The Deliveroo (LSE:ROO) share price hasn’t been a fantastic performer since its IPO in March — at least, not until recently. Since the last week of June, the stock has soared by around 25%, putting it on track to returning to its initial public offering (IPO) issue price of 390p. What caused this recent growth? And is now the time to add this business to my portfolio?
The power of lifting uncertainty
Since its IPO, investor uncertainty had been mounting concerning the status of Deliveroo’s riders. One of the firm’s competitors, Uber, had recently received a court ruling that stated its drivers were not self-employed contractors. The consequence was a massive surge in UK operational costs, which further pushed back the path to profitability. In other words, the time needed to make Uber profitable in the UK just got longer.
The seemingly growing concern from Deliveroo investors was that the same court ruling would be issued to the business as it operates in a similar way. However, on June 24, the UK court ruled in favour of classifying Deliveroo riders as self-employed contractors. I must admit I was surprised. But this result caused a lot of uncertainty surrounding the business to evaporate. So the surging Deliveroo share price makes perfect sense to me.
When combining this milestone with the relatively impressive first-quarter earnings report, it seems Deliveroo might be finally ready to start behaving like a growth stock. After all, total orders did increase by 114%, while gross transaction volumes more than doubled to £1.62bn! What’s more, its newly expanded partnership with Waitrose to use its network of riders to deliver groceries within 20 minutes to consumers opens a new avenue of revenue generation.
The risks circling the Deliveroo share price
Having said that, I still have some reservations. Like many growth stocks that have surged recently, Deliveroo remains unprofitable. That certainly adds risk to the share price. But it’s not necessarily a bad business trait as long as there is a pathway to profitability. However, in the case of Deliveroo (and other food delivery services, for that matter) I don’t see a clear one.
This is ultimately an industry with low barriers to entry and high fixed costs. Therefore, as the platform scales with new restaurants and customers, prices ultimately rise with it. This makes margin improvement exceptionally difficult, in my opinion.
Typically, in such circumstances, businesses can try passing on these additional costs to consumers or clients. But it doesn’t look like Deliveroo has that option due to its fierce competition from a myriad of other food delivery companies like Uber Eats and Just Eat. The latter of these has seen its losses surge since the introduction of its own delivery network in 2018.
The bottom line
I’ve previously stated that a path to profitability might exist for Deliveroo. And this recent court ruling certainly helps in that regard. But despite this milestone and the firm’s impressive growth, I’m becoming quite sceptical about its profit-generating capabilities the more I research this business model.
Therefore, I don’t think I’ll be adding Deliveroo to my portfolio anytime soon, even though the share price could continue to rise from here.
