Markets

Uber Stock Is Justifiably Undervalued

The May 2019 IPO of Uber (NYSE:) , the most anticipated and biggest IPO in recent memory, was a complete flop. Investors raised concerns about the company’s  valuation, lack of profitability, and slowing growth.

Uber Stock Needs to Find a Way to Stand Out

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Uber’s IPO price was $45. Uber stock failed to close above the IPO price in its first day of trading. That’s quite rare.  Indeed, Uber stock price has spent very little time north of $45. Instead, Uber stock has gone in the opposite direction. Today, the shares trade hands below $30, more than 30% below their IPO price.

At current levels, Uber stock is undervalued. Ride sharing is the future of transportation, and UBER is the leader of the ride-sharing market. Its top-line growth rates will remain robust for many years to come. Its margins will improve as it grows, since it’s making a gross profit on each ride. As a result, Uber will eventually be very profitable one day.

Uber stock is not priced for this reality today. Thus, Uber stock price is fundamentally undervalued relative to its long-term profit growth outlook.

But Uber stock may remain undervalued for the foreseeable future because the company is facing multiple risks. Until those risks pass, making its long-term profit growth outlook clearer, Uber stock will likely remain depressed.

Uber Is Undervalued

Uber stock is undervalued relative to its long term profit growth prospects.

My thesis is based on four man  ideas. Those ideas are as follows:

  • Uber is the unchallenged leader of the global ride-sharing market. Of the roughly 400 million ride-sharing users around the world in 2018, more than 90 million used Uber. That works out to a dominant 23% market share for UBER. Importantly, that’s up from 16.5% in 2016. At current growth rates, its share will rise to about 25% in 2019. Uber’s market share should continue to grow over the next several years as it adds more serivces like UberEats (you may not need a ride anywhere, but a late-night snack does sound pretty good).
  • Growth will lead to higher margins and huge profits. Sure, that $1.90 per ride on 5.2 billion rides in 2018 wasn’t enough to cover all the company’s expenses. But those other expenses are relatively fixed. As a result, if the company provides 10 billion or 20 billion rides, that $1.90 per ride should enable Uber to report  a profit. On 30 billion or 40 billion rides, Uber should report a sizable profit, greatly lifting Uber stock price.
  • Given all this, my modeling suggests that by 2030, Uber could net a profit of roughly $8 billion. Based on a  forward earnings multiple of 20, which is average for growth stocks, and a 10% discount rate, that implies a 2019 valuation target for Uber stock of  about $60 billion. The market cap of Uber stock today is under $50 billion.

    UBER May Remain Undervalued

    Although Uber stock is undervalued today, it may remain undervalued for the foreseeable future.

    UBER can eventually produce huge profits through enormous usage growth, sustained strong per-ride profitability, and resulting margin increases. But this scenario may not unfold due to multiple risks faced by UBER. Considering this uncertainty, the valuation of Uber stock today is appropriate and won’t go away until these risks clear up.

    The first risk is that usage growth could fall flat. That is, Uber has a ton of competition – and that competition is gaining share. If Uber continues to fumble on its marketing and PR campaigns, competitors could continue to gain ground, and if they do, Uber’s usage growth rates could slow meaningfully.

    The second risk is that its per-ride gross profitability could deteriorate below its historical 20%. That profitability  has fallen to roughly 17% this year, because, in response to the aforementioned competition, UBER has had  to offer deeper discounts and provide its drivers with higher incentives. If this dynamic persists, Uber’s per-ride gross profit could keep dropping.

    The third risk is that growth may not drive margin improvements. If Uber’s net revenue per ride drops over time, then Uber will need more rides to produce enough revenue to offset the company’s expenses. But it may not get enough rides to accomplish the goal.

    Right now, these three risks dominate the outlook of Uber stock. As long as they do, UBER stock will remain depressed.

    The Bottom Line on UBER Stock

    Relative to its long-term profit growth potential, Uber stock is undervalued below $30. But this is a byproduct of uncertainty surrounding the company’s long-term profit-growth potential. Until that uncertainty goes away, Uber stock will likely remain undervalued.

    As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

    The post appeared first on InvestorPlace.

    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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