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The E-Commerce Stock Everyone's Ignoring

By Jeremy Bowman - Oct 28, 2017 at 11:32AM

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It's not the most dramatic way that the internet is changing commerce, but food delivery offers some big opportunities.

E-commerce stocks are hot these days, and it's easy to see why.

The online retail sector has grown by about 15% annually for the last several years, but still makes up less than 10% of total retail sales. That means e-commerce should have a long tail of growth ahead as it gradually takes share from brick-and-mortar retail. With the convenience of online shopping, it seems almost inevitable that it will continue to replace physical retail, especially as technology improves and businesses add features to accommodate online ordering, like grocery pickup kiosks.

Not surprisingly, even as retail stocks have plunged this year, e-commerce stocks have thrived. Shopify has more than doubled this year, and Wayfair is up more than 80%. 

But there's one e-commerce stock that investors may be overlooking. Unlike most online retailers, it's profitable, trades at a reasonable valuation, and has even successfully fended off challenges from Amazon (AMZN -5.11%) and Uber. It's the nation's leading online food delivery marketplace -- Grubhub (GRUB).

A smartphone screen showing a food delivery order

Image source: Getty Images.

Food, glorious food 

Since GrubHub went public in 2014 the company has grown revenue by 26% or more each quarter, with sales steadily increasing over the last two years. The stock hit an all-time high after the company's third-quarter earnings report as revenue jumped 32% to $163.1 million and adjusted EPS increased 23% to $0.28.  Both figures beat analyst estimates. 

The online food delivery market is rapidly growing alongside broader e-commerce, and major restaurant chains like McDonald's and Chipotle are now focused on it, launching their own partnerships with delivery apps like GrubHub and related brands like Seamless, Eat24, and AllMenus. At a time when many restaurant chains have struggled, Domino's Pizza has thrived by mastering delivery -- its shares are up more than 300% over the last five years. 

Though analysts seem to picture online food delivery as a zero-sum game, the pie is growing for all players, and will continue to do so for the foreseeable future. Much in the way that Netflix believes video streaming is not a winner-take-all market, GrubHub doesn't have to be the only winner here in order to continue growing.

Facebook's recent decision to offer food delivery by connecting users to restaurants through delivery platforms like GrubHub was a ringing endorsement for the Seamless-parent and its ilk, and should hasten the transition to online ordering. According to Grubhub, offline methods of ordering -- including the phone -- are its primary competition, not peers like Doordash or Postmates.

Eyeing a huge opportunity, Morgan Stanley estimates food delivery to be worth $210 billion a year, and Grubhub and its peers have only scratched about 5% of that market. GrubHub's gross food sales will top $1 billion this year, but the Morgan Stanley report shows there is plenty of room for growth in the market. Overall restaurant sales in the U.S. are now about $500 billion a year. 

The roll-up strategy

Throughout its history, GrubHub has grown both organically and through a series of acquisitions. Most recently, the company took over Eat24 from Yelp and Foodler. CEO Matt Maloney promised that acquisition strategy would continue, and as the industry consolidates, GrubHub should gain further advantages through scale. Its network of brands has also led to something of a local monopoly in a number of cities across the country as the market is highly fragmented. According to data from Recode and research firm Second Measure, GrubHub is the leader in nine of the 22 biggest cities, and has a majority of the market in El Paso, Jacksonville, New York, Boston, Chicago, and Philadelphia. In New York, the biggest takeout market in the country, it has 86% market share.

With the Eat24 acquisition, that leadership will only grow: the company will now have a majority of the market in Denver and the biggest share in five other cities for a total of 14 out of 22.

Investors may be concerned about the threat from Amazon or Uber, but both have been operating in food delivery for a number of years and still lag Grubhub by significant margins. Unlike in other industries, there isn't an obvious benefit that Amazon can add or an advantage it has over competitors. It can't lower prices because delivery is almost always free, which also means there's no benefit in making restaurant delivery available through Prime, and restaurants will work with any ordering platform that brings them customers. Unlike Amazon or Uber, GrubHub is solely focused on food delivery, and its brand name is uniquely associated with it. 

It's also worth remembering that there are switching costs here. Like shopping on Amazon or riding with Uber, once you've downloaded the app and typed in your credit card number, it's easiest to just stick with that service rather than go through the hassle of entering your number on another app. Grubhub benefits from that as well, and the service is sticky, even addictive for some.

Delivery is essentially a commodity service, but as long as users are content with Grubhub, there's little reason for them to switch. This is why the acquisition strategy is key. It brings in existing customers, whom it would have had difficulty coaxing into switching, under its umbrella. 

With a long tail of growth ahead in food delivery, a defensible leadership position in the market, and a profitable business model, Grubhub could be primed for big returns. Shares are up 53% this year, and the company looks set to benefit from the same trends that are propelling other e-commerce winners. 

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