Markets

Are Investors Overlooking Uber's Potential Profit Problems?

With 68% of the rideshare market in the U.S., Uber (NYSE: UBER) has become a verb -- consumers now "Uber" to their destinations instead of taking a taxi. Uber's strong brand recognition and optionality to branch out into food and freight delivery could create long-term growth opportunities. Still, investors should consider some potential concerns before deciding to invest.

Pandemic impact

Uber was clearly adversely affected by the pandemic, when being in a vehicle with strangers became a health hazard. Uber's revenue from its mobility business fell 43% year over year in 2020 to $6.08 billion, but the impact was partially offset by a 179% surge in food delivery revenue to $3.9 billion. In all, Uber's 2020 revenue finished at $11.1 billion, down 14% year over year from 2019.

Man setting up navigation in car.

Image source: Getty Images.

Investors should consider that the pandemic environment remains a challenge for Uber. In the first quarter of 2021, Uber's revenue continued downtrends seen throughout 2020. First-quarter revenue was $2.9 billion, down 11% year over year from 2020, again reflecting a decline in Uber's mobility segment and growth in food delivery.

Currently, 49% of people are fully vaccinated in the U.S., and the effort continues. However, the virus is still a threat to the economy, with the new delta variant causing COVID-19 cases to again rise throughout the country. Uber could continue to be affected as long as the pandemic persists.

Uber's driver costs are too high

Uber classifies its driver payments as a "cost of revenue" in the company's financial statements. Uber spends 46% of its total revenue each year on these costs, which causes Uber's business losses. From 2018-2020, Uber's operating margin was negative 29%, negative 66%, and negative 44%.

Uber has a potential flaw in its business model because it needs more drivers to give more rides and deliveries. Uber's driver costs are increasing along with revenue because a driver can only work so much.

Legislative debates are taking place about whether rideshare drivers should be reclassified as employees rather than contract workers. California Assembly Bill 5 was legislation in 2019 that nearly made that happen, but a voter-approved Prop 22 exempted gig companies in 2020. U.S. Labor Secretary Marty Walsh has also come out in support of giving employee benefits to drivers, which both Uber and Lyft have strongly opposed due to the significant financial impact it would have on their businesses. If regulations tighten over time, it could significantly increase Uber's driver costs.

Uber's investment strategy

Uber created a division within the company in 2015 for developing self-driving technology but abandoned it in 2020 when it sold the division to technology start-up Aurora in an equity deal worth $4 billion. Uber is now partnering with Aurora, investing $400 million and obtaining a 26% stake in the company. Uber had spent more than $1 billion on self-driving research, but it changed its strategy to focus on growing its core business.

Uber has an investing strategy to acquire stakes in various transportation companies, including the following:

Company Where it is based/operates Uber's ownership stake
DiDi Global China 14%
Grab Singapore 16%
Aurora United States 26%
Yandex Taxi Russia, Eastern Europe, Africa, Mideast 33%
Zomato India, Mideast, U.K., South Africa 8%
Joby Aviation United States 6%
Lime United States 31%

Source: Company reports.

The total value of these holdings is $12.9 billion on Uber's balance sheet, representing 14.4% of Uber's market cap. It doesn't include actual acquisitions that Uber has made, including alcohol delivery service Drizly for $1.1 billion, quick delivery service Postmates for $2.65 billion, and logistics software company Transplace for $2.25 billion.

Uber is investing in direct and indirect ownership of its potential competitors, which will help keep competition at bay. Still, it remains to be seen if this strategy can help the company turn a profit. Uber's driver costs remain a financial headache that investors should monitor.

Here is the bottom line

Uber's business could see a bump as the pandemic passes and ridesharing activity bounces back, but investors need to think about the high driver costs that cause Uber to lose so much money. Uber's business has operating losses of more than $18 billion since 2018 while generating $37 billion in revenue. This large gap between the top and bottom lines could become a long-term issue for the company.

It may be too early for investors to draw conclusions about Uber, but there are times when a great service for consumers is a poor business for investors. If Uber cannot progress toward profitability in the next couple of years, investors may decide to look elsewhere.

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Justin Pope has no position in any of the stocks mentioned. The Motley Fool recommends Uber Technologies. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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