Deliveroo stock boosted with Bank of America's 'buy' rating

Bank of America (BAC) said it is initiating its coverage of Deliveroo (ROO.L) with a 'buy' rating, as the food delivery company's shares went up about 1.9% on Tuesday morning. It highlighted online grocery delivery as a bright spot in the market.

The investment bank, one of four that worked on Deliveroo's stock market debut, has set a target price of 335p, which is a 35% upside to where it trades now but still below the 390p offer price set when the company launched its IPO in March.

Deliveroo's IPO was less than stellar, with its share price plunging as much as 30% on its IPO debut on the London Stock Exchange.

Last month it posted strong first quarter results but said its outlook remained uncertain as lockdown eases. The company anticipates consumers may order less takeaways as they are allowed to go out more.

Deliveroo shares were trading at 251.72p at the time of writing.

"Despite its smaller scale, we think ROO can succeed, as we are still in the early days for the penetration of food delivery and even more so groceries," the bank said.

Deliveroo has proven unit economics and a strong management team, it said, adding that it expects the food delivery service to "over-deliver on 2021" and estimates Deliveroo has penetrated just 4% of its directly addressable market.

It also believes Deliveroo owns "some of the best sector unit economics, allowing it to invest aggressively in marketing while keeping free cash flow burn in check".

Bank of America said the company "has a clear edge" in membership programmes and dark kitchens, which allows it to minimise customer churn and keep strong and exclusive relationship with restaurant brands.

Deliveroo operates close to 250 dark kitchens, which are delivery-only.

It added that concerns over competition in the UK "are overdone as we think Just Eat (JET.L) and ROO serve different ends of the market."

However, when looking at risks, BoA did say that "the food delivery industry is characterised by high competition, primarily because players seek to secure a number one or number two position quickly. In the UK, Deliveroo's core market, after years of market share loss, Just Eat, the incumbent, has opted to fight back aggressively."

Meanwhile, it expects online grocery delivery to be a major winner for Deliveroo, representing "a surprisingly significant" contribution to orders and gross transaction value — 30% by 2025.

The bank said a big asset for Deliveroo is also the fact that its current largest shareholder is Amazon (AMZN).

"The relationship between Amazon and Deliveroo is at arm's length, but we think having such a high-quality backer and expert in delivery and logistics is a positive for Deliveroo's development," the bank said.

It also talked up the fact that "very experienced Amazon executives" are now in top positions at Deliveroo, including Eric French, chief marketplace officer, and Dan Winn, chief technology officer.

Bank of America was one of four investment banks that worked on Deliveroo's IPO, the others being Citi (C), Jefferies (JEF) and Numis (NUM.L).

Read more: Deliveroo hits a new all-time low as hedge fund Odey shorts the stock

Banks insist they have Chinese walls between departments that means analysts won't favour companies that their investment banking colleagues are working on.

But as per Investopedia, "if the analyst of a particular security works for the same investment bank that is underwriting the new issue, he/she may be inclined to give a positive recommendation to ensure that the offering is successful."

It added that "investment banks are like most other businesses. They are always trying to increase profits, and they can attract more business by issuing favourable reports about their clientele."

Meanwhile, it is also being reported that New York hedge fund ExodusPoint Capital Management has taken up a short position in Deliveroo that makes up about 0.56% of Deliveroo shares.

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