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A noted short seller bets against Grubhub

Investor Jim Chanos says that delivery margins are weak and may only get worse as costs rise and fees shrink, says RB’s The Bottom Line.
Photograph courtesy of Grubhub

the bottom line

At least one short-selling investor doesn’t believe in the future of delivery services, or at least one of them.

Jim Chanos, who is famous for betting against stocks, or short-selling them, this week revealed that he is short Grubhub, the restaurant ordering and delivery company.

“There’s just no margin in the business,” he told CNBC, arguing that the company makes only about 15 cents per order. He said that fees will have to come down and that labor costs will likely come up, both due largely to competition with other delivery providers.

Interestingly, Chanos said that Grubhub doesn’t have the ability to compete with Uber, which he likened to being “locked in a cage with a psychopath with an ax.”

Chanos is hardly the only person skeptical of the third-party delivery business. Domino’s CEO Ritch Allison told investors earlier this month that his company has seen significant discounting from third-party delivery providers as they’ve fought for market share.

“We don’t believe that level of discounting can go on forever,” Allison said, according to a transcript on the financial services site Sentieo. “In fact, we’ve already started to see … some of the third parties in the brands start to push more of those costs back onto consumers.”

The economics of third-party delivery on the providers themselves might be the biggest long-term question mark with the service.  

The business is clearly growing. Uber Eats’ revenue rose 80% in the first six months of the year. Grubhub, the more established of the two, has seen revenues rise 36%.

Grubhub does generate profits. It reported adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) of $54.7 million last quarter, a margin of nearly 17%.

But that was down 19% from a year earlier, a decrease the company blamed on growth in order volume and an increase in the number of delivery orders. Only about 35% of Grubhub’s revenue comes from delivery, though that is the area growing fastest.

In general, delivery companies’ profitability challenge is two-fold: Lower commissions from restaurant chains and higher costs as competition for drivers grows fierce. Efforts to fix either could limit the services’ growth potential.

Delivery companies have been increasingly willing to give chains better deals on commissions to get them on the service, as noted by McDonald’s renegotiation of its Uber Eats commission down to 15% earlier this year.

But third-party delivery is also more inefficient compared with in-house providers. Domino’s and Jimmy John’s can deliver at a lower overall cost because their drivers can take multiple orders on a single trip. For the most part, third-party services deliver one order at a time.

That puts more pressure on the companies to hire drivers. The low unemployment rate means it’s hard to find those drivers and thus it costs more. While Grubhub’s revenues rose 36%, for instance, its operations and support costs rose nearly 60%.

Delivery providers are developing solutions to improve volume, such as DoorDash’s “Dash Pass.”

Many companies are betting that their efficiency will improve as they scale the business. Grubhub, for instance, says that pay to delivery drivers exceeds its delivery revenue in newer markets but as those markets become more established they get more efficient and profitable.

Nevertheless, it seems that the most likely scenario is that the companies end up charging more for delivery orders, something restaurants are already doing.

“We will acknowledge that the cost burden does appear to be shifting from the company to the consumer, and we’re going to watch that closely,” Darden Restaurants CEO Gene Lee said this week, according to a Sentieo transcript.

But, he added, that brings other concerns. “It’s all about value and how much of the overall experience are you willing to dedicate toward convenience.” Lee remains a major delivery skeptic.

Consumers who want to have their food delivered are clearly willing to pay for the convenience, and frankly they should. But the higher charges could limit delivery’s long-term growth because consumers only have so much to spend. That could become especially important once our inevitable economic recession hits and consumers cut back.

That will require companies to find ways to improve efficiency so they can drive growth in the business without raising charges so much as to discourage consumers from using it.

But it’s also worth reminding that this is a very new business and a model we haven’t seen on the scale that companies such as Grubhub, Uber Eats and Door Dash, as well as Postmates, have been building.

Demand for the service is certainly there, at least in the short term. It frequently takes time for such companies to figure out a way to make it work profitably, and the guess here is that they do.

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