Questor share tip: Sell Just Eat's eye watering valuation

Just Eat
240p+20½p
Questor says SELL

ONLINE takeaway website Just Eat [LON:JE] reported a strong set of maiden interim results yesterday, sending shares almost 10pc higher in morning trading.

However, the company still trades below its stock market flotation price and it has a long way to go to justify an eye-watering valuation.

The company, provides a website that caters for pretty much any takeaway taste. By signing up restaurants and installing an electronic point of sale at each location, the company is steadily becoming the middleman for a UK takeaway industry that is worth an estimated £30bn a year.

The business model added a further 4,200 pizza, Chinese and curry houses to its roster during the first six months of the year, bringing the total to 40,800 by June 30. Customer growth was also strong with active users on the website up 35pc to 6.9m at the end of June who spent about £465m.

Just Eat earns a fee every time someone places an order through the website. The company reported revenue up 58pc to £69.8m, which works out at about 15pc per order.

The company makes much of its international reach with orders taken as far afield as Denmark, Ireland, Canada and Spain. But a small profit made in the Danish business was offset by losses from other overseas areas as the company spends to establish the Just Eat presence in places such as Brazil and Italy.

However, it is still predominantly a UK business. Just Eat generated about three quarters of its revenue from the UK and all of the group’s £15.9m in underlying earnings before interest, tax, depreciation and amortisation during the first half was dependent on its domestic operations.

The UK business performed well during the first half. Revenue increased by 61pc to £51.9m and underlying profits more than doubled when compared with the same period last year. Spending on advertising is a key driver of profits and marketing spend of £9.6m was up 28pc on the same period last year.

Michael Wroe, chief financial officer, told Questor the marketing spend for the full year would be weighted towards the second half of the year. However, the growth in revenue is still easily outpacing the marketing spend, leading to profit margins in the UK increasing to 39pc, from 32pc at the same stage last year.

Those are not just paper profits either, as the company is proving to be good at generating plenty of cash. Cash from operations of £15.4m in the first half was up from £8.7m at the same stage last year. That equates to a conversion rate of 97pc of underlying earnings into cash. Just Eat had no debt and £154m in cash on the balance sheet at the end of June.

Reported pre-tax profits are being held back by some significant share awards to management. The first long-term incentive plans, which award shares when performance targets are met, cost the company £2.5m and the full-year estimate is for a cost of about £5m. That is a fair amount when full year pre-tax profits are estimated to be £21.4m.

The final problem with Just Eat shares is largely one of valuation. The company is growing revenue and profits quickly but it needs to justify an extremely punchy rating. The shares trade on a forecast 2014 price earnings (p/e) ratio of 163 times. Revenue has to increase by 38pc and pre-tax profits jump another 75pc during 2015 to hit market consensus and even if the company achieves that, it will still trade on a p/e of 43 times.

That is not to say the company will not achieve those targets, merely that investors are exposed to a lot of risk, and receive no dividend, while they wait for the company to grow into the valuation it brought to the market.

As an example, if the company misses pre-tax profit forecasts in 2015 by 20pc, giving earnings per share of about 4p, and growth rates slow, reducing the p/e rating to 35 times, you would reach a share price target of 140p, or a 42pc loss from where it currently stands. It is always worth working out what the downside might be, as well as looking at the upside. Questor thinks there is too much risk here. Sell.