Gig economy companies could see margins squeezed further after EU bodies came to a provisional agreement to reclassify gig workers as employees automatically.
After several years of talks, the EU Parliament and European Council agreed a deal in December on new employment status rules which would “introduce a presumption of an employment relationship” between a company and worker when two of five indicators are present. These criteria include the fixing of working hours and pay by companies.
The new rules could potentially force food delivery apps such as Deliveroo (ROO) and ride-hailing companies such as Uber (US:UBER) to reclassify their gig riders as employees, meaning they would have to pay social security, the minimum wage, sick leave and other standard benefits. However, there is significant uncertainty about whether the changes will pass into law in their current form after diplomats failed to ratify the agreement at a late December meeting.
Analysts at Shore Capital argued there would be “significant profit degradation” for Deliveroo in Italy and France if riders were reclassified as employees, with this potentially increasing the company’s rider costs by 30 per cent.
Oddo BHF analysts said that "as the 20-30 per cent increase in delivery cost will need to be passed on to price-sensitive consumers, we expect a shift from logistics to marketplace to take place and consolidation in Europe to accelerate".
"There are potentially billions in unrecognised off-balance-sheet liabilities that will come into play" at Uber, Deliveroo, Delivery Hero (DE:DHER) and DoorDash (US:DASH) if tax authorities chase backdated social security payments, they added.
There is form for big apps exiting markets in an environment of less favourable regulation. Deliveroo pulled out of Spain in 2021 after the government announced a law to give the platform's workers more rights, although the wider context was management's conclusion that "a disproportionate level of investment" would be needed to make progress in the country.
- Employment rules could add 20-30 per cent to order costs
- Deliveroo and Just Eat already struggling with profitability
Gig economy companies could see margins squeezed further after EU bodies came to a provisional agreement to reclassify gig workers as employees automatically.
After several years of talks, the EU Parliament and European Council agreed a deal in December on new employment status rules which would “introduce a presumption of an employment relationship” between a company and worker when two of five indicators are present. These criteria include the fixing of working hours and pay by companies.
The new rules could potentially force food delivery apps such as Deliveroo (ROO) and ride-hailing companies such as Uber (US:UBER) to reclassify their gig riders as employees, meaning they would have to pay social security, the minimum wage, sick leave and other standard benefits. However, there is significant uncertainty about whether the changes will pass into law in their current form after diplomats failed to ratify the agreement at a late December meeting.
Analysts at Shore Capital argued there would be “significant profit degradation” for Deliveroo in Italy and France if riders were reclassified as employees, with this potentially increasing the company’s rider costs by 30 per cent.
Oddo BHF analysts said that "as the 20-30 per cent increase in delivery cost will need to be passed on to price-sensitive consumers, we expect a shift from logistics to marketplace to take place and consolidation in Europe to accelerate".
"There are potentially billions in unrecognised off-balance-sheet liabilities that will come into play" at Uber, Deliveroo, Delivery Hero (DE:DHER) and DoorDash (US:DASH) if tax authorities chase backdated social security payments, they added.
There is form for big apps exiting markets in an environment of less favourable regulation. Deliveroo pulled out of Spain in 2021 after the government announced a law to give the platform's workers more rights, although the wider context was management's conclusion that "a disproportionate level of investment" would be needed to make progress in the country.
A potential tightening up of rules in the EU would mean a divergence from the trading environment in the UK. In November, the UK Supreme Court ruled in a case brought by the Independent Workers Union of Great Britain (IWGB) that Deliveroo riders are not employees. And Just Eat (JET), which is less exposed than Deliveroo and Uber to risks from new European rules as it already employs its riders in key markets, went back to the gig economy model in the UK in early 2023 after firing 1,700 riders.
Just Eat faces legislative headaches outside Europe, though. It is still trying to find a buyer for its US unit, Grubhub, which it acquired in 2021 and announced in 2022 that it wanted to offload. The implementation of delivery fee caps in New York isn't helping matters.
Uber, which operates a food delivery business through subsidiary Uber Eats, turned a corner in 2023 on the back of profitability reforms. It posted quarterly free cash flow of $1bn for the first time, and net income of $456mn in the first nine months of the year.
DeliverEU
The EU rules development came after Deliveroo provided investors with a mixed capital markets update in November. Management announced an acceleration of its shift into non-food retail products such as flowers and cosmetics, already offered by Uber Eats and DoorDash, with chief executive Will Shu arguing that “the expansion of our platform to encompass retail, such as DIY, homeware and electrical goods” would be a growth driver.
The company also cut its medium-term annual gross transaction value (GTV) guidance to a percentage in the mid-teens, though – well below its previous guidance range of 20-25 per cent.
Food delivery apps continue to find statutory profitability elusive, and were unable to achieve this during the pandemic despite a surge in sales, with chunky running costs dragging them into the red. The cost of living crisis has hurt demand, with the latest quarterly updates revealing that Just Eat and Deliveroo's order numbers were down 7 per cent and 1 per cent, respectively, against the same period in the previous year.
The consensus analyst position, according to FactSet, is for Deliveroo to reach statutory profitability in 2025, but for Just Eat to still be lossmaking in 2027. Both companies expect to release fourth-quarter updates in the third week of January.
Shore Capital argued that Deliveroo and Just Eat's market penetration "still has a long way to go", with significant growth opportunities on the table through increased delivery app use by the 30-39 age bracket and grocery delivery expansion.
The broker's top pick in the wider sector is Domino's Pizza (DOM), "a high-quality cash compounder set to step up its ROIC [return on invested capital] from a five-year trailing average of 42 per cent to a five-year forward average of 57 per cent".
For Oddo BHF, Just Eat will benefit from an acceleration of food delivery market rationalisation due to increased regulatory pressure and weak balance sheets across the sector. "The industry overall is still destroying more than a billion euros in shareholder value each quarter. This is unsustainable," the analysts said.