DBS Group Research analyst Sachin Mittal has downgraded NASDAQ-listed Grab to “fully valued” from “hold” previously as he sees the company facing a dilemma between focusing on growth or its profitability. The analyst has, however, increased his target price estimate to US$3.16 ($4.21) from US$3.07 before.

In his report dated July 21, the analyst points out that while Grab needs to achieve an adjusted ebitda breakeven across the group, it cannot do that without reducing its incentives. The company has been trying to do so since the 1QFY2022 ended March 31, 2022, which enabled it to achieve an adjusted ebitda breakeven in its delivery segment for the 3QFY2022.

However, cutting incentives to its drivers and delivery people may mean hurting their supply of providers, which may lead to higher prices for its consumers. That may eventually lead to a slowdown in gross merchandise value (GMV) growth for Grab. To ensure a smooth supply of drivers and delivery people and maintain affordable pricing for its consumers, Grab will have to look into maintaining its incentives. In doing so, this will eat into the company’s profitability and delay it from achieving an adjusted ebitda breakeven across all segments, notes Mittal.

As such, the analyst has reduced his adjusted ebitda estimates as a percentage of GMV from 2025. “Grab will attempt to defend its market share, while experiencing reduced adjusted ebitda,” he says.

“Our forecasted adjusted ebitda as a percentage of GMV is also in line with Grab’s steady-state target, for both deliveries and mobility,” he adds.

“We project a 12% (previously 13%) ebitda margin leading to US$837 million (previously US$907 million) adjusted ebitda in FY2027. We used global peer Uber’s 24-month forward enterprise value or EV/ebitda of 15.3x (previous: 13.5x) for FY2027 ebitda, discounted back by 15% each year to value Grab, assuming investors seek an annual return of 15%,” says Mittal.

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“This is based on projected margins of 11% - 12% for mature peers such as Uber and Dash in 2024, which do not have the cross-selling benefits of Grab. We have also added US$4.8 billion in net cash to the discounted FY2023 EV, assuming a cash burn of US$200 million out of its current US$5.0 billion,” he adds.

Further to his report, Mittal highlights two key structural challenges that Grab faces, compared to its rival Uber, which operates mainly in North America.

Unlike Uber, which has the ability to charge higher commissions to its drivers, it is harder for Grab to do so due to the nature of the market the latter operates in.

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In the US, where Uber operates, about 92% of households own at least one car, with car owners using their own cars to earn their income (whether full-time or part-time) on the platform. According to multiple sources cited by Mittal, an Uber driver can earn an average of US$20 to US$30 per hour.

“Assuming the driver works for 10 hours, his total earnings for a day would be US$200 – US$300 per day, and the driver could rake in US$120 – US$200 after expenses,” says the analyst. “As a result, it is possible for Uber to charge higher commissions.”

In Singapore, most of the drivers on Grab’s platform do not own a car due to the cost of owning one. To be sure, cars are expensive in Singapore with the average car price at a whopping US$125,000 compared to the US’s average price of US$46,000. The car price to income ratio is at 0.66x in the US with the personal income per capita averaging at around US$70,900. In Singapore, the car price to income ratio is at 1.98x with the average personal income per capita at US$63,000.

As such, Grab drivers may have to rely on daily rented cars, for which they end up paying an additional $70 - $100 per day, in addition to the 22% - 24% commission fee and fuel expenses.

“This requires them to work full-time to make a decent living. The Grab driver may be left with little income after paying the daily car rental charges and other expenses, hence limiting Grab’s ability to cut the commissions offered to drivers,” Mittal observes.

Another instance where Grab may find it harder to reduce its incentives to its drivers is in the delivery segment. In the US, it is customary to tip Uber drivers, which leads to higher income on the whole. In Singapore, on the other hand, the tipping culture is not as prevalent, which means Grab delivery drivers will have to depend solely on their base pay and any additional incentives provided by Grab.

This difference implies that Uber can afford to raise commission rates in its other major segments compared to Grab, again leaving the latter with little room to lower the incentives offered to its drivers and delivery people.

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Grab’s third segment, fintech, is also expected to continue making losses, says Mittal, noting that the company expects this particular segment to experience peak losses in FY2023 due to the launch of digibanks in Malaysia and Indonesia.

“This is a segment which is absent in Uber. Meanwhile, Uber’s freight segment continues to narrow its losses, thus benefitting its adjusted ebitda growth,” the analyst writes.

“At its current share price levels, Grab is trading at a significant 12-month forward EV-to-gross profit (GP) premium to Sea Ltd. In terms of EV/GP, Grab is trading at a 12-month/24-month forward EV/GP of 8.0x/5.8x at an 81%/72% premium to Sea, which is difficult to sustain, in our view. Market prefers profit-based multiples over revenue multiples,” he adds.

In Mittal’s bear-case scenario, which means higher incentives in delivery and mobility leading to less profitability, his target price is at US$2.50, which assumes an ebitda margin of 10% in FY2027 and 12x ev/ebitda multiple.

Other risks include a potential decline in GMV due to regional competition and an inflationary environment.

“Grab faces competition from Gojek in the largest market (Indonesia), which could affect its GMV, and inflation can lead to a reduction in the usage of on-demand services,” says Mittal.

As at 10.58pm (SGT), shares in Grab are trading 3.5 US cents lower or 0.97% at US$3.56.

DBS downgrades Grab to ‘fully valued’ on ‘structural challenges’

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