The growth potential for online food delivery is massive, given an annual $350 billion restaurant spend in the US alone.

Yet investors should tread carefully, there are challenging dynamics that have led to a cash-burning contest among competitors, such as UK-listed pair Deliveroo (ROO) and Just Eat Takeaway (JET).

Investors have followed diners into the online food delivery space as the rise of platform apps makes it easier for consumers to chow down on takeaways.

According to the latest data, around two-thirds of Americans now order food delivery online, and growth opportunities are vast given extremely low penetration of the substantial US and global restaurant spend, including fast food.

CASH BURN BATTLE

Headline growth numbers are enticing but dig a little deeper and you’ll find a more nuanced story. On one hand, online food delivery spending in the US could grow at an eye-catching 18% annually, jumping from 6% penetration last year to 13% in 2025, according to Morgan Stanley estimates.

But the sheer scale of that opportunity has led to a cash burning promotional battle as leading platforms chase diners and orders. This food fight has pressured potential earnings and made a high-growth story far less appealing.

Berenberg analyst Sarah Simon in a recent look at Deliveroo commented: ‘Particularly in the UK, Deliveroo faces aggressive competition from Just Eat Takeaway, which has pledged to do whatever it takes to maintain leadership of the market, and to regain share in London. Grab, Glovo, Uber Eats and Delivery Hero are also competitors, though to a lesser extent.’

The reason firms are grappling for market share is that most observers reckon its only by having a highly dominant share of a
market that a delivery platform can generate sustained profit.

In a report from Morgan Stanley Research last year, the investment bank’s US Internet and Restaurant teams detailed the state of online food delivery and outlined various scenarios that could help both aggregators and restaurants capitalise on the growth of online spending.

‘Consolidation and rationalisation among food delivery aggregators will be key to improving, and arguably generating, higher overall profitability,’ said Brian Nowak, one of Morgan Stanley’s internet industry equity analysts.

In 2020 and beyond, ‘a rational environment with lower promotional activity and ad intensity coupled with improvements in delivery efficiency and customer service will be key to improved earnings,’ Nowak stated.

Easier said than done. Just last month a study showed that the number of temporary delivery drivers available for shifts had fallen by over a quarter as thousands return to their pre-pandemic professions in hospitality and retail.

Delivery jobs were a lifeline for many jobseekers during lockdown, as the UK’s hospitality and non-essential retail businesses closed and consumers did more online shopping than ever before, but  as lockdown restrictions ease, ‘many of the temporary drivers who kept Britain moving in its time of need are boomeranging back to their old jobs,’ said Jack Beaman, CEO and co-founder of Indeed Flex, the online marketplace for flexible workers.

This is happening at a time when demand for drivers is soaring, up by 15.6%, according to Indeed Flex stats, as delivery sector employers wrestle with ‘pingdemic’ staff shortages. Great news for the thousands of relatively low-skilled, low-paid drivers and riders that make the delivery platforms work, not so good for investors as staff costs escalate, pushing sustained profitability further down the road.

For example, in the half year to 30 June 2021, Just Eat Takeaway ran up a pre-tax loss of £486 million, including its Grubhub acquisition in the US. Deliveroo’s first half loss totalled £104.8 million, with its marketing and overheads jumping 61% to £290.9 million.

Still, fans point to rampant growth in orders and revenue, which doubled there or thereabouts, for both firms.

SIZABLE RUNAWAY FOR DELIVERY

A 2020 survey by Alphawise, the proprietary survey and data arm of Morgan Stanley Research, found that 65% of respondents
had ordered food delivery online during the past six months.

Meanwhile, food delivery via phone orders is forecast to shrink by 3% annually through 2025, suggesting a migration to digital. One of the reasons for the migration is the influx of restaurant chains. Not long ago, the lion’s share of outlets using online delivery platforms
were local full-service restaurants and small regional chains.

That has now changed. Nearly every major fast food chain is now partnered with at least one platform and most with more than one.

MacDonald’s, for example, uses Uber Eats and Just Eat Takeaway in the UK, DoorDash and Grubhub in the US, Zomato and Swiggy in India.

Given this wider net for delivery, Morgan Stanley’s Nowak and his team raised its estimate for the total addressable market from $260 billion in 2017 to $325 billion this year. Further, they forecast that this market could grow at a compound annual growth rate of 5% through 2025, implying an overall market size of roughly $470 billion.

BIG CHAINS PRESSURE ‘TAKE RATES’

However, the arrival of chains is complicated. Chains have been key to bringing diners online but the economics are more challenging since lower average order values or AOVs make it more difficult to deliver food profitably.

While fast food is the largest segment of the restaurant industry, it is also the most price-sensitive, with two-thirds of transactions under $7 per person, according to Morgan Stanley’s analysis. Diners might well think twice about paying an extra couple of bucks, or pounds, on top for home delivery.

Chains also have the financial clout and scale to put platform charges, or ‘take rates’, under pressure. This is normally a percentage of the transaction that the takeaway platform retains as revenue.

Another challenge is that leading platforms continue to use aggressive discounts and free delivery to lure diners to sign-up, hoping to retain their business long term.

This makes sense strategically since promotions and deals play a role in 58% of diners’ decision-making, according to Morgan Stanley’s research, but it is also leading to negative earnings, especially in less built up cities and towns.

‘US platforms lose money in every region except New York,’ says Morgan Stanley’s Brian Nowak. They face similar problems in Europe and elsewhere. Delivery journeys in London, Manchester and Glasgow are typically short in terms of distance and time, not so in Seven Oaks or Cirencester.

Still, fears that platforms would only get used by the young and digitally savvy have proved misplaced. The AlphaWise survey found that younger, digitally adept diners aged in the 18-34 category unsurprisingly top the user charts but data from app consultancy Apptunix shows decent take-up among more mature people also.

Back to the youngsters, they may responsible for nearly 60% of all users but they’re also the most promotion-sensitive, with the Alphawise survey finding that 63% check for promotions and deals before ordering, or only ordering at all with a promotion.

Don’t expect loyalty either, convenience is king. The Alphawise survey found just over a third of users (36%) stick with a single platform, and that seems anecdotally high. Most people go with what’s easy and discounted, chasing deals or free delivery, much like most of us do with car insurance or your choice of supermarket.

This invites the question, while promotional spend might draw users into the delivery platforms space, do individual platforms get         any direct benefit from their considerable marketing budgets?

HOW CAN THE PROFIT TAPS BE TURNED ON?

First and foremost, fewer platforms will help. investors in this space will be hoping for a more rational approach on the part of participants, with private firms not so willing to rack up huge losses as a means of attracting customers.

Further industry consolidation is widely anticipated by industry and equity analysts in a bid to narrow the competition and help usher in a détente in the cash-burning promotions war. Last year some of the top players in the US market discussed various merger permutations, however, no progress came from the discussions.

Globally, however, other regions have already seen moves toward consolidation with a number of mergers and acquisitions between aggregators.

For example, Just Eat merged with UK rival Hungry House in 2016, then with Dutch peer Takeaways.com, and bought US-based Grubhub, a $7.3 billion deal that only completed in June this year.

Equity analyst Richard Windsor, of the Radio Free Mobile website, believes delivery platforms need to grab at least a 60% market share if there are to truly enjoy the implied valuable network effects of its scale. In other words by being the player with the most users and restaurants they will become more attractive to both parties.

According to research by Edison earlier this year, the UK’s number one Just Eat Takeaway had a rough 45% market share, with Uber Eats (27%) and Deliveroo (26%) some way behind. Foodhub, founded in 2017 and the UK’s fourth player, has most of the remaining 2%.

DoorDash, the $62.5 billion company that listed in New York in December last year, is the US leader with a 48% market share. The Uber Eats/Postmates combo (they merged in June 2020) have around 35% with GrubHub number three with 15%.

As Morningstar analysts put it, ‘keeping all sides of the platform happy is key to keeping the network effect flywheel going’.

ROBOT DROP-OFFS

The biggest profits lever any delivery platform could pull is to strip itself entirely of its riders and drivers by embracing autonomous delivery vehicles, including drones. That may sound both a little misanthropic and like science fiction, yet the impetus is there given how significant staff costs are becoming as platforms expand.

Just Eat Takeaway’s staff costs jumped 147% to €393 million in the first half of 2021. Sure, that includes the staff acquired with Grubhub but you can get a sense of the potential savings of autonomous vehicle delivery.

Brian Nowak of Morgan Stanley estimates that every 1% of autonomous food deliveries, through drones or other devices, could lead to a slightly more than 1% increase in company-wide earnings, and could possibly cut delivery times.

One unnamed platform has been trialling   delivery drones alongside a restaurant chain partner, arriving at a designated landing site and test customer with the aim of decreasing delivery times to under 10 minutes.

PICK OF THE SECTOR

Morningstar analysts believe Just Eat Takeaway is the best positioned food delivery player in Europe trading at a material discount to their discounted cash flow-derived fair value estimate of €152 (approximately £130) and relative to peers. The stock is currently trading at £68.01 on the London market.

With its most recent acquisition of Grubhub in the US, Just Eat Takeaway has not only gained access to one of the largest food delivery markets in the world but also managed to combine the four largest profit pools in the space, being the US, UK, the Netherlands and Germany.

It also looks better insulated from downside risks and has options if it wants to expand its delivery capabilities into other areas like groceries.

TOP PLATFORMS

DELIVEROO (ROO) 390p 

London listingDeliveroo is a London-based food delivery start-up, which works in over 200 cities. It is the most popular food delivery app across Europe. It enables customers to order food from restaurant outlets that don’t have a set-up of their own and charges a fee from the customer and the restaurant for the service. Users are charged as per their order, whereas restaurants pay a commission.

DELIVERY HERO (DHER) €115.75 

Frankfurt listing

Germany-based with a mission to deliver anything, it claims to be the ‘world’s leading local delivery platform,’ it operates a giant global ecosystem of riders, restaurants, shops and partners. From prepared meals to groceries, flowers, coffee, medicine, whatever you need fast, easy and to your door. Has begun the expansion beyond fast food that many of its peers will surely follow. Owns the Foodpanda brand.

DOORDASH (DOOR) $184.85 

New York listing

DoorDash is one of the more established food delivery apps. It supports over 300 cities in 32 markets. The app offers services in Canadian cities including Toronto, Calgary, Edmonton, Vancouver; and U.S. cities including Atlanta, Seattle, Boston, New York, and Chicago.

JUST EAT TAKEAWAY (JET) £68.01

London and Amsterdam listings

Set up in 2001 in Europe, it has used its shares to acquire aggressively and emerge as Europe’s top food delivery player, operating across several brands and bringing together thousands of diners with thousands of food outlets, charging a commission fee from them. Recently acquired GrubHub’s widespread list of more than 30,000 restaurants in more than 800 US urban communities will make sure to satisfy their customers, thereby making it one of the best food ordering apps. GrubHub has offices in Chicago, New York, and London.

SWIGGY 

privately-owned

Swiggy is the top-rated mobile app, based in Bengaluru, India. With close to 1,500,000 downloads in the play store, Swiggy has been rated Number one online food delivery app in India and is currently available in almost all the cities across the country.

UBER EATS, part of UBER TECHNOLOGIES

(UBER) $39.78, New York listing

UberEats is operational in more than 1,000 major cities in various countries around the world. The app enables clients to choose their preferred food from local restaurants and delivers food to the clients’ place in the shortest possible time. Postmates delivery app is available in more than 90 cities throughout the US.

ZOMATO (ZOMATO) 

₹137.45 (Indian rupees), Bombay listing

Zomato, an online restaurant search platform, was founded under the name ‘Foodiebay’ in 2008. The company expanded the features by including food ordering and delivery in the top cities of the world. Zomato is now available in nearly 25 countries all over the world including India, Australia, and the US.

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