Uber: Right Track, Wrong Valuation

Source: Investing.com

After that rough stretch, however, Uber finally seems to be on track. Indeed, it’s hard not to be at least a little impressed by the company’s third-quarter report last week. A company that, for all its warts, always offered massive potential finally seems to be realizing at least some of that potential.

Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) continued its march into the black. The delivery business is doing well. And it certainly seems like Uber is taking market share in ride-sharing.

There’s real good news here. The concern, however, is how much good news remains priced in.

Back in 2019, Uber’s IPO valued the company at $82.4 billion. That was an incredible figure for a company nowhere near profitability, even on a heavily adjusted basis.

Three years later, however, Uber actually is profitable, at least depending on an investor’s definition. Adjusted EBITDA in Q3 was $516 million — up from just $8 million the year before. Uber is guiding for $600 million to $630 million in the fourth quarter, in the range of seven times the year-prior result.

Skeptics will rightly point out that adjusted EBITDA paints the company in the best possible light. Most notably, it excludes share-based compensation, which totaled $432 million. Uber’s free cash flow for the quarter was $358 million; all of that cash flow, and then some, came from the issuance of stock to employees.

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All that said, this is real progress. In the fourth quarter of 2019, Uber’s adjusted EBITDA was a loss of $615 million. Guidance, thus, implies a swing of roughly $1.2 billion in just three years.

It’s not just ride-sharing, either. The delivery business has reversed from massive initial losses to a profit (again, on an adjusted basis). The freight business increased revenue more than 300% in Q3.

What makes UBER intriguing here is that this trend highlights the positive economics of a platform business. Each incremental ride, delivery or freight booking that Uber generates should, in theory, be exceptionally profitable. Once the ride-sharing system is set up, for instance, the marginal cost of one more ride is negligible. Drivers need to get paid, of course, and there are other costs involved, but Uber’s profit margins, in theory, should expand at a rapid clip as revenue grows.

And for the most part, that’s what we’re seeing. The delivery business went from losing 50 cents on every dollar in revenue in Q3 2019 to earning more than six cents in the same quarter three years later.

That trend should continue in delivery; ride-sharing margins can expand, particularly if Uber takes more market share from rival Lyft (NASDAQ:LYFT). And on the back of a few billion in annual revenue, plus continued 20%-plus growth, Uber’s EBITDA over time should move from simply covering stock-based compensation to generating real value for shareholders.

The problem with UBER stock is that this case is not exactly hidden. The market is pricing in pretty significant profit growth.

This remains a company with a market capitalization of $49 billion. Q4 guidance suggests free cash flow might be barely positive when accounting for stock-based compensation.

And it’s worth noting as well that the macroeconomic environment likely is helping to at least some degree. Despite inflation, consumers are spending. Indeed, Uber chief executive officer Dara Khosrowshahi said on the Q3 conference call that “frankly, we’re not seeing any signs of consumer weakness.”

That may change. As the CEO of rival Lyft put it, $30 salad delivery can’t last forever in an inflationary environment. Travel demand is near a peak as well.

Investors can see value here, admittedly. It’s possible to model multi-year growth of free cash flow in the several-billion-dollar range — more than enough to suggest solid upside from the current price.

But Uber’s macroeconomic exposure means growth isn’t necessarily going to be in a straight line. And it’s not guaranteed to be fast enough to make the stock a steal at $27. Uber has done a nice job so far this year, but investors still can remain patient.

Disclaimer: As of this writing, Vince Martin has no positions in any securities mentioned.