Grubhub Faces a New Headwind in Its Biggest Market
Grubhub's (NYSE: GRUB) stock recently dipped after The New York Post claimed that the New York State Liquor Authority (SLA), which regulates alcohol-serving restaurants statewide, is developing rules to reduce third-party delivery fees and tighten its grip on those services.
Under the SLA's proposed rules, delivery platforms would only be entitled to a 10% cut of a takeout order -- compared to the current rate of 15% to 30% -- if the business has a liquor license. If delivery platforms want a bigger cut, the SLA could force restaurants to list the services on their liquor licenses, which could cause a myriad of legal and bureaucratic headaches.
Image source: Getty Images.
The SLA cites an existing rule stating that any business that profits from a liquor license must be listed on the license, even if alcohol isn't part of a sales transaction. Landlords are exempt from that rule, but they can usually claim up to 10% of a restaurant or bar's profits without a license. In other words, the SLA is proposing that delivery platforms and landlords be treated the same -- if they don't want to be listed on liquor licenses.
That would be dire news for Grubhub, for two reasons: New York City is its biggest market, and it's already struggling to balance rising costs with its delivery fees.
Why New York matters to Grubhub
Grubhub controlled 69% of New York City's third-party food delivery market in May, according to Second Measure. Uber (NYSE: UBER) Eats ranked second with a 14% share, followed by DoorDash's 10% share.
But on a nationwide basis, Second Measure claims that DoorDash overtook Grubhub as the market leader in May, claiming 32% of the market compared to Grubhub's 31.7% share. Uber Eats ranked a distant third, with 19.7% of the market.
Second Measure claims that Grubhub leads in only four major markets: New York City, Chicago, Philadelphia, and Boston. DoorDash is the dominant player in Los Angeles, San Francisco, Dallas-Fort Worth, Houston, Washington, D.C., and Phoenix. Uber is the market leader in Atlanta and Miami.
That regional fragmentation is troubling, but Grubhub frequently relies on its strength in New York, the most populous city in the U.S., to offset its softness in other markets. It also uses New York as a launchpad for new partnerships, including its recent deals with Blue Apron and Dunkin' Brands.
Image source: Grubhub.
How new rules could hurt Grubhub
A move by the SLA to slash Grubhub's delivery fees in its biggest market would inevitably throttle its growth, which already decelerated significantly over the past year. Here's a look at recent year-over-year growth:
Metric | Q1 2018 | Q2 2018 | Q3 2018 | Q4 2018 | Q1 2019 |
|---|---|---|---|---|---|
Daily average grubs (meals) | 35% | 35% | 37% | 19%* | 19% |
Gross food sales | 39% | 39% | 40% | 21% | 21% |
Active diners | 72% | 70% | 67% | 22% | 28% |
Revenue | 49% | 51% | 52% | 40% | 39% |
Data source: GrubHub quarterly reports. *22% excluding Eat24 from both periods.
More importantly, a big drop in delivery fees would hit Grubhub's bottom line, which was already slammed by rising marketing expenses in recent quarters. Again, a look at the recent year-over-year numbers:
Metric | Q1 2018 | Q2 2018 | Q3 2018 | Q4 2018 | Q1 2019 |
|---|---|---|---|---|---|
GAAP net income | 74% | 104% | 75% | (110%) | (78%) |
Non-GAAP net income | 88% | 99% | 72% | (47%) | (41%) |
Adjusted EBITDA | 51% | 61% | 41% | (26%) | (21%) |
Data source: GrubHub quarterly reports.
But investors shouldn't panic yet
The SLA's proposed rules could cause headaches for Grubhub, but investors shouldn't overreact. Only restaurants serving alcohol would be affected in a worst-case scenario, and Grubhub recently told Bloomberg that it already operates in "full compliance" with existing SLA rules and argues that the agency has no jurisdiction over food sales.
Several analysts also came to Grubhub's defense after the report. Needham analyst Brad Erickson stated that the New York Post report was "thin" on facts, and that the rumored rules had "a low probability of success" unless they were applied to all delivery platforms.
Stephens analyst Will Slabaugh also questioned the accuracy of the Post report, noting that the SLA already determined last October that Grubhub was "an unlicensed marketing company that does not have an interest in any liquor license." Slabaugh states that the issues raised in the report were already "asked and answered" and that the risk of a new mandate is "exceedingly low."
What should investors focus on?
Grubhub investors should monitor the situation in New York, but it's not the most important issue facing the company right now.
Instead, they should focus on competition from DoorDash and Uber Eats, its ability to secure new partnerships to widen its moat, the expansion of its ecosystem with payment and loyalty point services, and its ability to stay profitable -- a key strength that DoorDash and Uber Eats both lack.
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Leo Sun owns shares of Grubhub. The Motley Fool recommends Dunkin' Brands Group, Grubhub, and Uber Technologies. The Motley Fool has a disclosure policy.