Here’s 1 expanding FTSE 250 stock that I wouldn’t touch with a 10-foot bargepole

Deliveroo (LSE: ROO) could be one of the UK’s great 21st-century success stories. It only formed in 2013 but posted £2bn revenue last year and already reached the FTSE 250. The firm delivers a million meals a week up and down the country and has expanded across Europe and Asia as well. 

All the hallmarks of a thriving business are present, and yet I won’t touch the shares with a fairly lengthy bargepole. Here’s why. 

Growth needed

To start with, billions in revenue doesn’t mean you actually make any money. And a lack of earnings has been something of a theme of Deliveroo’s operations so far. Granted, it turned a profit last year for the first time and dividends are already being mentioned. But the firm is trading at 45 times forward earnings. That’s not a good buy for me without a hefty chunk of earnings growth. 

Now, you might say, many unprofitable companies go on to be terrific buys. This is indeed true. I remember seeing Reddit IPO last year having not made a cent since 2008. But it turned a profit a couple of quarters later and the shares are up about four times in value since then. That’s often the story with these fledgling, jam tomorrow-type stocks. I accept it could be the case with Deliveroo. 

Where things start to fall down for me is the business model. Deliveroo’s pricing is around £3 per order. That’s an acceptable amount to get food delivered, but is there room for increases in order to grow earnings? I think that while a rise in the fee could help boost profits, there’s also a risk it could deter some customers and the company has made no suggestion that it’s even considering such an increase. That’s understandable, as surely folks wouldn’t want to pay much more to get sent a couple of Hawaiian poke bowls (the firm’s most popular order, by the way).”

Regulatory issues

On the other side of things, I don’t think there’s much fat to trim from operations either. The firm relies on cheap labour in a sector with lots of competition. With other big delivery services competing for business, it’s hard to see much room for margin expansion here either.

There’s the question of regulation too to take into account which is always a threat in these nascent gig economy types operations.

All in all, there are a lot of questions here. Can Deliveroo deliver (ahem) on earnings growth or win market share against the competition? Can it avoid the regulatory hammer? Maybe management has all the answers, the stock flies up and I look back in 10 years with egg on my face. 

I wouldn’t be overly surprised. The firm’s rise so far has been exceptional. It has millions of regular customers and other investors are putting a heady valuation on the shares. In any case, it’s not a buy for me today.

The post Here’s 1 expanding FTSE 250 stock that I wouldn’t touch with a 10-foot bargepole appeared first on The Motley Fool UK.

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John Fieldsend has no position in any of the shares mentioned. The Motley Fool UK has recommended Deliveroo Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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