GrubHub Will Have to Spend Big If It Wants to Gobble ‘Stomach Share,’ Says Morgan Stanley

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By Tiernan Ray

Shares of online food ordering impresarios GrubHub (GRUB) are down 54 cents, or 2%, at $27.71, after Morgan Stanley‘s Brian Nowak today cut his price target on the stock to $26 from $30, and reiterated an Equal Weight rating, after concluding the company needs tocontinue to spend on building its own food delivery infrastructure, which will impact profit.

Nowak’s main insight is that people don’t use the company’s services, such as the “Seemless” online ordering system, as much as they might, or they “churn” away from GrubHub, because of limited selection of restaurants.

That means GrubHub has to build out more delivery resources of its own, not just expect its restaurant partners to do it themselves:

GRUB makes up an estimated 50+% of the online food delivery market, and our AlphaWise data show the site has 2x more brand awareness than its nearest competitor. That said, our AlphaWise data also show that only 24% of people that are aware of GRUB use the service (in the last 6 months) – lower than the overall online food delivery user penetration (34%). Further, 44% of people who churn from GRUB do so because of limited selection. These data, in our view, highlight GRUB’s need to continue to add more restaurants (in particular outside of the top 10 markets as shown in Exhibit 6 Exhibit 6) if it hopes to drive faster top-line growth. We see GRUB needing to continue investing in its own in-house delivery (beyond 2016) if it hopes to add selection and restaurant supply. As such, we are raising our ’17/’18 estimated delivery investment and now expect GRUB’s net delivery losses to be $15mn /$5mn/$1mn in ’16/’17/’18.

Nowak cuts his estimate for GrubHub’s likely 2017 Ebitda to $147 million from $157 million previously projected, even though his revenue number is now higher, at $567 million versus $552 million. That is below Street consensus for $163 million in Ebitda on revenue of perhaps 573 million.

Nowak issued his note in conjunction with an second, industry-wide survey note, based on responses to questions of 5,000 U.S. consumers, conducted in April. In that note, he muses on the future of online food delivery, titled “What If All Food Could Be Delivered as Easily as Pizza?”

Pizza is two thirds of online food ordering and a “the harbinger of what’s to come”:

While food delivery has been around for generations, its availability has historically been limited to urban, densely populated areas… or to pizza. Indeed, pizza has benefited from and driven the online food delivery industry, with one-third of pizza now delivered online, and pizza making up an estimated 60% of the total online food delivery market. Online delivery has changed the pizza market as well, causing a consolidation of market share within the top three brands – Domino’s, Papa John’s, and Pizza Hut – which gained an incremental 600bps of share at the expense of smaller players. This demonstrates the power of combining easier brand access through online ordering and the stickiness of a first mover advantage. Consumers say they want more than pizza delivery, but can’t always get it: Only about a third of the population orders delivery food that’s not pizza, according to our recent AlphaWise survey of 5k US adults, but consumers do like take-out food – nearly 60% have ordered food to go from a restaurant in the last six months and demand for take-out is consistent across urban, suburban, and rural markets. We conclude from this that there is a significant unmet demand as new delivery models (both restaurant and third party) evolve to serve those consumers. Importantly, our survey work suggests restaurant food delivery is highly incremental, with two thirds of occasions replacing a meal eaten at home.Solving online food delivery, he writes, can be huge, just like ride-sharing and other things that rationalize and optimize businesses:

Our survey work suggests that there is clearly some unmet demand for delivery and many pick up themselves instead. But couldn’t this be even bigger? The next $150B is off premise fast food while two thirds of this or $100B goes through the drive thru, there’s $50B that does not. Ultimately though we think the entire $210B of off premise food is up for grabs. What gives us confidence? Current to-go and delivery figures are based on existing infrastructure and lifestyles, but as we’ve seen with retail, travel and transportation, technology can and does change those patterns when access is easier and cheaper.

It’s a really big market, and GrubHub has a lead, which he models in this infographic:

But to keep its lead, Nowak concludes that for GrubHub to lure chain restaurants, which he thinks it must, it will have to continue to spend on delivery capabilities:

We are not modeling any material change in GRUB’s position toward a consumer fee, but in our base case we are now assuming GRUB continues its delivery investment into 2017 and 2018. Because while GRUB’s 44,000 restaurant (as of 1Q:16) share is larger than its peers, it is still small in the grand scheme of things, with 625,000 estimated total restaurants in the United States (350k of which are independent). We believe GRUB has to make these investments if it hopes to continue to grow its top-line and this overall market. Why do chains matter? Chains make up >50% of restaurant food sales in the US and likely an even higher portion of sales outside of urban areas. Because of this, GRUB’s ability to sign up chains will be key in adding restaurant supply. To offer a compelling service to chains, online aggregators must offer not just demand but delivery capabilities

Nowak also sees startups specializing in delivery as a threat:

We believe the lack of interest from chain restaurants to sign on with GRUB because of their restaurant-based fee structure and the lack of a need for chains to pay GRUB for reach/awareness has created the opportunity for emerging logistics players like Postmates and DoorDash. For now, we see these models continuing to grow rapidly, as our AlphaWise data show ~45% of people (and 50%+ of millennials) are willing to pay $5+ for food delivery. This consumer trend continuing, Postmates/DoorDash’s ability to lower their consumer fees, and/or their ability to increase restaurant selection over time will be monitored as they could represent incremental threats to GRUB’s overall “share of stomach.” On the other hand, their inability to scale as unit economics evolve represents a risk to their forward growth.