Why I’ve changed my view of the Deliveroo share price

The last time I covered the Deliveroo (LSE: ROO) share price, I explained that one of the things I will be looking out for in 2021 is the company’s performance in a post-Covid-19 world. 

While the coronavirus is still a very real and present threat, the economy has gradually opened up over the past few months. Initially, spending data showed consumers were rushing to return to restaurants. I thought this was a threat to Deliveroo’s business model.

Sales on the group’s food delivery platform surged last year as stuck-at-home consumers’ options for delivery were limited. With restaurants open again, I thought activity on the platform would drop. 

As it turns out, this has not happened. 

Growing sales 

According to a trading update published by the company last week, order volumes on the platform have continued to increase. Orders grew 88% year-on-year at the group level to 78m in the second quarter of 2021. Orders in the UK and Ireland grew 94% year-on-year to 38m. 

As a result of this better than expected performance, the company has increased its expectations for the second half of the year.

Management now believes total order value will increase by between 50% and 60% for the whole year, compared to previous expectations of 30% to 40%. Unsurprisingly, the Deliveroo share price reacted favourably to this update. 

These figures suggest that the company’s business model is far more sustainable than I initially thought. It seems customers are happy to stick with the platform, even though they have more options. 

Unfortunately, while these figures have changed my opinion of the business, the company’s growth spending is still consuming profits. It is now forecasting that its gross profit margin will be in the lower half of its previously communicated range for the whole year.

The company’s first-quarter numbers predicted a gross profit margin for the entire year of 7.5% to 8%.

Deliveroo share price challenges 

I think this is the biggest challenge the company faces right now. It has to invest significant sums in marketing and growth initiatives to fight off peers, such as Uber Eats.

At this stage, it is not clear if or when the company will ever be able to reduce spending on this front. It is also unclear how much of an impact this spending will have on operating profit in the long run. 

As such, while I have now changed my view of the Deliveroo share price, I am not in a rush to buy the stock today. If anything, I would only acquire a small speculative position with the stock at current levels. From there, I would wait and see how the business performs over the next year or two. Most importantly, I am eager to see its sales growth translate into profit growth and cash flow. 

In the meantime, without any profitability, it is going to be challenging to value the shares. However, as the company’s income starts to grow, this should change. That is what I am waiting for now.