With Zomato rallying over 25% in the past month, street looks at the road ahead

• Zomato’s promise to turn net profit positive in a year has cheered investors.
  
• Margins in its core food delivery business has hit a multi-quarter high.
  
• The worry? Monthly transacting users and gross order value has declined versus the previous reported quarter.
  
• Nomura believes Zomato will find it difficult to achieve double-digit contributory margin with high growth in the long term
  

Two years after it listed on the bourses, Zomato is on a recovery path. The stock which hit a high of over ₹150 per share fell sharply subsequently to below ₹50 a piece. However, the last quarter (Q1FY24) has seen a recovery from that level and it has now surpassed its listing price of ₹76.

The stock has been rising steadily in the last three weeks, after its Q4 earnings report where it turned EBITDA positive in its core business, without including Blinkit, its quick commerce business. EBITDA is net income (earnings) with interest, taxes, depreciation, and amortisation.

Moreover, the management also promised to turn positive not just at the consolidated adjusted EBITDA level but also at the profit after tax level in a year. Financial services company, JM Financial says this commitment is the ‘cherry on the cake’.

“Tough macro posed growth headwinds but management showed urgency on profitability and that was despite the Gold programme launch,” said Jefferies. Zomato Gold is a subscription plan that offers free deliveries within a 10-kilometre radius for orders above ₹199. During the quarter, as many as 30% of the gross order value, from 1.8 million customers, came from Gold.

The Gold plan could hurt its contributory margins (CM) because of its inability to charge every order. Yet, as of Q4, its CM in core food delivery business are comfortable after hitting a multi-quarter high. Contributory margins represent the incremental money generated for each unit sold after deducting the variable portion of the costs.

“The core business milestone was achieved mainly on the back of solid expansion in the food delivery contribution margin to 5.8% in Q4 vs 5.1% in Q3. This was because profitability levers such as improvement in restaurant commissions and ad income, and lower discounts/variable cost offset the adverse impact of Gold launch,” said JM Financial.

Ordering effects

After the post-pandemic boom effects faded away, a lot of consumption patterns have changed, also evident in consumer spending on fast food — impacting growth in quick service restaurants. These headwinds have been impacting Zomato as well.

The growth in Zomato’s food delivery business seems to have flatlined. Food gross order value declined 2% quarter-on-quarter, even as it grew 12% year-on-year. Moreover, its monthly transacting users (MTU) declined by 5% QoQ to 16.6 million, while growing at 6% YoY.

Apart from the one-time impact of its decision to exit from 225 cities, the company attributes MTU decline to optimised marketing spend and withdrawal of the human support interface for abusive customer cohorts.

“Also because of Zomato Gold, the MTUs have come down and not gone up because we do see an impact of clubbing some orders in the same households, which might have just a single membership,” Akshant Goyal, chief financial officer of Zomato said in an earnings concall.

The management, however, remains confident about food delivery ordering going up in the first quarter of FY24. Analysts, on the other hand, are not too confident about their ability to sustain growth beyond the first quarter as summer holiday and IPL impact during April/May are one-off events.

Its other businesses, however, continue to display good growth. Blinkit’s gross order value grew 17% QoQ, while order volume grew 24%. Revenues of Hyperpure, its business to supply ingredients to restaurants, grew 13.5% QoQ.

Offsetting margins with growth

While it’s on a path to profitability, Zomato is also caught between a rock and a hard place — of growth versus margins. To boost growth, it will have to go in for discounts – the lack of aggressive discounting by all players is already visible in the moderation in food ordered during the IPL season, generally a big occasion for online food platforms.

This year, the IPL spike in food ordering was at a modest 7% for the industry as compared to the 2020 IPL when it was over 50%, as per Redseer. This time, there were no high decibel ads along with deep discounts.

Like other players in the business, the company will also find it tough to keep up with the high margin trajectory, while also chasing growth.

“Overall, we lower our growth assumptions for its food delivery’s gross order value growth, from around 20% to around 17%, but raise our FY24F contributory margin estimate from 5.8% to 6.5%. We continue to believe Zomato will find it difficult to achieve double-digit contributory margin, with high growth in the long term,” said Nomura.

Restaurant commissions grow but may hit an ONDC wall

In the last two years, the company was also able to improve take rates or the commissions it charges restaurants consistently. Its take rates are now close to 18%.

“Broadly, with our take rates, the mission is to be competitive, and we are lower than what the competition is charging. So, as we continue to add more value to restaurant businesses, we expect some improvement in commission revenue going forward,” said Goyal.

But competition is heating up in the sector. The Department for Promotion of Industry and Internal Trade’s Open Network for Digital Commerce (ONDC) has breached the territory that was hitherto dominated by Zomato along with Swiggy.

On the face of it, it might seem like restaurants might be offered better terms on ONDC. While Zomato will be able to compete with ONDC on efficiency and also even overall costs – as third party deliveries might be costlier– HSBC Global Research believes that it might flatten growth.

“Estimates for food delivery revenue in the long term remain largely unchanged. Our short-term estimates change slightly as we build in a marginally slower increase in take rate,” the research firm said.

In spite of short-term and long-term challenges ahead, Zomato seems to have settled into its listed company status to deliver value to investors by chasing topline growth instead of customers, with discounts.