Instacart: Reasonable Valuation, But It Is At Risk Of Disintermediation (NASDAQ:CART)

Maplebear Inc., better known as Instacart (NASDAQ:CART), has continued to see its share price decline since its IPO. Despite the fact that it started its life as a public company at a relatively more reasonable valuation, compared to the peak private valuation of $39 billion that it reached at the height of the pandemic.

With the company now trading at an almost 90% discount to that valuation, we think it is a good time to evaluate the shares.

Company Overview

Instacart presents itself as the leader in online grocery digital platforms. It has some data points to back this up, including partnering with more than 1,400 retail banners across more than 80,000 locations. The company estimates that its partners represent over 85% of the US grocery market. Still, most customers still buy directly at the stores from these retailers, or through the retailer-controlled apps or websites.

Probably the most important indicator to evaluate Instacart is Gross Transaction Value or GTV. GTV is the total value of the products sold by the company based on prices shown on Instacart. One of the main reasons customers use Instacart is for convenience. Instacart’s scale allows them to improve the speed at which they can fulfill orders. In 2018, the fastest delivery option was to schedule the next available 2-hour delivery window. Now their fastest delivery option is called priority, with a median delivery time of less than fifty minutes and making up roughly 36% of their orders in the third quarter.

We believe the company has been smart in leveraging partnerships to strengthen its position and bring in new customers. For example, they recently launched a partnership with Mastercard (MA) in the US that provides eligible cardholders a two-month free trial of Instacart+ and $10 off their second eligible Instacart purchase each month.

Customer and Employee Dissatisfaction

While Instacart appears to deliver on its promise of being a convenient option for grocery purchases, it unfortunately has highly dissatisfied customers and employees. While most people who take the time to post a customer review online might be motivated by a bad experience, it appears Instacart’s average is particularly bad. For example, its Trustpilot rating is 1.2 stars out of 5. For comparison, Target (TGT) has 1.7 stars, and even Walmart (WMT) has a higher score of 1.5 stars.

For employee satisfaction, we took a look at their Glassdoor employee reviews. The 3.4 out of 5 stars does not look too bad, but reading through the comments it is clear a lot of their shoppers feel underpaid. Still, many of them mention they really value the flexibility of the job and being able to choose their working hours. The CEO of Instacart, Fidji Simo, also has a very low grade, with only a 35% approval rating.

Competition and Risk of Disintermediation

The biggest threat we see to Instacart’s business model is that its suppliers will be tempted to bypass the company. The grocery industry is known to have very low profit margins, and it is likely that it will want to re-capture some of the margin they are currently losing to Instacart. Historically there are many examples of companies that went from using wholesalers and retailers to a more direct-to-consumer model once they had the strategy ready. Examples include Apple (AAPL), which eventually decided to open its own dedicated stores, and Tesla (TSLA) which bypassed car distributors. This increased the company’s gross profit margin and allowed the company to have more control over the customer experience.

For the time being, many grocery retailers are willing to collaborate with Instacart, while they get their own logistics and infrastructure ready. One of the best examples is Kroger (KR), which is collaborating with Instacart, but at the same time, it is automating its new warehouses licensing Ocado’s (OTCPK:OCDDY) technology, and experimenting with electric self-driving automated deliveries. More recently, Kroger has also been experimenting with the use of self-driving trucks. While Nuro, the startup with which Kroger partnered has been experiencing some issues, its website lists several cities where they are already operating. In any case, these Kroger partnerships clearly point in one direction. Disintermediating the likes of Instacart, and vertically integrating online groceries, from the warehouse to the delivery destination.

As online grocery shopping becomes a bigger percentage of total sales, these companies will be more incentivized to invest in a strategy to make the deliveries themselves, ideally from their own warehouses. Already Instacart justified some recent layoffs by saying fewer employees were needed as some suppliers were using their own employees to fulfill the orders, instead of relying on Instacart’s in-store shoppers. Another example is the curbside grocery program, where customers drive to the stores to receive the orders. Many of these orders are still placed through the Instacart app, but it means Instacart is one step closer to being placed out of the loop.

Further complicating the competitive landscape, competitors like Uber (UBER) and DoorDash (DASH) are looking at grocery deliveries for growth. They have massive networks of users and drivers that can be quickly re-deployed to compete in this business if they see it as an attractive opportunity.

Financials

In the third quarter gross transaction value increased 6% year-over-year to $7.4 billion, while orders were up a more modest 4% to 66.2 million. The company reported a massive GAAP loss, mostly driven by $2.6 billion of stock-based compensation expense (SBC). While these are very likely multi-year awards as a result of becoming a public company, we still find the amount excessive when compared to the company’s enterprise value.

Instacart shared that they delivered five consecutive quarters of profitability pre-IPO, and generated adjusted EBITDA of $163 million in the quarter. Revenue of $764 million represented 10.2% of GTV, which we believe is a very high take-rate for this industry. Surprisingly the average order value, or AOV, increased only 2% year-over-year to $113, less than the inflation rate. Another worrying development is that GTV performance from their mature cohorts (2021 and prior) collectively declined year-over-year. Still, the company managed to increase its revenue by bringing in new customers, and by boosting advertising revenue. We believe advertising revenue is a double-edged sword, as it can increase the overall take rate of a platform, but it does so at the expense of degrading the experience for its customers.

Outlook

Guidance for the fourth quarter was relatively weak, with the company expecting GTV year-over-year growth of between 5% and 6%, mostly driven by order growth. As for adjusted EBITDA, the company expects it to be between $165 million and $175 million.

Balance Sheet

Instacart ended the quarter with about $2.2 billion in cash and short-term investments. It plans to use around $500 million for its share repurchase program.

Valuation

According to estimates found on Seeking Alpha, the forward EV/EBITDA multiple for the company is 7.6x, a significant discount to the average of its industry of 11.2x. If you believe Instacart can successfully defend itself from competition from Uber, DoorDash, and similar platforms. As well as prevents disintermediation from its suppliers, so they don’t bypass Instacart and offer a cheaper direct-to-consumer alternative, then shares might actually be trading at an attractive valuation. It appears that the market is valuing the company somewhere in between a grocery retailer and a technology platform.

Based on average analyst estimates, the FY25 forward price/earnings ratio is around 25x. Given the enormous growth expected in online groceries, this does not appear excessive either. Our concern is that we are not convinced Instacart has a strong enough competitive moat to defend itself from its suppliers and competitors.

Risks

We have already discussed some of the risks we see with Instacart, from competitors that have massive networks like Uber and DoorDash, to its suppliers potentially becoming direct competitors to the company.

If this is not enough, it also faces challenges from gig worker regulations. It already has had some controversies in this respect, with alleged misclassification of shoppers as independent contractors. New rules or regulations in this regard could add costs and complications for the company.

Conclusion

Instacart has seen a massive decline in its valuation, from a peak of around $39 billion to a current enterprise value of close to $4.5 billion. At current prices, shares look cheap, but we are worried about the competitive threats the company faces. For people who believe Instacart can successfully fend off competition from other delivery platforms, and suppliers implementing a direct-to-consumer model, the valuation looks attractive. However, we believe risks are quite high, and there is too much uncertainty as to how the competitive landscape will evolve.