Shares of GrubHub (NYSE:GRUB) plunged on Thursday, Feb. 7, after the online food ordering and delivery giant reported miserable fourth quarter numbers alongside a weak guide. As of this writing, GrubHub stock is down nearly 15%, and was down nearly 20% at one point.
The sell-off in GrubHub stock makes sense. Fourth quarter numbers were bad. Revenue growth slowed. Diner growth slowed. Gross food sales growth slowed. Margins came crashing down.
Profit growth turned sharply negative. And, the guide wasn’t much better. The first quarter and full-year revenue guides weren’t bad, but still called for slowing growth going forward. Meanwhile, the profit guides were awful, and implied meaningful margin compression and muted profit growth over the next several quarters.
All in all, it was a really bad report. This wasn’t a cheap stock. Heading into the print, GrubHub stock was trading at 40 forward earnings. Thus, bad numbers converged on a big valuation to create a huge sell-off in GrubHub stock.
But this sell-off is overdone.
Zooming out, the big picture here remains OK. GrubHub is still a leader in the secular growth online food ordering and delivery industry. Competition is heating up and causing the company to invest big. This will bring margins down for sure, but, the revenue growth trajectory remains healthy.
Moreover, current margin compression is exaggerated by temporarily large growth-related investments that are expected to largely phase out by later 2019.
Thus, in the big picture, GrubHub remains a big growth company with some lingering yet overstated margin issues. That combination implies that GrubHub stock is undervalued and oversold at $70, meaning this post-earnings plunge is worth buying.
The Numbers Were Bad
There’s no hiding all the bad things that were present in GrubHub’s fourth-quarter-earnings report, so I’ll just list all of them off here:
- Q4 revenues missed expectations, and revenue growth slowed to 40%, from a roughly 50%-plus run rate the company had established over the past several quarters. Revenue growth is expected to slow further next quarter (~38%) and next year (~36%).
- Active diner growth slowed to 22%, its weakest mark in several quarters. Same with Daily Active Grubs and Gross Food Sales growth.
- Adjusted EBITDA margins compressed meaningfully in the quarter, dropping from 28% in the year ago quarter to 15% this quarter. This margin compression is expected to continue. First quarter 2019 EBITDA margins are expected around 14% (versus 28% in the year ago quarter), and full year 2019 EBITDA margins are expected around 18% (versus 23% this year).
- Adjusted EBITDA growth actually dropped year-over-year in the fourth quarter by 26%, versus 40%-plus EBITDA growth that had been reported in each of the prior four quarters. Adjusted EBITDA is expected to drop even more next quarter, too, and rise by only 7% in fiscal 2019.
Overall, the quarter contained multiple negatives. Growth across the board is slowing, and margins are dropping in a big way. Under the hood, management is starting to feel the pressure from increased competition. To fight off this competition, the company is doubling down on marketing spend and operational expansion in order to “out grow” the competition.
On the top-line, this is working. Revenue growth rates remain healthy. But, it’s coming at the expense of margins. Investors are spooked by these massive investments and the sudden lack of profit growth in this supposed hyper-growth company. As such, they are selling first and asking questions later.
This investor capitulation to bad numbers is an opportunity for contrarian investors.
The Big Picture Is Still Good
During rough patches, it’s often best to zoom out and look at the big picture. When you do that with GrubHub stock, the ugly fourth quarter earnings report is put in context of a much broader and positive long term growth narrative.
GrubHub is leveraging technology and internet connectivity to disrupt a several hundred billion dollar industry and make it more efficient and convenient for consumers. In so doing, they are pioneering what promises to be a very large online food ordering and delivery market.
My research indicates that the global online food ordering and delivery industry will measure out to $100 billion-plus in sales by 2025, and that GrubHub should be able to take home about $20 billion in gross food sales by then. Using a 25% transaction rate, that equates to $5 billion in revenues by 2025.
Nothing about the fourth quarter report changes this outlook. Revenue growth is still expected at over 35% this year, after running at 35%-plus rates for the past five years.
If revenues come in at $1.35 billion this year, then all you need is 25% revenue growth per year to get to over $5 billion in revenues by 2025. That seems doable, considering the growth rate is and has been over 35% for several consecutive years.
The only thing that has changed in the big picture as a result of ugly Q4 numbers is the long term margin outlook. I have long thought that GrubHub would be able to phase out growth related expenses and get EBITDA margins back to 30% in the long run. I no longer have faith that this is possible.
Those growth-related expenses are swelling to bigger levels than previously forecast. Plus, the phasing out will also take longer than expected. As such, long term EBITDA margins will likely stabilize around 25%, not 30%.
Making that cut, I’m revising my 2025 EPS target on GRUB down from $10, to $7.50. Still, at $7.50, that implies GrubHub stock is undervalued here. Based on a restaurant average 20 forward multiple, a reasonable fiscal 2024 price target for GrubHub stock is $150. Discounted back by 10% per year, that equates to a fiscal 2019 price target of about $90.
Bottom Line on GRUB Stock
GrubHub’s fourth quarter numbers were bad, and the stock deserved to fall in response. But, a double-digit haircut on a stock that was already deep into bear market territory is overdone.
At current levels, GrubHub stock is both oversold and undervalued. This is an opportunity buy.
As of this writing, Luke Lango was long GRUB.
