Investors are coming off one of the toughest years for the technology sector since the dot-com bust in the early 2000s. The Nasdaq-100 index declined by 33% in 2022, and many individual stocks fared even worse than that.
So what changed last year? Inflation surged, which sent interest rates climbing, leading to fears of an economic slowdown across the globe. Investors flocked to safe assets and rewarded profitable companies while shunning high-growth, unprofitable enterprises -- most of which are in the tech industry. This shift led to a drastic decline in valuations.
In some cases, that presents an opportunity to buy quality stocks at a discount, but not all discounts are created equal. Shares of food delivery giant DoorDash (DASH 2.01%) have plunged 74% from their all-time high. However, despite accelerating revenue growth, its net losses are sinking deeper into the red.
Here's why I'm avoiding the stock in 2023.
Food delivery is a challenging business
Food delivery was already a big business in the preceding decade, but the industry exploded in 2020 with the arrival of the pandemic. Since consumers couldn't dine in person at most restaurants anymore, services like DoorDash became the only option to enjoy their favorite foods.
But long after restaurants reopened their dining rooms, the food delivery industry continues to grow, albeit at a slower pace than in 2020 and 2021. DoorDash remains the king of the sector with an estimated 65% market share, but unfortunately, it hasn't converted its success into profits just yet.
That's partly because food delivery is so competitive. The market has low barriers to entry, and it can be very difficult for DoorDash to differentiate its service from well-resourced competitors like Uber Eats. As a result, the industry leaders are forced to compete on price, which leads to a race to the bottom, making it very difficult to support a profitable business.
Plus, consumers have little reason to remain loyal to one particular platform. They're most likely to use the service with the lowest fees, or the one that features their favorite restaurants -- the brand of the delivery platform itself is unlikely to be the driving force behind their decisions.
DoorDash's revenue growth is accelerating, but there's a problem
DoorDash's revenue came in at $1.8 billion in the fourth quarter, an increase of 40% year over year. It was the fastest rate of quarterly growth in the whole of 2022.
But there's a problem. Because of the aforementioned issues with competition, for example, DoorDash has experienced a steady drop in its gross profit margin. This is the consequence of operating in an industry with low barriers to entry -- price is one of the only competitive levers DoorDash can pull, and the race to offer the most competitive rates leads to a squeeze on profitability.
The results can be financially catastrophic over the long term. If DoorDash generates less gross profit on each dollar of revenue, it has to trim operating costs to keep its net losses in check. But in such a competitive industry, it can't afford to materially slash its marketing budget or its delivery network, so the end result is a bottom line that sinks deeper into the red.
Its fourth-quarter net loss does include a $312 million one-off impairment loss from an investment the company made, but even discounting that, it was still the steepest loss of 2022.
Throughout 2022, DoorDash's operating costs increased by $2.4 billion. Its revenue, on the other hand, only grew by $1.7 billion. Combined with its shrinking gross margin, the company found itself with a net loss that tripled on an annual basis from $468 million in 2021 to $1.4 billion in 2022.
This is a great example of why fast revenue growth isn't always a precursor to a healthy financial picture. Based on all the signs, even if DoorDash's revenue growth continues to accelerate in 2023, its bottom line will still deteriorate further.
Investors should proceed with caution with DoorDash stock
The latest financial results include DoorDash's newly acquired Wolt, a last-mile delivery platform for the retail industry in Europe. It was designed to expand the company's presence, not only geographically but also vertically.
Wolt's revenue contributions boosted DoorDash's overall results, but on the earnings call, management noted that Wolt actually had a negative impact on the company's gross margin. Put simply, it seems DoorDash has doubled down by adding another loss-making business with thin prospects for long-term profitability due to the competitive nature of the last-mile delivery industry.
DoorDash does have $3.5 billion in cash, equivalents, and marketable securities on its balance sheet, so at its 2022 annual loss rate, it has a runway of several years to turn things around. But I will find it difficult to be a buyer of DoorDash stock until it can reverse the decline in its companywide gross margin. That's going to be a major challenge in an industry that remains ultra competitive -- and without the tailwinds of pandemic-era restrictions.
