Morgan Stanley Delivery report

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  • MORGAN STANLEY & CO. LLCJohn Glass

    Brian Nowak, CFA

    Christopher E Carril

    Jonathan Lanterman, CFA

    In-Line

    Attractive

    Restaurants

    North America

    IndustryView

    Internet

    North America

    IndustryView

    Restaurants and U.S. InternetRestaurants and U.S. InternetJune 14, 2016

    N. America Insight: Food Delivery: WhatIf All Food Could Be Delivered as Easilyas Pizza?

    For ~50 years pizza has dominated food delivery, but new online

    delivery models are poised to expand selection. We lay out 4

    potential scenarios for the future of food delivery and who wins in

    each. For GRUB, we see an overlooked need to invest in delivery, and

    are 9% below 2017 consensus EBITDA.

    Pizza: the harbinger of what's to come? While food delivery has been

    around for generations, its availability has historically been limited to urban,

    densely populated areas or to pizza. Indeed, pizza has benefited from and

    driven the online food delivery industry, with one-third of pizza now delivered

    online, and pizza making up an estimated 60% of the total online food

    delivery market. Online delivery has changed the pizza market as well,

    causing a consolidation of market share within the top three brands

    Domino's, Papa John's, and Pizza Hut which gained an incremental 600bps

    of share at the expense of smaller players. This demonstrates the power of

    combining easier brand access through online ordering and the

    stickiness of a first mover advantage.

    Consumers say they want more than pizza delivery, but can't always

    get it: Only about a third of the population orders delivery food that's not

    pizza, according to our recent AlphaWise survey of 5k US adults, but

    consumers do like take-out food nearly 60% have ordered food to go from a

    restaurant in the last six months and demand for take-out is consistent

    across urban, suburban, and rural markets. We conclude from this that

    there is a significant unmet demand as new delivery models (both restaurant

    and third party) evolve to serve those consumers. Importantly, our survey

    work suggests restaurant food delivery is highly incremental, with two

    thirds of occasions replacing a meal eaten at home.

    Delivery beyond pizza: Online food delivery is still in its nascency as, by our

    math, only 5% (or $10B) of the ~$210B core addressable restaurant

    spend is done through online delivery, and more than half of that is

    pizza. This is 1/2 the penetration of e-commerce and 1/8th of online travel. In

    this note we analyze the future of the online food delivery market, which, in

    our view, is in the early days of a significant shift in the access to

    delivery food as various mobile Internet-enabled businesses begin to scale

    and offer variety, speed, and convenience to the consumer. These include order

    aggregators such as Grub Hub (GRUB), private courier models such as

    Postmates and DoorDash, and restaurants themselves, from the legacy pizza

    players to recent entrants into self-delivery, such as Panera.

    How can investors play this now? We see the restaurant chains as the

    most likely winners, with favorable outcomes in three of our four

    Exhibit 1:Exhibit 1: Four possible scenarios: chain restaurants couldwin--or least not lose--in three of the four, while onlineaggregators/couriers could win in two of the four

    - Chains adopt 3rd party aggregator model - Chains endorse 3rd party aggregators,but maintain control over customers

    - Aggregator models flourish andare able to take control over customers

    - Online Delivery penetration grows

    - Negative for chain restaurants; risk losing - Expands restaurant demand; good forcontrol of pricing, consumer; advantages branded chains, w/ possible exceptionindependents of pizza which risk losing delivery share

    - Chain restaurants work with aggregators - Chain restaurants are able to build ownin very limited capacity in-house delivery business similar to

    pizza market- Aggregator availability fails to scaleand drive incremental demand - Aggregator availability fails to scale and

    drive incremental demand- Online Delivery penetration stays low

    - Online Penetration grows- Neutral for restaurants; nothing gained,but little invested - Advantages those best positioned for

    self-delivery (PNRA, WING, possiblycoffee players)

    - Online Delivery penetration grows rapidly

    - Aggregator models flourishes

    Frenemy Rising Tide Lifts All Boats

    Status Quo Chains Win+-

    +

    -

    Chains

    On

    line

    Ag

    gre

    gat

    ors

    Sou rce: Morgan Stan ley Research

    Morgan Stanley does and seeks to do business withcompanies covered in Morgan Stanley Research. As a result,investors should be aware that the firm may have a conflictof interest that could affect the objectivity of MorganStanley Research. Investors should consider MorganStanley Research as only a single factor in making theirinvestment decision.

    For analyst certification and other important disclosures,For analyst certification and other important disclosures,refer to the Disclosure Section, located at the end of thisrefer to the Disclosure Section, located at the end of thisreport.report.

    | June 14, 2016Restaurants and U.S. Internet

    1

  • scenarios. While Dominos (DPZ) will likely continue to win in online pizza, our

    survey shows the next most ordered categories are sandwiches and Italian,

    while coffee is lower on the list. This supports our OW and above-consensus

    view on Panera (PNRA), an early mover in self-delivery, and increases our

    conviction on smaller cap Wingstop (WING), where consumers are clamoring

    for delivery and we think management will soon accede. Its also a positive for

    Darden (DRI)'s Olive Garden brand, which has a burgeoning delivery business.

    Consumers also ask for delivery from Buffalo Wing Wings (BWLD),

    Cheesecake Factory (CAKE), and Chipotle (CMG). Findings imply that delivery

    for Starbucks (SBUX) and Dunkin Brands (DNKN) may be less impactful than

    investors hope near term, as demand is lower, though delivery for those

    names is not core to current investment debates. Demand for traditional fast

    food (MCD, WEN, et al.) is also relatively low.

    From the aggregators' perspective, while GrubHub is in the lead among

    the third party aggregators, our AlphaWise survey data, the scenario analysis

    above, and competition from other aggregators for chain business all speak to

    the importance of continuing to grow restaurant selection. On one hand, GRUB

    could change its fee structure and start charging consumers in order to entice

    the brands but, for now, we view that as unlikely. Rather, we see GrubHub

    needing to continue to invest in delivery to drive selection, which, while

    potentially positive for the long term, will pressure near-term profitability. As

    such, we are increasing our GRUB delivery cash burn assumptions in '17/'18.

    This change drives our adjusted EBITDA estimates 9%/19% below consensus.

    We remain EW and have reduced our DCF-based PT to $26 from $30 (see

    GrubHub: The Cost of WinningGrubHub: The Cost of Winning). Postmates and DoorDash have an

    advantage with chains given their consumer-fee based model, but the

    sustainability of growth will come down to consumers' willingness to pay

    (which for now our AlphaWise data support). The larger aggregators (Amazon

    and Uber) are still materially trailing in selection, but must be watched given

    their brand loyalty imagine if Amazon had material restaurant selection that

    offered free delivery to all Prime members and theoretical ability to price

    aggressively.

    | June 14, 2016Restaurants and U.S. Internet

    2

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