gorodenkoff
The debate remains on whether Uber (NYSE:NYSE:UBER) is able to deliver a good balance of growth in the business as well as move towards improving profitability and ramping up of free cash flows. Lots of investors have discounted Uber as an investment idea because of lack of clear signs that the company can ever be profitable. However, I think that the contrarian investor could leverage on this negative sentiment to bring outsized investment returns, as I think that there are clear signs that the company can turn profitable in the near future if management continues to execute well on its strategy.
Investment thesis
My central investment thesis for Uber takes a contrarian view on the company as I think that the market has not priced in the improving profitability and free cash flows of the company. The investment case for Uber has always been filled with doubts about the company being able to reach profitability. However, with management’s explicit goals set in narrowing losses and achieving profitability by 2024, as well as the good progress made in its 2Q22 results, I think that management has been executing well in a difficult operating environment, and that this has not yet been priced into the current stock price.
I continue to take the view that management will be able to achieve its free cash flow and adjusted EBITDA goals for 2024 as the industry looks to be more rational than before and as Uber improves on its operating leverage given the increasing scale of the business. Furthermore, business fundamentals continue to trend in the right direction as mobility continues to recover strongly with the return of global travel while delivery remains sticky. I think that Uber’s platform strategy will prove successful in the long run and as such, I am optimistic about the company and initiate the company with a Buy rating.
Positives and negatives of 2Q22 earnings
Uber’s 2Q22 earnings demonstrated that management was on track to deliver its guidance of $5 billion adjusted EBITDA in 2024, while also addressing some of the concerns investors have with the company.
I’ll first highlight some of the positives in the quarter. First, 2Q22 adjusted EBITDA came in above market consensus as well as management’s guidance at $364 million, although the total gross bookings were just about meeting expectations. This was largely driven by improved operating leverage and lower investments made in driver supply for the mobility business, resulting in stronger incremental margins. Second, the company continued its momentum and guided a better than expected adjusted EBITDA guidance for 3Q22 that is expected to be delivered as the company continues to benefit from improving operating leverage as scale improves as well as more controlled incentives and promotions given. I think that this continued momentum in adjusted EBITDA is rather encouraging to investors as it shows management’s ability to work towards its targets set out earlier.
The third positive point pertains to the general positive commentary that management had in the business. In particular, management was positive about the consumer travel trends as it looks to a broad recovery. Also, almost 15% of mobility bookings are now airport bookings, reaching a similar level to before the pandemic. Lastly, management continues to be upbeat about free cash flow generation as they expect an inflection point in free cash flow generation as well as profitability. This was demonstrated by the 2Q22 positive free cash flows of $382 million that exceeded the adjusted EBITDA for the quarter. Furthermore, management is optimistic in having monetisation opportunities for its equity stakes in other businesses that could lead to the company reaching the status of investment grade and also being able to generate and return capital to shareholders.
Management did highlight that on an annualised basis, its 3Q22 guidance would implies gross bookings of about $120 billion and annualised adjusted EBITDA of roughly $1.9 billion. As a result, this brings management closer to its investor day targets of achieving $175 billion gross bookings and $5 billion adjusted EBITDA by 2024.
However, on the negative side, 2Q22 gross bookings of $29 billion was softer than expected due to lower bookings from delivery as the company saw more challenges in markets outside of the United States. As a result, the gross bookings guidance for 3Q22 was slightly softer than expected with a guidance of $29 billion to $30 billion as mobility gross bookings is expected to deliver the growth for the business in the quarter. Lastly, the take rate for mobility was down compared to the prior quarter because of less surge pricing and fuel surcharge.
All in all, while the macroeconomic environment is rather volatile at the moment, the 2Q22 earnings report of Uber does demonstrate management’s ability to work towards its goals set out in the 2022 investor day. In addition, Uber managed to demonstrate that with its product portfolio, it has managed to build scaled competitive advantages in each segment and a wide variety of products is leading to consumer adoption of its subscription model as it now has 10 million members.
A platform approach
Uber continues to leverage on the power of its platform to tackle the challenges of the pandemic and as the world comes out of it. Management continued to reiterate their views that the company has a structural competitive advantage when it adopts a platform approach. This means that by operating both the delivery and mobility businesses under one platform, this brings about advantages for the entire platform. Users using Uber for the mobility aspect can then easily move into Uber Eats and it works the other way around as well. This kind of flywheel effect the Uber platform has benefits the company by having rather low customer acquisition costs by leveraging on users going across the platform for different use cases.
Furthermore, with the Uber One membership, this ensures higher loyalty from customers and brings in more sticky recurring revenues, making it a more viable business model for the long-term. I think that we will see Uber have opportunities to monetise this platform or easily roll out other applications for its platform as it continues to leverage on its platform approach to expand and grow.
On mobility, management continues to see demand improve and the encouraging thing is that the demand is also becoming more predictable than before. Furthermore, Uber’s growth in the segment will be driven by its core UberX business as well as new products like hailables, Uber 4 Business, for example. Other sources of growth, in my view, will comes from increasing its penetration geographically. I think that another important thing to note for the mobility business is that we are starting to see the competitive environment improve globally, which bodes well for Uber as it transitions towards profitability.
On delivery, management commented that the habits were actually stickier than what they had expected. This means that with regards to basket size, the frequency of orders and the retention of the user, Uber sees that the average customer continues their habits for some time longer than what management expects. As a result, this is helping their improvement in margins for the business, along with increasing the density of each order as well as a lower driving cost per transaction. Management expects to spend less on marketing as it expects the competitive environment to mature more quickly. As a result of improving delivery margins, the company is now expected to roll out new verticals like grocery and convenience. Both grocery and convenience are large new verticals that present very exciting upsell opportunities for Uber as it leverages on its platform to bring in new verticals for further growth. This will also further solidify its platform, bringing product innovation and greater value add to consumers. Also, for its advertising business, Uber expected to target a $1 billion run rate by 2024, with the current run rate going at $350 million.
Monetisation of equity stakes and capital allocation
With regards to the investments in companies it has on its balance sheet, Uber is clear which ones are strategic and what ones are not. For example, its investments in Aurora (AUR) is strategic as it sees the company as a great partner for self-driving, and it sees Grab (GRAB) as its partner for the Asia business. However, its stakes in companies like DiDi (OTCPK:DIDIY) are not strategic. Management is looking at monetising these stakes over a period of time. While no timeline was given, this is not a huge priority for the company as the management believes that they are still having a healthy balance sheet and cash flows.
For capital allocation, as the company has already achieved positive free cash flows with $382 million in the second quarter of 2022, they expect to continue to be positive free cash flows in the foreseeable future assuming there are no other pandemics. As a result, the company is expected to first achieve investment grade status and then, with incremental capital that is accumulated, management expects to be able to return these capital to shareholders through buying back the company’s stock. In the near-term however, the main goals are still to achieve the status of investment grade, executing against its 2024 profitability targets and reinvesting in the business.
Valuation
My 1-year target price for Uber is $45.50, implying 72% upside from current levels. I use a mix of an EV to sales method as well as a DCF method, both equal weighted to determine Uber’s target price. In addition, I apply a rather conservative holding company discount of 20% given the various investments and joint ventures Uber has stakes in. For the mobility segment, delivery segment and freight segment, I assumed an EV to sales multiple of 1.6x, 3.5x and 1.0x respectively. I think that these multiples are justified given that we are seeing a recovery in consumer demand for Uber’s services, Uber’s leadership in both mobility and delivery segments and Uber’s progress towards profitability.
Based on the target of $5 billion adjusted EBITDA by 2024, this implies an EV/EBITDA multiple of 11.8x based on the targeted 2024F adjusted EBITDA figures. It is important to note that I think that Uber will still continue to see at least 20% revenue CAGR over the next few years with multiple secular growth in different end markets as well as new markets. As such, I do think that there is more upside than downside given where the company is headed today with the improving fundamentals and improving scale of the business in a post pandemic world. As such, the risk/reward is positively skewed, in my view, and this presents a great buying opportunity for Uber at these levels as the company progresses well towards profitability.
Risks
Regulatory risks
Given that the regulatory environment can be rather uncertain, for example, around the classification of Uber’s drivers. The regulatory environment can lead to an erosion of the Uber brand and potentially lower revenues as well as higher expenses to be incurred.
Macroeconomic environment
While management is making considerable progress towards its 2024 targets, there could be external shocks that lead to these targets being no longer attainable. One such example is the weakening global macroeconomic environment that continues to be volatile. Both mobility and delivery segments can be affected rather adversely in a macroeconomic slowdown and as such, this scenario poses significant risks to management’s 2024 goals.
Competition
Central to the investment thesis for Uber as well as management’s efforts is to improve free cash flows and adjusted EBITDA of the business. If competition were to intensify in either delivery or mobility businesses, this will lead to Uber taking a longer than expected time to narrow losses. In the worst case scenario, investors may lose confidence in the company’s ability to narrow losses if competition becomes too tough.
Slower than expected mobility recovery growth
If the recovery in mobility is slower than expected after the pandemic, this could also affect the investment thesis for Uber. As a result of the pandemic, airport rides, business travels led to lower rides in the mobility business but the general expectations is for mobility to recover to pre-pandemic levels as countries move towards removing all restrictions and global travel returns. However, there is a risk that a further deterioration of the global economy or worsening of the covid pandemic situation may lead to slower than expected recovery in mobility.
Conclusion
I think that we will continue to see management make progress towards rising profitability as the business scales and the competitive environment rationalises. As a result of its platform strategy, Uber is able to cross-sell and upsell to its large pool of users as it rolls out new verticals like grocery and convenience, and it can continue to grow its advertising business by leveraging on the strength of its platform. Furthermore, the 2Q22 result shows an improved outlook for the business in 2H22 as the business looks to be at an inflection point for its free cash flows and profitability.
My 1-year target price for Uber is $45.50, implying 72% upside from current levels. I think that the current stock price has not yet priced in the recent signs of improving fundamentals of the company with its first ever free cash flows and improving adjusted EBITDA. I take the view that the risk/reward is skewed to the positive for Uber given the improving business fundamentals and improving consumer trends for the business, along with improved scale and economics driving improved profitability. As such, this presents a great buying opportunity for contrarian investors wanting to take advantage of the negative sentiment around the stock as the current valuation does not reflect this inflection point in free cash flows and profitability.
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