statewide. Regardless of the outcome in this particular situation, it is reflective of general concern in the restaurant industry that food-delivery services are taking an inequitable share of their revenue and to the extent that food-delivery sales are not incremental, this is reducing their profits. As food-delivery services continue to grow this issue is only like to become more prominent, particularly as food-delivery sales are less likely to be incremental.
Figure 13: Food Delivery Market Share by City September 2019
(source: Second Measure)
Nokia Analogy
GrubHub’s current situation reminds me of Nokia (NOK) when the iPhone was introduced. Nokia was the market leader at the time with solid profitability and high growth rates. When the iPhone was introduced the basis for competition shifted and Nokia was left with an uncompetitive product. They were unable to adapt and their business did not recover. GrubHub’s online food marketplace has historically been the market leader in the U.S. but as the basis of competition has shifted to delivery they have been left with an inferior service to companies like DoorDash that are focused on delivery. If GrubHub is unable to adapt, they could suffer the same fate as Nokia.
Figure 14: Nokia and GrubHub Share Prices
(source: Created by author using data from Yahoo Finance)
Valuation
At this point I do not think this is an existential crisis for GrubHub, provided they can stem market share losses and cap delivery expenses. There are aspects of GrubHub’s business to like:
- Order volume is dominated by profitable small restaurants.
- A minority of orders are currently placed through GrubHub’s delivery service.
- Order volume is dominated by attractive markets like New York.
- GrubHub focuses on partnered restaurants, which drives better economics.
GrubHub’s management team has admitted there is a problem with the business, which is a positive, but their current strategy does not inspire confidence. I believe GrubHub’s share price is now more closely aligned with the prospects of the company, but there is still potential for further downside if they cannot find a way to improve growth and profitability. GrubHub needs to be valued as the low-margin, low-growth business they now are, and based on a discounted cash flow analysis I estimate their intrinsic value to be approximately $29 per share.