Delivery Hero — DAX worthy?

Preclude

It is long overdue for this article to be released, for Delivery Hero (DHER) has been included in DAX following the fallout of Wirecard. But late is better than not at all. As with many young, high-growth tech companies such as Tesla, Uber whereby the road to sustainable profitability remains to be seen, questions surrounding its capability of turning profit cast shadows over its DAX’s worthiness. As a result, I am writing this article to figure out for myself whether Deliver Hero is “DAX material” or not.

Financial Analysis

Looking at its current financial performance, one can easily spot several red flags. A very high growth company partly due to intense acquisition activities in recent years, the Delivery Hero suffers the same setback as others who share the similar acquisitive profile: negative EBIT margin (-52% adjusted for customer acquistion and R&D capitalization), low ROIC (Return on Invested Capital). In exchange, it is one of the most high-growth companies in its sphere, averaging 63 percent yearly growth for the last three years, as represented by the following graph:

Average 3-year Growth vs ROIC (figures from the last 10k)

On another note, Delivery Hero, a German company, has through acquisitions rapidly expanded outside of its niche market (Europe), making Asia its biggest market followed by MEA (Middle East and Africa). The strategy does pay off in that the company quickly gains its foodhold in both regions and its brand foodpanda is considered the most widely known food-delivery service. In Hong Kong, its market share has risen to 63 percent. In other markets such as Singapore and Taiwan, foodpanda is the biggest player, albeit a less dominant one.

Sales breakdown (FY 2019)

As growth stagnates throughout the western world, it is sensible to expand to markets where most of economic growth will happen in the second decade of the 21st century. However, it does not come without cost. The German group has a higher cost of capital than other European-based companies, due to its high-exposure to emerging markets:

WACC calculation summary

Valuation and Recommendation

The valuation is based on several important assumptions and explanations for:

  • Terminal growth of 3%: Depsite being a German company, it has become apparent to investors that Delivery Hero aims to bet on emerging markets such as Asia, Middle East, and Africa to deliver growth for the next decade. As a result, a terminal growth of 3% was justified by that
  • ROIC of 1.49 (peer average) for the first 5 years and its sales/capital ratio will come down to global average of 0.71
  • EBIT margin will converge to 15% in 5 years
  • Growth of 85% the following year and 50% growth from year 2 to 5 that will eventuall come down to the terminal growth of 3%: the assumption seems too optimistic. However, due to extended lockdowns, one can make a strong case that consumers have been offered the opportunity to try out a new way of living and that restarants have adjusted their business models to adapt to “new normal” and are willing to coorperate with DHER.

The assumptions mentioned above will lead to the following valuation:

Deliver Hero’s Valuation

Such valuation produces a share price of EUR 93.04, which is pretty close to current market price EUR 99. The stock value was weighed down by Deliver Hero’s outstanding option values, especially the EUR 591 mn equity option value of EUR 1.7bn worth of convertible bonds waiting to be converted.

As a result of this valuation, I am giving a DHER a HOLD recommendation. Without fundamental changes to retain relationships with customers and somehow introduce some “stickiness” to their business model, it is difficult to imagine a brighter day for DHER, especially with the intense competition from the restaurant chains such as McDonalds or Domino Pizza who have the financial resource to develop their own ordering apps and deliver their own products.

Timing-wise, as the market is rotating back to stay-at-home stocks due to surging Covid-19 cases around the world, it seems Delivery Hero’s will stay elevated for a while. However, when things go back to normal, there is a high chance DHER will be down, which is the perfect time to get in the position.

Conclusion

Delivery Hero, despite its cash-bleeding problems, has been included in DAX because of several factors. The Wirecard’s accounting scandal has opened the door for the company. More importantly, as the DHER has good relationships with investors and was able to get sufficient financing to make big bets through acquisitions, the bets rewarded them handsomely in large part because of the pandemic as it gives consumers time to try out a new lifestyle in which they take away and dine at home more often. Furthermore, DHER is becoming unexpected beneficiary of the pandemic as the group has grown into a sufficient size to take advantage of the economics of scale, drive down costs, and improve its operating margin. However, their acquisitive instinct could be the knife that cuts both ways, as the Berlin-based group has not yet been capable of keeping customers’ loyalty and is bleeding cash through customer and restarant acquisitions. So far, they have been able to finance their operations. Whether investors have enough patience for DHER to turn profit remains to be seen, especially when competitions have been intensified by restaurant chains such as McDonalds and Domino who have sufficient financial firepower to perfect their own ordering apps and deliver their own food. Deliver companies and ride-hailing service companies will also get into the game, further pushing the competitiveness of the business to another level.

Alternatively, if one is determined to invest in food-delivery service, which I think is the relevant business model going forward, HelloFresh is worth taking a closer look, as the company, has stayed lean and mean for the time being when they have not yet figured out the business model to go forward. With just a slightly negative operating margin of -1.4 percent and an extraordinary Sales/Capital Ration of 4.7 (every Euro invested returns 4.7 Euro in Sales), the company is not bleeding cash and treading carefully before they figure out which business model to take on. But maybe all it takes to succeed is a go-getter attitude, and Delivery Hero’s CEO Niklas Östberg definitely has that.

Link to my detailed Valuation spreadsheet is here:

Catch you guys in the next post! :)

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