Anyone who thought that investment interest in online-based food-delivery services might be waning need only look at the latest funding round of privately held DoorDash. Held in late May, this investment series valued the briskly expanding delivery service at $12.6 billion, just three months after a previous round of funding pegged its valuation at $7.1 billion.
The delivery sector obviously still fascinates both institutional and retail investors. Total restaurant industry sales are projected to reach $863 billion in the U.S. this year, and the off-premises food delivery business is on track to hit $19.5 billion in 2019, at an impressive annual growth rate of 8.5%.
In the investing world, it often makes sense to jump into a nascent market, especially if you possess the patience and appetite for the often-chaotic stock trajectories that accompany early battles for market share dominance among a few pioneering players. But the food delivery market isn't close to crowning a clear winner yet. Moreover, there are several risks to take into account before you allocate precious portfolio dollars to this trend.
Assessing the industry
There are only a handful of pure-play food delivery companies an investor can buy on public exchanges at the moment. Delivery pioneer Grubhub (GRUB) went public in 2014 at $26 per share, and shares now trade at $63. But over the last 12 months, Grubhub's stock has lost 42% of its value, as intensifying competition and higher spending on operations infrastructure and sales and marketing have taken their toll on financial results. In the company's latest quarterly earnings report, sales jumped 39% year over year to $324 million, but operating margin plunged by nearly 11 percentage points to just 2.7%.
Formidable competitor Postmates has filed for an IPO, and its shares are expected to price this summer, giving investors another viable delivery leader to invest in. Postmates submitted its S-1 registration statement to the SEC in February, and investors will see Postmate's financials roughly two weeks before its begins presentations to investors, so a long-awaited peek under the company's hood should be around the corner.
You can also invest indirectly in online platform delivery businesses. An obvious choice is newly public Uber Technologies (UBER 0.33%), which priced at $45 on May 9; shares are trading near $40.50 as of this writing. The company's delivery business, Uber Eats, happens to be its fastest-growing revenue stream.
Uber reported its first quarter as a publicly traded company on May 30. In the filing, investors learned that Uber Eats revenue increased nearly 90% over the prior-year period to $536 million, making up 17% of the company's total quarterly revenue of $3.1 billion.
While Uber Eats' stats are compelling, remember that for now, an investment in Uber requires a complex decision, in which an investor must balance market potential with significant current losses. For example, Uber posted a $1 billion loss and burned through roughly $700 million in operating cash in its last three months of operations. In short, don't buy Uber for its food delivery segment unless you're comfortable owning a share of the entire business.
Risks of investing in delivery platforms
Let's zoom out to ponder a few larger risks inherent in the food delivery sector. First, as we can see from Grubhub's margins, rising competition is diminishing the profit potential in this space. And while the big four services -- Grubhub, DoorDash, Uber Eats and Postmates -- dominate the current market, with market share in April of 32%, 29%, 22%, and 10%, respectively, according to research company Second Measure, other deep-pocketed entrants are eyeing this space.
For example, Amazon.com's Amazon Restaurants delivery service, which caters mostly to the company's Prime members, owns a negligible share of the market. Yet the service has launched in numerous major metropolitan areas in the U.S. as the company quietly builds its delivery capabilities. If and when Amazon decides to obtain appreciable market share, it will introduce immediate pressure on delivery sector pricing -- and profits.
Another risk investors should note is that the eventual size of the delivery market is unknown. The National Restaurant Association's annual state of the industry report for 2019 found that half of all consumers, and 67% of millennials, claim that the availability of delivery makes them more likely to choose one restaurant over another. And certainly, the size of the delivery sector is small relative to the restaurant industry.
However, no one really knows where the equilibrium point for delivery services exists, or what percentage delivery will comprise of the total restaurant market. The vast majority of food prepared outside of the home is likely to continue to be consumed in restaurants. In other words, it's a fallacy to conflate the size of the total restaurant industry with the potential for delivery: There's a finite runway for online-platform growth that will become better-defined in the coming years.
It's also critical to understand that restaurant owners can be quite ambivalent regarding delivery services. Certainly, participating in major services like Uber Eats or Postmates can help add new sales to a restaurant's books. But depending on the platform, restaurants pay a commission on each order that ranges from 15% to 30% of the ticket.
In an industry where net profit margins often fall in the low single digits, this commission structure works for highly profitable restaurants for which delivery represents additional incremental sales and profits. But a low volume of orders can actually be detrimental to the bottom line of many moderately profitable restaurants. Some restaurants see delivery services as an adversarial weight on their income statements: an expense that must be taken on in the interest of remaining competitive.
Among platforms, Grubhub in particular appears to understand this phenomenon and is keen on being seen as a partner to both independent and enterprise-scale restaurants. The company has invested heavily in technology that helps restaurants improve brand presence, build loyalty programs, and attract and retain new diners.
Here's a final, big-picture risk to consider. Most platforms are still trying to nail down the most profitable way to do business, and to this end, they rely on gig-economy workers -- that is, freelancers who aren't formally contracted as employees. Such workers don't receive insurance, other benefits, or any long-term work guarantees. The relationship and payment structure between delivery platforms and a vast network of freelancers is still in flux.
For example, even as Postmates preps for its IPO, it's come under fire in recent weeks for dropping its $4 minimum per-delivery guarantee for drivers. Although the company claims that workers will make up the difference through technology enhancements and a new pricing structure, some drivers are lobbying for reinstatement of the former guarantee.
Ensuring adequate compensation for the drivers who make up the backbone of the delivery service sector is an issue of fairness and equity over the long term. But it also represents an investment risk, as driver expense tends to be the biggest single expense for delivery platforms.
Trying a different approach, Louisiana-based Waitr, which serves small and medium-sized cities, actually employs all of its drivers. Waitr's management believes that providing job stability and benefits will manifest in superior customer service, more loyal customers, and eventually, higher net income.
A parting thought
The food delivery business in its present state dangles much promise, but offers few clear winning investment ideas. While the sector may seem tantalizing for the sheer opportunity available within the restaurant industry's mammoth annual revenue haul, ultimately, it's a service business with questionable profitability and low barriers to competitive entry. This doesn't mean that you won't be able to identify a home run in this market in the future. But there's no persuasive reason to rush in: Patience in finding companies that will ultimately lead the sector with profitable operations will likely be amply rewarded.