Instacart: An Undervalued IPO? Initiating At Buy

It's been a little over a month since Instacart's (NASDAQ:CART) IPO at $42 per share, and it's probably safe to say that the grocery startup company chose among the worst macro climates to go public. Despite showing a strong bottom line alongside consistent growth rates, Instacart is competing with 5%+ risk-free interest rates, which ultimately soured the offering.

Now at the time of writing, shares of Instacart are trading ~40% below their offering price:

This is where an opportunistic investor like me can step in to survey the damage. In my view, this is a case of overwrought macro pessimism that is unfairly punishing an otherwise excellent business. When we take a step back, we see a company that A) is leading the grocery delivery space and has partnerships with many of the largest grocers in the country, B) enjoys a greenfield market territory with huge underpenetration of technology in everyday grocery purchases, and C) even at its relatively smaller scale has already been able to produce profits.

I'm initiating Instacart at bullish and strongly recommend buying on the recent dip. Note as well that the company releases earnings for the first time on November 8, which could be a potential upside catalyst for the stock if it continues to showcase double-digit growth alongside margin expansion.

The market opportunity

First things first: Instacart, for investors who are unfamiliar with the company, is a platform for ordering groceries to your doorstep. Users can scroll through products at their local store via Instacart.com or the app, add items to their cart, and place an order.

As shown above, taken from the company's website, Instacart serves 14,000 cities across the U.S. and is interlinked with over 80,000 stores. These stores range from smaller local grocery shops to big-box chains ranging from Raley's, Walmart (WMT), and Costco (COST).

Though delivery is the primary fulfillment option, customers can also choose to order through the app and pick up their orders in person - usually saving on fees in the process. Delivery fees can also be as fast as under 30 minutes, depending on location and with added cost.

It's worth noting as well that Instacart users primarily skew to the middle and upper-middle class, urban or suburban dwellers:

The market opportunity in the grocery space is huge. According to Instacart's prospectus filing, annual grocery spend in the United States alone is $1.1 trillion. Of that, online grocery sales were only 12% of the total in 2022 - which, in turn, was up sharply from just 3% of overall grocery sales in 2019.

The pandemic, needless to say, has fostered a culture of convenience. While I don't necessarily see e-commerce ever reaching more than 50% of total grocery sales, I think room to climb from the current low-teens penetration is quite reasonable.

Competition

Of course, Instacart is not the only name in the game. I'd categorize the other players into two buckets: restaurant delivery companies and Amazon (AMZN).

In the restaurant delivery space, apps like Uber Eats (UBER) and DoorDash (DASH) have attempted to broaden their TAM by adding convenience stores and grocery stores. While I do think these apps provide viable competition to Instacart, the advantage Instacart has is its breadth of offering and specialization in the grocery space - as well as loyalty programs like Instacart+, which offers free shipping and lower services fees for $10/month or $99/year.

Amazon, of course, is the other behemoth in the space, especially with its ownership over Whole Foods. Amazon also has the advantage of price trust with its consumers (a common hesitation to using services like Instacart is that it's difficult to know if grocers charge more for the same product on their online storefronts, whereas Whole Foods list prices remain consistent). On the other hand, however, getting a Whole Foods delivery is only relevant if you live in the vicinity of a Whole Foods - and so again, Instacart's breadth of offering provides a distinct advantage here.

Financials demonstrate a growing, profitable business

Let's now go through Instacart's financial profile. The company's results through the first half of FY23 are available in its prospectus; it will release Q3 results in early November:

Instacart's revenue in the first half of 2023 grew 31% y/y to $1.48 billion, keeping in mind that we're already comping against pandemic benefits in FY22 (a year in which Instacart revenue grew 39% y/y).

At the same time, as shown in the chart below, Instacart's gross margin has also expanded - up seven points to 75%, putting the company on par with most software companies.

Gross transaction value in the quarter, meanwhile, rose 4% y/y to $14.9 billion. It is important to note that customer orders themselves have slowed in recent periods:

In Q2, order growth was just 3% y/y, and in Q2 orders were actually down -2% y/y, following a period of rapid doubling/tripling in 2019 and 2020. The reason Instacart has been able to drive double-digit revenue growth, meanwhile, is driven in part by higher fees (Instacart charges transaction fees to both the retailers selling the products as well as the consumers placing the orders). The chart below illustrates where dollars are disbursed in a typical Instacart order, with Instacart taking ~6.3% of a total order value in fees.

Note as well that the company earns on advertising as well, as product brands can pay Instacart for more prominent featuring in its app. A larger stream of ad revenue has helped Instacart's overall "take rate" jump to 8.8%.

Note as well that the company's Instacart+ offering has grown to 5.1 million users as of the end of Q2, up ~11% y/y from 4.6 million users in Q2 of last year.

Profitability is another major highlight for Instacart. As take rates have soared, gross margins have also improved, leading Instacart to generate $279 million of adjusted EBITDA in the first half of FY23: or a 19% margin of revenue, up 21 points from -2% in the year-ago period. Instacart even generates positive GAAP net income ($242 million, or $0.30/share) - which is a rarity among recent IPOs.

Valuation and key takeaways

Considering strong financials and a robust bottom-line, I think Instacart's recent devaluation has left the stock quite cheap. At current share prices near $25, Instacart sits at a market cap of $7.14 billion. Netting off the $1.97 billion of cash on Instacart's balance sheet as of the end of Q2, as well as the $564 million of expected IPO proceeds that hit the balance sheet after the close of Q2, gives us an enterprise value of $4.61 billion. Note as well that Instacart's balance sheet is clear of any debt.

Meanwhile, for FY24, Wall Street analysts are expecting Instacart to continue its growth trajectory (albeit at a more moderate pace), with consensus calling for $3.28 billion in revenue (+9% y/y). And assuming Instacart's current 19% adjusted EBITDA margin holds (a fair assumption when top-line growth rates are slowing down more in-line with order growth rates), the company would generate ~$623 million of adjusted EBITDA on that revenue. This would put Instacart's valuation multipacks at:

• 1.4x EV/FY24 revenue
• 7.4x EV/FY24 adjusted EBITDA

To me, this is quite a modest valuation multiple for a tech company that is still growing. That's not to say that Instacart is without risks, of course. The core risks that I'm tracking are:

• Slowing order growth / limited ability to increase fees to continue generating double-digit revenue growth
• Competition from Uber and DoorDash's ability to bundle grocery delivery with other services (especially a more holistic platform like Uber One)

That being said, even with competition in the arena, the fact that app-based grocery delivery is only 12% of a >$1 trillion annual market makes me hopeful that Instacart still has plenty of greenfield territory to grow. Keep an eye on this stock and buy before its first earnings release in early November.