The meal delivery company’s stock plunged 26% on its first day of trading. At 84p, the shares are down an incredible 70% overall.

Here’s why I won’t be ordering Deliveroo shares today.

No moat

Warren Buffett likes his companies to have a wide moat around them, and he likes sharks in the moat. That is to say, he looks for industries with very high barriers to entry. That’s also what I look for in my investments. Good examples of wide-moat companies include Coca-Cola, Visa and ASML.

The problem for Deliveroo is that the barriers to entry in the food delivery industry are very low. A quick search shows me that, beyond Deliveroo, there’s also Uber, Just Eat, Getir, Foodhub, and many other smaller players.

Internationally, there are thousands of competitors. There’s nothing stopping some of these companies from expanding to the UK one day and attempting to steal Deliveroo’s customers with discounted offers.

This cut-throat competition probably explains the difficulty the company has had expanding internationally. It currently operates in 12 countries, but has just quit the Netherlands.

Unconvincing business model

I just don’t think Deliveroo’s business model is scalable beyond a certain point. Entering new markets costs a lot of money, and the company is now in cost-saving mode as it desperately attempts to prove to the market that it can become profitable.

In its latest quarterly report, Deliveroo has warned that full-year growth will be at the lower end of expectations. Gross transaction value (GTV) was up 8% in reported currency terms to roughly £1.7bn, which isn’t too bad. But it doesn’t expect to be generating any form of positive cash flow until the back end of 2023 or some time in 2024.

Limited pricing power

I also think there’ll be further regulation of the gig economy in the future, which probably won’t be beneficial to the company. If Deliveroo has to pay its drivers more, then it’ll have to pass on those additional costs to its customers.

I just don’t think that’s realistic, though, especially as we enter tougher economic times. Consumers will simply go to other (cheaper) platforms, drive to pick the food up themselves, or stop ordering takeaways altogether.

Could Deliveroo be acquired?

To be fair, Deliveroo does have some brand equity, given that it’s a household name in the UK. This recognisability could make it an acquisition target for a larger company wanting to enter the food delivery space.

The most likely candidate here would be Amazon, which already owns a 16% stake in Deliveroo. Obviously, any hint of Amazon buying the company would likely send the shares much higher.

Even so, I don’t invest in firms on the basis that they might be acquired. I invest in companies that I think have – or are building – durable competitive advantages. And to me, Deliveroo doesn’t have any of these yet. So I’m giving the shares a wide berth.

The case for large upside

The highs over the past year are 327p. So, let’s be clear from the beginning, my £500 has the capacity to easily double in value over the next year if anywhere near this level is seen again. It’s not like I’m buying the stock when it’s breaking into uncharted territory with all-time highs. Deliveroo shares have traded at that price within the recent past.

However, I’d need to see a change in the trend lower before I could remotely claim a £1,000 value by 2023. One avenue that could help to achieve this is the continued growth of partnership deals. In the H1 results, I noted a push for new deals with McDonald’s, Lloyd’s Pharmacy and Waitrose. As these deals bed in, I think there’s large potential. The business is being transformed from just servicing restaurants to now also grocers, a wider variety of fast food outlets and pharmacies.

I think that the current share price is reflecting an overly pessimistic pandemic hangover. I recall a lot of people saying that as we came out of the lockdowns, Deliveroo would struggle to maintain order levels and transaction values. This has been disproved so far in 2022. H1 orders actually grew by 10% versus the same period in 2021.

If this pandemic stigma starts to wear off, investors could buy Deliveroo shares as they factor in that this business wasn’t just a lockdown hit. Rather, it has the ability to grow even in the post-pandemic age.

Concern around Deliveroo shares

Despite my optimism, it’s clear that the broader market doesn’t agree with me. The fall in the share price (particularly over recent months) has been very noticeable.

One of the reasons why a £500 investment might not be worth much in the future is due to the valuation. At the initial public offering (IPO), the business was forced to offer shares at the lower end of the expected range at 390p. Even at this price, I look back and think the valuation of the business here was too high. Put another way, it was too optimistic to start trading at 390p given the fact it was still loss-making and was in the pandemic storm.

Therefore, with a current market capitalisation of £1.65bn, today’s share price might be a truer representation of the value.

I’ve decided that I’m not going to invest £500 at the moment. I do believe the long-term share price should be higher than current levels, based on the success of new partnerships. But in coming months, I don’t see anything that would stop the trend lower continuing. Even in a year’s time, I struggle to see a £500 investment giving me any kind of decent return.

So does that present a buying opportunity for my portfolio? Or might the shares keep declining until they sell for 50p each, or even less?

Wrong business model, wrong time

The decline in the share price reflects a changing landscape for delivery companies like Deliveroo.

Its basic business model seems flawed to me. The cost of attracting customers and retaining them, along with delivering individual orders, can be high. But firms only have limited ability to add extra costs onto the delivery price before many customers decide they can just pick up their own food.

Several years ago, investors were excited about the potential market opportunity of digital platforms for home delivery. The pandemic had unleashed huge demand and money poured into businesses such as Deliveroo. It timed its stock market listing in March 2021 well to take advantage of that investor enthusiasm. But from its very first day as a public company, the share price started to fall.

Tech stocks are now less popular with many investors than they were a year or two ago. I think the decline in the Deliveroo share price reflects both this shift in sentiment and its continued failure to turn a profit.

The opportunity for Deliveroo

However, all is not lost for Deliveroo. It has a large established customer base and brand recognition. Indeed, that familiar branding was why I decided to try the service out recently.

I do think there will be strong long-term demand for food delivery and the company is a leading player in the space. That could help it keep growing sales.

If it can figure out the right business model to make individual food delivery at scale profitable, I think Deliveroo could do well as a business. Even if another company cracks that challenge and Deliveroo simply changes its business model to ape the successful one I think it could have a bright future.

For now though, there is no sign that that is about to happen any time soon. Indeed, in its half year results, the company recorded a loss before income tax that was 54% higher than the same period last year, even though sales had risen.

Where next for the share price?

If losses keep mounting, I think investor confidence in the company’s business model could further erode. That might push the shares down further. I would not be surprised if they fall below 50p at some point, for example if Deliveroo issues a profit warning, or its full-year results are worse than expected.

I do not want to invest in the business until it has proven its business model can be consistently profitable. Signs of that could push the shares up. But even though the Deliveroo share price is in pennies, I will not be adding it to my portfolio just yet.

The shares now trade for pennies. At that level, they may look cheap. After all, Deliveroo has recorded regular revenue growth and benefits from a strong brand in a consolidating market. But is the Deliveroo share price really a bargain?

Business model problems

Even after its fall, I think the answer is no.

The problem I see with Deliveroo is not the company itself, which I regard as one of the leaders in its marketplace. Rather, the question I have from an investment perspective is whether the marketplace itself makes sense.

It is easy to see why there could be strong future demand for food delivery. But what I find harder to fathom is how that desire can be met profitably. Logistics firms like Royal Mail deal with massive volumes on regular routes. Companies that make a lot of one-off deliveries like FedEx tend to be transporting items with enough value that a delivery charge can be imposed without hurting demand.

But is that true for a sandwich or a lasagne dinner for one? These items are not expensive, so the added cost of delivering them can mean the bill goes up a lot proportionately. Customers may not want to pay that — but restaurants are in business to make a profit so might also not care to pick up the bill.

That cuts to the heart of the issue I see with Deliveroo: it has not cracked the challenge of how to make delivery profitable. If it sticks with its current business model, I am not confident it ever will.

Deliveroo share price woes

For the Deliveroo share price to recover, I think the company needs to reassure the market that it has found a model that could well be profitable, even if it is not yet.

So far that has not happened. In its interim results last month, the company spoke of “challenging market conditions”. It recorded a loss before income tax of £147m, an increase of 54% on the same period last year.

That heightened loss was despite revenue increasing by 12% compared to the same period last year. Again I think this shows the weakness in Deliveroo’s current business model. Growing revenues ordinarily ought to help a healthy business reduce losses. At Deliveroo, as revenues are growing, so are losses.

I do not think this problem is impossible to fix. Food delivery is here to stay in one form or another and Deliveroo has a large customer base. In the first half, for example, it handled 160m orders. So I think the company could adapt its business model and find a path to profitability. If it does that, I see an opportunity for the Deliveroo share price to recover.

My move

For now, though, the company continues to rack up losses. I think that could go on for the foreseeable future. That could mean that the already battered Deliveroo share price continues to drift downwards.

Until the company has proven that its business model can be profitable, I will not be investing in it.

Stuck in traffic

Deliveroo’s H1 results were a bit of a mixed bag. There was a modest increase in revenue, along with other metrics such as gross transaction value (GTV), orders, gross profit, etc. Meanwhile, other metrics such as GTV per order, monthly order frequency, and adjusted EBITDA saw declines.

At first glance, I don’t like the slow down in growth, given that Deliveroo is meant to be a growth stock. However, I can forgive the deceleration when I take the wider context into account. The firm faces tough comparisons against last year’s results, which were helped by the pandemic. Additionally, high inflation is eating away at consumers’ disposable income, leading to a reduction in discretionary spending. Nonetheless, CEO Will Shu did point out that order frequency remained above pre-pandemic levels.

Despite worries about the company potentially losing market share due to the slow down in growth, management stressed on the earnings call that they continue to expect Deliveroo to capture more customers in the UK and EU.

Diverse Deliveroo

Part of the reason for Deliveroo’s success in gaining market share can be attributed to its diverse streams of revenue. Aside from delivering food from restaurants, Deliveroo has branched out to groceries and other non-food items, and formed partnerships with many grocery and essential stores. These include the likes of Sainsbury’s, Carrefour, WHSmith, and many more. The effects of these partnerships were reflected in the company’s grocery GTV, which increased as a percentage of total GTV.

Moreover, Deliveroo recently signed a deal with McDonald’s, with the effect of its rollout still yet to be reflected in the numbers. It’s also expanded its Amazon partnership to Italy, France, and UAE, which should see more Deliveroo Plus members, and more orders as a result. I’m expecting these catalysts to allow the delivery service to continue growing its market share locally and internationally.

Furthermore, Deliveroo opted to further diversify its revenue stream with the introduction of an advertising platform. It plans to allow brands to target its customers through the app, as well as social media, e-mail, and via push notifications. Management expects advertising to become a substantial part of its revenue mix. If successful, this could push Deliveroo into profitability at a much quicker pace.

Riding towards profitability?

All in all, the board still maintains its guidance to achieve EBITDA breakeven by mid-2023 to mid-2024. They expect to execute this through better cost control and more efficient marketing spending. And this can already be seen through its exit from the Dutch and Spanish markets, which provided little return on investment.

With a solid balance sheet of £1.13bn and zero debt, Deliveroo should have sufficient capital to runs its business until it achieves profitability. Even so, food delivery companies are notorious for being unprofitable. Therefore, despite a lucrative upside and an average price target of £1.31, I’m not inclined to buy Deliveroo shares given the company’s unproven business model.

Vodafone

Vodafone (LSE:VOD) is a British multinational telecommunications company. It predominantly operates services in Asia, Africa, Europe, and Oceania. The company runs at least some form of operations in over 150 countries.

Following lacklustre numbers from its Q1 trading update, the share price dropped by 5%. It has stayed there since. Despite that though, it’s a sign of confidence when a high-ranking director purchases shares. And this week, Vodafone’s Chairman decided to reinvest his dividends into buying more Vodafone shares.

• Name: Jean-François van Boxmeer
• Position of director: Chairman
• Nature of transaction: Dividend shares
• Date of transaction: 10 August 2022
• Amount bought: 9,975 @ £1.21
• Total value: £12,069.75

Deliveroo

Deliveroo (LSE: ROO) is a British online food delivery company. It operates in over 200 locations across the UK, and is the second-biggest food delivery platform in the country. It also operates internationally with operations in France, Singapore, Australia, and many more.

In this week’s transaction, a director exercised his option to redeem stock compensation. Following this, he opted to sell approximately half of the shares received to cover tax liabilities. That being said, it’s worth noting that this is a monthly occurrence from the company’s CFO. As such, these actions shouldn’t impact investor sentiment surrounding the stock. It’s worth pointing out, however, that the sale of these shares dilute shareholders’ value. This is because there are now more Deliveroo shares floating on the market.

• Name: Adam Miller
• Position of director: Chief Financial Officer
• Nature of transaction: Award shares
• Date of transaction: 15 August 2022
• Amount vested: 83,400 @ £0.96
• Total value: £80,247.48

• Name: Adam Miller
• Position of director: Chief Financial Officer
• Nature of transaction: Sales of shares to cover tax liabilities
• Date of transaction: 15 August 2022
• Amount sold: 40,402 @ £0.95
• Total value: £38,381.90

FirstGroup

FirstGroup (LSE: FGP) is a British multi-national transport group. The FTSE 250 firm is the leading transport operator in the UK and North America. It is widely known for being a provider of public transport, especially buses in the UK.

Rather surprisingly, its shares have managed to outperform the wider UK market index this year. But after the share price took an 11% hit last week, a couple of large director dealings were carried out. The first involves a non-executive director purchasing a substantial number of shares. But what really caught my eye were the conditional share awards that could be awarded to FirstGroup’s CEO and CFO. This should shore up investors’ confidence in the stock, as the group’s management will have to perform and meet investors’ expectations in order for these award shares to vest.

• Name: Sally Cabrini
• Position of director: Non-Executive Director
• Nature of transaction: Purchase of shares
• Date of transaction: 17 August 2022
• Amount vested: 10,000 @ £1.15
• Total value: £11,482

• Name: Graham Sutherland
• Position of director: Chief Executive Officer
• Nature of transaction: Award shares
• Date of transaction: 18 August 2022
• Amount vested: 972,590 @ Nil
• Total value: N/A

• Name: Ryan Mangold
• Position of director: Chief Financial Officer
• Nature of transaction: Award shares
• Date of transaction: 18 August 2022
• Amount vested: 1,003,226 @ Nil
• Total value: N/A

Types of Shares

To provide context, there are a few types of shares that can be purchased by directors. Some directors opt to purchase shares via the open market. Having said that, directors also have the option to purchase and receive shares via a share incentive plan (SIP).

A SIP is an employee plan for companies within the UK to flexibly award shares to employees. Publicly listed companies normally exercise this option because it’s tax-efficient for both the employer and its employees.

In this week’s set of director dealings, a few types of SIPs were exercised. For starters, Vodafone’s Chairman opted to purchase more Vodafone shares from the dividends he received from his current shares.

On the other hand, Deliveroo’s CFO decided to exercise the option of redeeming his restricted stock units. These are a form of award shares which allow for directors to redeem shares at a later date, as either as part of their salary or based on meeting performance obligations.

FirstGroup’s CEO and CFO were awarded shares as well, but these will only be vested once performance targets are met. In this case, more than 1.5m shares are up for grabs between the two directors under the operator’s long-term incentive plan (LTIP). The LTIP award will normally vest on the third anniversary of the date of award, subject to satisfaction of performance conditions and continued employment. The award is also subject to an additional holding period of two years from the date on which the award vests.

However, a Covid hangover has seen it once again suffer. In the last 12 months, Deliveroo has fallen a massive 75%. This year alone it’s down 53%.

So, could it possibly fall some more? Or would picking up Deliveroo shares now be a smart move?

Half-year updates

Late July saw the business update investors with its second-quarter trading performance. While the group saw a small growth in gross transaction value (GTV), headlines were stolen by the decision to downgrade its full-year GTV growth outlook from between 15% and 25%, to somewhere closer to the 4% to 12% range. With the firm pinning this to “a more cautious economic outlook,” given the way 2022 has played out, this isn’t a surprise.

More recently, Deliveroo provided shareholders with its performance for the first six months of the year, in which it warned of rising pressures from the higher cost of living. While revenues were up 12%, losses before tax grew to £147m, up from just £95m the year prior. Its adjusted EBITDA also sat at a loss of £68m, a large rise from the £26m seen in H1 2021. With that said, this figure had been trimmed compared to H2 2021.

Where next?

After this, what’s next for Deliveroo?

Its most pressing issue is inflation. While this has pushed up staff costs, the cost-of-living crisis has also seen consumers tighten their belts as they cut back on takeaways. With inflation expected to peak at 13% this year, the second half of 2022 could only see further cutbacks on the part of customers.

What also worries me about the business is its inability to turn a profit. Despite a booming 2021, it still posted losses of £300m. Although it’s confident in its EBITDA margin guidance, along with stating that its balance sheet “remains strong,” this is obviously a concern.

One area that provides me with hope is the partnerships that the firm managed to strike. This includes the likes of McDonald’s and WHSmith.

More recently, it also announced a new relationship with Asda for the rapid delivery of groceries. With the deal in place for 15 stores, there are plans to expand the partnership to 300 Asda stores by the end of the year. The hopeful rise in business from deals like these should help Deliveroo offset rising costs.

Would I buy?

So, has the Deliveroo share price bottomed? And should I buy?

The business has shown glimmers of its potential over the last few years. But I won’t be buying any shares today. I think Deliveroo will struggle further into the year as rising costs eat away at its bottom line. Its lack of profit is also of concern to me. Regardless of the drastic fall, I’ll be avoiding Deliveroo for now.

Food delivery business model concerns

My primary concern with Deliveroo is true about its industry generally not just Deliveroo specifically. In short, can it make money?

Tech companies invest heavily in platforms that they can scale up easily when they get new customers. Think about Netflix as an example. Making films and marketing to customers is not cheap. But at some point, every new customer account is almost pure profit. The content is already made, the digital infrastructure is already in place. The marginal cost of delivering existing content on an existing digital platform to a new customer is close to zero.

Now compare that to food delivery. Setting up the infrastructure is still expensive. But food cannot just be sent down the wire in the same way as the latest episode of Stranger Things. It needs to be cooked, wrapped, picked up, transported, and handed over at a specific address. A company can try to slice that in different ways, acting as a digital middleman and not getting involved in the labour-intensive elements. That is one reason the industry has had a lot of debate about whether delivery drivers should be employees or contractors.

Labour intensity

But however the model is developed, I see a fundamental challenge: it is ultimately still reliant on human labour. That reduces the benefit of scalability on which the profitability of many tech business models depends.

Just Eat has announced a €3bn writedown today in the balance sheet valuation of its Grubhub business. Grubhub has its own challenges, but I see the writedown as symptomatic of bigger challenges for the whole food delivery space. Whether it delivers revenue growth or not, there is a structural challenge around the profitability of such a model in my view.

Where next for the Deliveroo share price?

Deliveroo continues to lose money and I expect that to continue. Like its competitors, it has not yet cracked the challenge of how to acquire customers and deliver food to them profitably.

It may do so in future. Amazon is still refining its model after decades in business. For example, the cost of delivering food on the final leg to a customer is similar whether it is a sandwich or a full meal. But focussing on higher priced items like meals means the large transaction value could absorb delivery costs more easily. That is basically the approach taken to home delivery by grocers such as Sainsbury. It encourages customers to order bigger baskets for home delivery by using a sliding scale of delivery charges.

Deliveroo has assets that could help it do well, such as an established customer base and known brand. But until it finds a profitable business model I do not feel it merits a market capitalisation of £1.7bn. So I will not be adding its shares to my portfolio, even though they trade for pennies.

So – does that make them a possible bargain for my portfolio?

What explains the plummeting Deliveroo share price?

That sort of value destruction does not just happen for no reason.

I think the shares were overpriced when they were listed. Tech shares were riding high in the first half of last year and the initial valuation reflected that. Indeed, on its first day as a listed company the shares had already tumbled as much as 30% at one point.

On top of that, investors have concerns about the performance of the business. Last year, revenue grew 57% to £1.8bn. But the pre-income tax loss also soared. It was up 40% to almost £300m.

For now, liquidity is not an issue as the company ended the year with £1.3bn in cash and cash equivalents. However, the it continues to make a sizeable loss. In the first half, the firm’s gross transaction value (which is not the same as its own revenue) grew by 7%. I see a fundamental challenge with the current business model. How can Deliveroo profitably scale its business model without racking up massive losses?

Where next for the business model

It is common for well-funded tech businesses to spend heavily refining their business model and growing their customer base. The hope is that they can later raise prices and cut out unprofitable operations.

Deliveroo may yet do that. There could be a pathway to profitability for the firm. But I also see some ongoing challenges. The service remains heavily reliant on human beings doing the delivery. Whether they are treated as employees or not, rising wage expectations could add to the firm’s cost base one way or another.

A worsening economic environment may also lead to people cutting back on luxuries like home food delivery, threatening revenue and profit growth. In the UK and Ireland, for example, the company’s year-on-year gross transaction value growth of 12% in the first quarter slipped to 4% in the second quarter. Its performance in other markets was worse, with growth falling from 11% to 1%.

I think Deliveroo has a long, hard road ahead of it to refine its business model and prove it can make a profit.

I’m not ordering

I expect food delivery to be a large business for years to come. Deliveroo has built a strong brand. The firm could yet turn into a highly successful business.

But I think a lot still needs to be proven. Even after the Deliveroo share price fall, the loss-making business continues to have a market capitalisation of £1.5bn. I do not see that as a bargain given the risks involved. I therefore have no plans to invest.

Aviva

Aviva (LSE: AV) is a British multinational insurance company. It has millions of customers across its core markets. Aviva is also the UK’s largest general insurer. This week, an influential director purchased shares through the firm’s Global Matching Share Plan.

• Name: Jason Storah
• Position of director: Chief Executive Director
• Nature of transaction: Partnership shares and matching shares
• Date of transaction: 15 July 2022
• Amount bought: 38.413602 @ £3.93
• Amount received: 76.827204 @ £3.93
• Total value: £452.70

Royal Mail

Royal Mail (LSE: RMG) is Britain’s biggest postal service and courier company. The group runs the brands Royal Mail and GLS. It released its Q1 trading update this week. Two director dealings also occurred.

• Name: Mick Jeavons
• Position of director: Chief Financial Officer
• Nature of transaction: Free shares (Deferred Share Bonus Plan 2019)
• Date of transaction: 18 July 2022
• Amount bought: 14,132 @ nil
• Total value: £N/A

• Name: Katherine Amsden
• Position of director: PCA of Mark Amsden, Group General Counsel and Company Secretary
• Nature of transaction: Purchase of shares
• Date of transaction: 21 July 2022
• Amount bought: 34,262 @ £2.92
• Total value: £99,977.21

Deliveroo

Deliveroo (LSE: ROO) is a British online food delivery company. It operates in over 200 locations across the UK and internationally. In the UK, it is the second-biggest food delivery platform. In this week’s transaction, a director exercised their option to redeem stock compensation.

• Name: Adam Miller
• Position of director: Chief Financial Officer
• Nature of transaction: Free shares
• Date of transaction: 15 July 2022
• Amount received: 83,400 @ £0.85
• Total value: £70,973.40

• Name: Adam Miller
• Position of director: Chief Financial Officer
• Nature of transaction: Sales of shares to cover tax liabilities
• Date of transaction: 15 July 2022
• Amount sold: 40,407 @ £0.85
• Total value: £34,345.95

Types of shares in a SIP

To provide context, there are a few types of shares within a company’s share incentive plan (SIP). A SIP is an employee plan for companies within the UK to flexibly award equity to employees. Publicly listed companies normally exercise this option because it’s tax-efficient for both the employer and its employees.

In this week’s director dealings, Aviva’s CEO opted to purchase partnership shares. Partnership shares give employees the opportunity to buy shares via deductions from their salary, before tax deductions. But where partnership shares are offered, the company can also offer matching shares. This can range up to a maximum ratio of two free matching shares per partnership share purchased, as was the case. That being said, it’s important to note that matching shares must normally be held in a trust for at least three years, and held for five years in order to receive full tax relief. However, these shares may be forfeited if an employee withdraws their partnership shares from the trust.

On the other hand, the Royal Mail CFO received free shares. This occurred under the company’s Deferred Share Bonus Plan from 2019. Having said that, the director is expected to retain their share-based awards until they achieve an equivalent of 200% of their salary.

As for Deliveroo’s CFO, he received free shares. These are a form of restrictive stock units (RSU). RSUs are a form of stock compensation. It is a promise from the company to award a company’s shares in the future. RSUs are most often used in younger companies. This is because cash on its balance sheet is used to grow the business instead.