Uber: Strong Profitability Improvement; Stock Is 40% Undervalued (NYSE:UBER)

Uber Technologies (NYSE:UBER) has demonstrated significant gross booking and revenue growth in the past. Their focus on operational efficiencies and expense management has helped improve the take rate and operating margin. I am initiating coverage with a ‘Buy’ rating and a fair value of $90 per share.

Multiple Years Growth in Mobility Business

As illustrated in the table below, Uber’s mobility business has exhibited robust booking growth and adjusted EBITDA growth over the past few years.

The growth of the Mobility business is propelled by both its core product and additional offerings. As disclosed in their earnings call, the core UberX is experiencing a 20% year-on-year growth, attributed to the continuous addition of drivers to their platform. In addition to the core UberX business, they have introduced new growth initiatives, including hailables products, taxis, three-wheelers, and Uber for Business products. Together, these collective businesses generate $9 billion in revenue, marking an impressive 80% year-over-year growth.

They forecast high growth for their Mobility business in the next few years, citing significant potential in international markets where current market penetration is relatively low. Uber has successfully established itself as the market leader in the Mobility sector, experiencing healthy growth in both the number of drivers and riders. The additional services offered on their platform contribute to generating additional revenue with minimal incremental costs.

The chart below illustrates the gross booking growth in the ride-sharing business for both Uber and Lyft (LYFT). It is evident that Uber has demonstrated more robust growth in its Mobility business compared to its competitors.

Delivery Business Started to Deliver Profits

Uber’s delivery business now constitutes more than 34% of its total revenue, and the company achieved positive adjusted EBITDA profits in FY22. Despite the highly competitive landscape in the delivery sector, I am optimistic about Uber’s ability to enhance business profitability for several reasons.

Firstly, they are capitalizing on network efficiencies as they scale their operations. In the Delivery business, route density is crucial, and the primary means to increase it is by expanding the business scale. In Q3 FY23, Uber disclosed a notable over 5% year-on-year decrease in cost per trip in the US marketplace business, reaching an all-time low.

Secondly, Uber is strategically leveraging both Mobility and Delivery technology platforms. This approach allows for the sharing of engineering resources, unlocking synergies at the group level. These platform synergies contribute to reducing operational and research and development expenses for the Delivery business.

Lastly, Uber is diversifying its Delivery business into new vertical markets, including grocery stores, convenience stores, and alcohol. This expansion into new verticals has the potential to broaden their distribution network and enhance operational efficiencies. For instance, Uber has entered into a partnership with Albertsons (ACI) grocery chains, serving their 1,200 stores.

It’s worth noting that Uber’s Delivery business faces direct competition from DoorDash (DASH), which is adopting similar business strategies. DoorDash has exhibited rapid growth in recent quarters, making it essential for Uber investors to closely monitor DoorDash’s performance in the future.

Recent Result and FY24 Outlook

Over the past few years, Uber has demonstrated rapid growth, excluding the pandemic period. The company has shown improvement in cash flow and operating margin, thanks to its emphasis on operational expense management. Notably, they achieved positive free cash flow starting from FY22. Furthermore, Uber maintains a robust balance sheet with a net cash position.

In Q3 FY23, Uber achieved a remarkable 10% growth in revenue in constant currency, accompanied by an impressive 111% growth in adjusted EBITDA. This surge was attributed to the improvement in take rates and a substantial 20% growth in gross bookings. Ending the quarter with $5.2 billion in cash and cash equivalents, Uber boasts a robust balance sheet. The strong profit improvement and topline growth were also reflected in their free cash flow, which witnessed a remarkable 153% year-over-year increase.

For Q4 FY23, Uber guides a robust 18%-21% gross booking growth on a constant-currency basis, with adjusted EBITDA expected to be in the range of $1.18-$1.24 billion. This guidance suggests a continuation of strong topline growth and notable margin expansion. Considering their impressive year-to-date results, I anticipate no surprises in their Q4 earnings. The market’s primary focus is likely to shift towards Uber’s FY24 guidance.

I project that Uber can maintain approximately 20% revenue and gross booking growth in FY24, coupled with ongoing margin improvement. A potential interest rate cut by the Fed would be positive for Uber, enhancing affordability. The robust gross booking growth demonstrated in their Q3 FY23 results indicates sustained strength, and I foresee no immediate reasons for a slowdown. Moreover, Uber’s commitment to operational efficiency and disciplined expense management makes it highly likely for them to continue delivering margin expansion.

Valuation

I am confident that Uber can sustain margin expansion over the next decade by leveraging operating leverage and scaling their operations. Assuming a normalized revenue growth of 20% for the next two years, I project a gradual moderation to 8% by FY32. While modeling revenue growth over the next ten years is challenging, it makes sense to anticipate a moderation in the growth rate as the company faces a higher base over time. In addition, 1.2% of acquisition growth is assumed in the model as tuck-in acquisitions are part of their business strategy. With the impact of operating leverage, my forecast indicates a 12.6% operating margin by FY32.

I am utilizing a 10% discount rate and a 4% terminal growth rate in my model, consistent with the assumptions applied in most of my financial models. Based on these parameters, my estimate places the fair value of Uber at $90 per share. Presently, the stock is trading at 37 times FY24’s free cash flow, as calculated in my model. I anticipate that Uber’s margin expansion and topline growth will contribute to a substantial improvement in its free cash flow over the next few years.

Key Risks

Dara Khosrowshahi: Uber’s current CEO, Dara Khosrowshahi, formerly served as the CEO of Expedia (EXPE). During his time at Expedia, Khosrowshahi had an aggressive approach to acquisitions. In my view, Expedia was not effectively managed under his leadership, resulting in a loss of competitiveness against Booking.com (BKNG).

Drizly: In 2021, Uber acquired Drizly for $1.1 billion, only to announce its decision to shut down this alcohol delivery app by March 2024, as reported by the media. It’s important to clarify that Uber is not discontinuing alcohol delivery altogether; rather, they are sunsetting the Drizly app. Essentially, the acquisition of Drizly seems to be more about eliminating a competitor, effectively flashing the $1.1 billion investment down the drain.

Takeaways

I am optimistic about Uber’s potential for exceptional revenue and gross booking growth in the near future. The significance of their margin expansion is crucial for stock price appreciation. In my assessment, the current stock price appears undervalued by more than 40%, prompting me to initiate a ‘Buy’ rating with a fair value target of $90 per share.