Zomato, the food delivery platform that got bids of over Rs 2 lakh crore for its Rs 9,375 crore initial public offering, has since lost about 54 percent of its market capitalisation. Its shares have tanked over 61 percent from its 52-week high of Rs 148.85 on December 9, 2021.
Investors have been shunning lossmaking new-age tech stocks across the globe, a trend that is now driving companies towards the need to improve profitability while hitting the pause button on growth.
Zomato’s latest quarterly results showed its consolidated net loss narrowed to Rs 250.8 crore in the three months ended September 2022 from Rs 434.9 crore in the September 2021 quarter. Adjusted revenue grew 48 percent on a YoY basis to Rs 2,107 crore. The company said it crossed the billion-dollar annualised revenue mark for the first time in the quarter.
Does this mean the worst is behind Zomato? Before we answer that question, here is how Zomato makes money.
Revenue streams
Zomato’s platform currently has three major offerings – food delivery, Hyperpure, and quick commerce. Food delivery generates revenue through commissions charged to restaurant partners for using the platform. It also earns from restaurants advertising on the platform.
Its second-biggest business segment, Hyperpure, supplies fruits, vegetables, poultry and dairy sourced from farmers, mills, producers and processors to restaurants.
Through its recent acquisition of Blinkit, Zomato entered the quick commerce space, which operates on a commission revenue model, earning from local shop owners and merchants that it has tied up with. Additionally, a delivery fee is charged if the order amount is below a minimum purchase criteria.
There is also a minor dining-out segment across India and the UAE, which is monetised through advertisements that restaurant partners pay for to enhance their visibility on the platform.
However, not all metrics improved. Zomato’s gross order value (GOV) growth decelerated as a result of focusing on improving unit economics.
“We have strategically chosen to trade low-quality growth for better unit economics,” Zomato founder Deepinder Goyal said in a letter to shareholders on November 10. “That’s part of our long-term strategy to build a high quality, high growth business. At the same time, we are not shying away from investing behind high quality compounding growth.”
Analysts’ reactions to Zomato’s strategy were mixed. Valuations are split, ranging from a downside of 14 percent to an upside of as much as 116 percent. However, on average, analysts pegged an upside of 50-70 percent in the stock price from current levels.
Nomura suggested uncertainty in achieving an ambitious double-digit contribution margin (CM) as well as concerns over the Blinkit acquisition affecting the bottom line due to intense competition and poor unit economics. It sees CM peak at 7.5 percent by FY31, food-delivery revenue to moderate by FY27F, with gross order value CAGR at 22 percent between FY22 and FY27 and plummeting to 12 percent between FY27 and FY32. It said adjusted EBITDA for Blinkit will not turn positive till FY31.
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Bullish on delivery
JM Financial, on the other hand, remains bullish on the company’s long-term growth prospects in the hyperlocal delivery space and said it is well-positioned to benefit from tailwinds such as improving tech penetration and rising income share of digitally native millennials/Gen Z. It expects food delivery GOV to grow at a CAGR of 26 percent between FY22 and FY27 before reducing to 23 percent between FY27 and FY31 and said Blinkit will achieve EBITDA breakeven by FY26.
The company said overall adjusted EBITDA loss (ex-quick commerce) will decline further with breakeven expected in the next two to four quarters.
“Over the medium term, our ambition lies in getting food delivery adjusted EBITDA to ~4-5 percent of our GOV. Based on our current growth projections, that could happen with a contribution margin as a percentage of GOV of ~8 percent,” Akshant Goyal, chief financial officer of Zomato, said in the letter to shareholders.
Experts said a number of catalysts might play out in Zomato’s favour.
In terms of growth, Zomato still has a long way to go, with the Indian food delivery segment expected to reach $25 billion by 2033E, expanding at a CAGR of 12 percent from FY22-33, according to Macquarie. Market expansion and scaling up will be paramount. The food tech industry is still highly underpenetrated, reaching only about 60 million individuals as compared to the expected 150 million individuals by 2025, as per JM Financial.
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Zomato’s performance proves the point that while the potential for growth exists, bringing in profitable growth continues to be a challenge. From the perspective of public markets and stock performance, it will have to demonstrate growth and profitability.
What works for Zomato is that it has gained market share steadily. Swiggy and Zomato registered food delivery/quick commerce GOVs of $1.3 billion/$257 million and $1.6 billion/$2 billion, respectively in the first half of calendar 2022.
But can Zomato deliver growth accompanied by improving consumer stickiness and better unit economics? So far, Zomato’s investments towards expansion in tier II, III and IV cities have led to a lower contribution of 1.7 percent in FY22 compared with 5.2 percent reported for FY21.
However, Zomato now reaches 1,000+ towns and cities in India where the contribution margin has improved even beyond the top eight cities. In the second quarter of FY23, there were 248 cities that were contribution-positive (+15 percent QoQ), contributing 91 percent to GOV.
Smaller cities
Jefferies said while smaller cities have lower average order values (AOV), the cost base is also lower and 248 of the cities that were contribution-positive in the second quarter were not the largest 248 cities, with the smaller cities performing on profitability.
It also estimates a 32 percent CAGR in delivery revenue over FY22-26E and said that unit economics will steadily improve with scale as Zomato unlocks cost efficiencies and as customer willingness to pay for convenience increases.
Another reason for analysts’ optimism is that Zomato has strategically undertaken initiatives over the years to keep an eye out for long-term growth opportunities and has consistently built capabilities, including acquisition of Carthero Technologies in FY18 to add hyperlocal delivery capabilities, and the launch of Hyperpure in FY19 to enter the B2B supplies vertical.
With its acquisition of Blinkit, Zomato is expected to create synergies via cross-leveraging the user base and the delivery fleet. Addition of a value-added service like grocery delivery to the portfolio also presents potential cross-sell and up-sell opportunities, analysts said.
Blinkit performance improved with respect to its contribution margin (-7.3 percent in Q2 of FY23 vs -17.3 percent in Q1 of FY23) and GOV that increased by 26.5 percent on a quarterly basis, backed by focus on stabilising operations, smooth app integration, increased throughput per store and the take rate, which is the commission fees levied by Zomato on restaurant partners as a percentage of the order value.
Besides, Zomato has undertaken two initiatives to support expansion in the food delivery business, namely Intercity Legends, which is the intercity food delivery service, and Zomato Instant, which is food delivery in 10-15 minutes launched in some locations in Gurgaon and Bengaluru. Analysts said these low-capital initiatives are showing good traction and some of them could generate incremental growth over the medium to long term.
Tall order
However, from the poor level of profitability, it may still be a tall order for the company to maintain growth while improving profitability.
Zomato’s food delivery GOV CAGR is expected to be 25-30 percent for FY22E-25E to reach abut Rs 44,000 crore, while overall revenue CAGR estimates are in the 40 percent range for the next three years with the expectation of touching Rs 14,000 crore by 2025E. EBITDA is also expected to largely turn positive in the same period. Net profit estimates vary, with many brokers assuming it to also turn positive by 2025E. Deutsche Bank said it will reach Rs 1,000 crore by 2025E while on the other extreme, Dolat Capital expects it to still remain negative at about Rs 2.39 billion, while also remaining conservative on EBITDA estimates, and expects it to reduce losses to Rs 600 crore by 2025E.
Analysts have valued the company through a discounted cash flow (DCF) model with a discount rate and terminal growth rate in the range of 11-14 percent and 2-6 percent, respectively. “We do believe the company can compound its revenues by 10x over FY22-FY30E but with modest profitability and cash generation and thus believe DCF valuation as an ideal tool to value real long term potential,” Dolat Capital said in its report.
According to Jefferies, Zomato trades at 5.0x CY23E EV/revenue, which is a premium to the median of global food platforms at ~2.3x, and believe it to be warranted by Zomato's stronger growth.
Although the long-term growth outlook and valuation largely looks positive, the management’s uncompromising growth ambitions might delay their profitability goals such as achieving food delivery adjusted EBITDA as a percentage of GOV of 4-5% over the medium term.
“We believe the company has multiple levers to achieve this target, such as 1) further increase in restaurant take-rates, 2) further rationalisation of customer subsidies (delivery charges and discounts), and 3) operating leverage,” JM Financial said. “However, given the near-term growth concerns, margin improvement can be slower than earlier anticipated.”
It said the near-term growth blip could be an interesting entry point for investors to accumulate positions and partake in the long-term value-creation opportunity.
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