Shares of Grubhub (NYSE:GRUB) tumbled 12% on Oct. 25 after the company released its third quarter earnings report. The decline was initially surprising, since the food delivery service provider easily beat analyst estimates on the top and bottom lines.
Grubhub's revenue rose 52% annually to $247 million, beating expectations by $8.5 million and marking an acceleration from its 51% growth in the second quarter. That growth was supported by a 67% annual increase in Active Diners (16.4 million), a 37% increase in Daily Average Grubs (416,000), and 40% growth in Gross Food Sales ($1.2 billion).
Its adjusted EBITDA rose 41% to $60.1 million, and its non-GAAP net income grew 72% to $42.2 million, or $0.45 per share, beating expectations by four cents. On a GAAP basis, Grubhub's net income rose 75% to $22.7 million, or $0.24 per share.
But here's the bad news...
For the fourth quarter Grubhub expects its revenue to rise 38% to 43% annually, easily beating expectations for 33% growth. However, its forecast for a 12% to 30% decline in EBITDA for the quarter missed expectations for about 30% growth.
This indicates that Grubhub plans to spend heavily to maintain its lead in the U.S. food delivery market -- which could become tougher as its rivals gain ground. Grubhub controlled 34.4% of the market by revenue in July according to Edison Trends, followed by Uber Eats (27.9%), DoorDash (17.9%), Postmates (11.8%), and Square's (NYSE:SQ) Caviar (3.5%).
Uber Eats plans to expand its reach from about 50% of the US market to 70% by the end of the year, which could result in a pricing war between the two market leaders. Grubhub acquired smaller rivals, like MenuPages, Allmenus, DiningIn, Delivered Dish, LAbite, Yelp's (NYSE:YELP) Eat24, and Tapingo, to maintain its lead, but that strategy is a costly one. That's why the company plans to invest an incremental $20 million to $30 million in marketing and the expansion of its delivery network during the fourth quarter.
Furthermore, Grubhub announced that its chief operating officer, Stanley Chia, was resigning to become the CEO of another company. The loss of Chia, who had been with Grubhub for nearly four years, raises additional questions about Grubhub's future.
Grubhub's insiders also don't seem to have a rosy outlook for the company. Over the past 12 months, insiders sold nearly 750,000 shares of the stock, and haven't purchased a single share on the open market. The stock also still trades at over 40 times next year's earnings -- and that multiple could surge higher if analysts slash their estimates.
Why Grubhub could still recover
The bear case against Grubhub is easy to grasp, but it glosses over a few of the company's strengths. First, Grubhub has been expanding its ecosystem with recent acquisitions like LevelUp, which added payment and loyalty services to its "Grubhub for Restaurants" platform. Expanding that ecosystem to include more services for restaurants enables it to cross-sell new services, lock customers in with subscriptions, and widen its moat against its rivals.
Square is employing a similar strategy with Square for Restaurants, which bundles together its payments, table bookings, and Caviar delivery options into a single package for restaurants. But just as Square is leveraging its strength in payment services to challenge Grubhub, Grubhub can leverage its lead in food deliveries to push back. Moreover, Grubhub's platform is integrated with Yelp thanks to its purchase of Eat24, which makes it the default delivery choice for users of the popular business review app.
The bears will likely note that Uber Eats is gaining ground quickly by providing deliveries for fast food giants like McDonald's, and that DoorDash is providing services for popular chains like Shake Shack. Yet Grubhub also has plenty of heavyweight partners like Yum Brands, which outsourced its U.S. deliveries for KFC and Taco Bell to the company earlier this year.
There's also plenty of room for food delivery platforms to grow. The US food delivery market could still grow from $43 billion in 2017 to $76 billion in 2022 according to Cowen analyst Andrew Charles. This means that there's still plenty of room for the market leaders to grow without trampling each other.
Lastly, Grubhub remains an obvious takeover target for Amazon, which failed to disrupt the food delivery market despite early claims that its growing platform would kill Grubhub. The combination of Amazon and Grubhub's platforms could cause serious pain for rivals like Uber Eats.
The bottom line
I own a small position in Grubhub, but I admit it isn't a stock for queasy investors. The company's bottom line will face pressure as the competition intensifies, but I think its first mover's advantage and aggressive expansion strategy will help it fend off its rivals.