Food app Zomato tastes bittersweet, splits brokers on flavours of growth

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Zomato is a stock that has triggered extreme reactions. It had had brokerages taking contrarian ‘buy’ calls even when the stock was tumbling down, triggered memefests and caused a brokerage to come out with a spirited defence of its optimistic view.

Now it has brokerages coming out with widely varying views on its future course. One leading brokerage says that it will see a downside of more than 29 percent, while another well-respected one estimates the opposite—of more than 43 percent upside. While the first argues that high profitability margins isn’t compatible with the food app’s growth ambitions, the second sees break-even by September 2023 in food delivery as a key positive.

Also read: Zomato: Should you bite into this business?

‘Reduce’ call

Nomura, which has a reduce rating with a target price of Rs 50 (more than 29 percent downside than the current market price or CMP of around Rs 70), reiterated its stance that the food app will find it challenging to achieve double-digit contributing margin (CM) with high growth in the long term. Contributing margin is the difference between revenue earned and variable costs, and is expressed as a percentage of gross order value (GOV).

This is what the brokerage had opined in its earlier report too, from two months ago. In the August 19 report, the analysts wrote that a double-digit CM would require a rise in commissions from restaurants and in delivery fees charged to customers. While they see the former rising from 15 percent in FY22 to around 17.5 percent in FY31F, they see the latter holding steady at around 6 percent over the same period. Earnings from delivery fee are likely to stagnate with lower frequency of food orders and customers’ unwillingness to pay highly for the convenience.

Therefore, they expect CM to peak at 7.5 percent by FY31F versus global food-delivery companies’ long-term target of 4-8 percent in developed markets, “where online FD is more mature and customers’ willingness to pay for convenience is higher”.

Also, they expect food-delivery revenue to moderate by FY27F, with GOV CAGR at 22 percent between FY22 and FY27 and it plummeting to 12 percent between FY27 and FY31.

‘Buy’ call

Jefferies, which sees a more than 43 percent upside in the stock and a high-conviction ‘buy’ call on the stock, leaned on management’s guidance on a strong growth outlook.

While the management sees break-even by September 2023, they intend to balance growth and profitability, without compromising on the former, according to the analysts. “Profitability is not the only milestone, per mgmt (management). Growth will not be compromised to drive break-even - the effort will be to balance the two. Pace of the new user addition has not slowed down,” they wrote.

The analysts did note the “softish demand” in the quarter ending September. They pegged the moderation in GOV growth (23 percent YoY and 3 percent QoQ) to management trading unit low-quality growth for poor-unit economics, and to customer’s “lower intent to spend”. “Inflation may have had an impact and monsoon period has a seasonality impact as well,” they said.

Also read: ONDC will let market forces decide commissions charged to restaurants

On profitability, the analysts seem more optimistic about customers’ willingness to spend on convenience. The analysts expect unit economics to “to steadily improve with scale as Zomato unlocks cost efficiencies and as customer wilingness to pay for convenience increases”.

In the latest report, Jefferies' analysts valued food delivery at 42x FY26 EV/Ebitda and QC (quick commerce of Blinkit) at 3x FY26 sales to arrive at a PT of Rs 100. “Current valuations are undemanding in the context of profitable growth,” they wrote.

Blinkit integration

Nomura’s analysts saw the acquisition weighing on the bottomline. “Poorer unit economics in Q-commerce (take rate of ~17% vs ~25% in FD in FY31F) and fiercer competition from well-funded competitors are, in our view, likely to lead to cash losses for Blinkit (unlisted; acquired in Aug-22) over the medium term,” they wrote in their August report. In the latest report, dated November 11, they noted the improving operating metrics of the quick-commerce (QC) platform-- MTU growth of 18 percent q-q, AOV growth of 8 percent q-q, GOV growth of 26 percent q-q and CM loss improving from - 17.3 percent in 1Q to -7.3 percent in 2Q—but believe that its adjusted Ebitda (6 percent) will not turn positive till FY31.

On the other hand, Jefferies’ analysts expect Blinkit to deliver contribution break even by FY26 and Ebitda break-even post that.