Zomato Needs New Growth to Justify its Soaring Stock. It Won't be Easy...

Putting aside the steep fall we saw in the past two sessions, Indian stocks, in general, have continued to rally strongly. It has been a pretty good time to be a shareholder in smallcap and midcap Indian companies.

Among the top growing stocks - Zomato shares have rallied over 160% in the past year and currently trading near its 52-week high.

Lately, there has been growing chatter around the current rally in Zomato and whether it's mainly driven by speculation or if we are in one of the largest investment bubbles ever?

Why Zomato Share Price is Rising

Online food delivery witnessed explosive growth as pandemic restrictions drove demand for contactless food orders. Zomato, as a market leader, benefited significantly from this surge.

Furthermore, India's online food delivery market is projected to reach a staggering US$ 16 billion (bn) by 2025, making Zomato a frontrunner in a sector brimming with future potential.

Zomato recently achieved its first-ever quarterly profit, demonstrating progress towards profitability and bolstering investor confidence. Furthermore, the company's enhanced disclosures have been viewed positively by investors.

Starting Q2-FY24, Zomato has started charging a nominal platform fee (Rs 2-5) for each order that will help it to stabilise its economics even further.

The platform company's foray into hyperlocal delivery (Zomato Instant, Blinkit) and loyalty programs (Zomato Gold) offer promising new revenue streams and have been well-received by the market.

Zomato's share price is also going up because of rumors that the Open Network for Digital Commerce (ONDC) has changed its reward system to lessen reliance on discounts.

The market has responded positively to the recent management changes too.

The confluence of all these factors has led to the incredible 160% rally in a year.

This ultimately begs the question - is this growth sustainable and is Zomato a good investment at the current levels?

Let's find out...

Zomato: The Present

As of September 2023, Zomato had 18.4 million (m) average monthly transacting customers out of which 3.8 m are active Zomato gold members. In just 3 quarters of launch, Zomato's loyalty program - Zomato gold has 3.8 m customers.

The overall quarterly revenue from the food delivery business was at Rs 79.8 bn, a 9% QoQ / 20% YoY growth. Zomato has expanded its portfolio to include companies like Blinkit and Hyperpure.

Blinkit (formerly known as Grofers), Zomato's instant commerce wing, delivers groceries and essentials to doorstep within minutes, turned contribution positive for the first time in Q2 FY24, registering a revenue of Rs 5 bn (29% QoQ growth).

Zomato Hyperpure focuses on supplying fresh, high-quality ingredients and supplies to restaurants. It offers over 2,000+ ingredients and kitchen products, ensuring next-day delivery and quality assurance.

In the quarter ending in September 2023, Hyperpure registered a quarterly revenue of Rs 7.4 bn, a 19% QoQ increase.

The Past Record

Founded in 2008, Zomato aggressively expanded its restaurant network, offering attractive discounts to customers. This strategy propelled Zomato to the top of India's food-delivery market, but at a significant cost. The company incurred heavy losses, relying on investor funding for growth.

The Covid-19 pandemic, initially a threat, turned into an opportunity for Zomato. The surge in online food delivery demand found Zomato ready to capitalise.

The company not only expanded its market share and user base but also began focusing on operational efficiency and cost-cutting. This shift, along with increased revenue, hinted at potential profitability.

This profitability was reached in Q1FY24, 16 years after its foundation and 2 years after its IPO.

Here's a quick summary of Zomato's past 5 quarters.

Consolidated, Rs bn	Q2FY23	Q3FY23	Q4FY23	Q1FY24	Q2FY24
Revenue	16.6	19.5	20.6	24.2	28.5
Net Profit	-2.5	-3.5	-1.9	0.02	0.4
EPS	-0.3	-0.4	-0.2	0	0.04

Data Source: Equitymaster

The Future Promise

Predicting Zomato's future profitability remains a complex question with no guaranteed answer.

While the company has shown promising signs with its recent financial performance, several factors will influence its ability to maintain profitability in the long run.

Positive Indicators

Improved unit economics: Zomato has consistently reduced its losses and finally achieved a 5.5% adjusted EBITDA margin in FY23, demonstrating progress towards profitability.

Focus on cost efficiency: The company has implemented cost-cutting measures and rationalised its operations.

Strong brand and market share: Zomato enjoys a robust brand image and market leadership position in online food delivery in India, granting it bargaining power with restaurants and customers.

Diversification efforts: Zomato's ventures into hyperlocal delivery (Zomato Instant, Blinkit) and loyalty programs (Zomato Gold) offer potential revenue streams beyond core food delivery.

Growth Strategies: Zomato's growth strategy includes expanding its reach to other countries, establishing partnerships with restaurant partners, and leveraging data and analytics to optimise customer experiences and drive growth.

Challenges and Concerns

Intense competition: Swiggy remains a strong competitor but new players are constantly entering the market. Maintaining market share and profitability in a competitive environment will be crucial.

Economic headwinds: A potential economic slowdown could dent consumer spending and impact Zomato's order volume and revenue.

Dependence on high-value orders: Zomato's focus on high-value, low-frequency orders might not be sustainable. Expanding its order base with higher frequency would be key for long-term growth.

Profitability of new ventures: The success of Zomato Instant and Zomato Gold hinges on effective execution and attracting sufficient user engagement. These ventures could contribute to losses if not properly managed.

The Competition

The food delivery industry has a low entry barrier, razor thin margins, and fierce competition.

Currently it runs on a duopoly of Zomato and Swiggy.

Let's delve into a head-to-head comparison to understand their strengths, weaknesses, and future trajectories.

Market Share	47%	53%
Average Order Value	Higher	Lower
Profitability	Still to achieve	Recently achieved first-quarter profit (FY23)
Unit Economics	Stronger	Tighter
User Interface	Simpler, cleaner	More detailed, informative
Additional Services	Instamart (grocery delivery)	Zomato Instant (hyperlocal delivery), Zomato Gold (loyalty program)
Strengths	Higher average order value, diversification with Instamart, simpler interface	Stronger brand, wider restaurant coverage, comprehensive user experience
Weaknesses	Still unprofitable, limited diversification beyond food delivery	Tighter unit economics, need to improve average order value
Challenges	Competition, economic slowdown, expanding order base and frequency	Competition, economic slowdown, capitalizing on brand strength, successful execution of diversification plans
Future Prospects	Depends on maintaining Instamart momentum, improving average order value, and differentiating from Zomato	Depends on improving unit economics, capitalizing on brand strength, and successful execution of diversification plans

Data Source: Equitymaster

Zomato does enjoy a better brand recognition and market share, while Swiggy beats it in the unit economics and average order value - two of the key components that decide profitability.

Swiggy's potential IPO in 2024 can attract new capital, allowing them to invest heavily in marketing and expansion, potentially challenging Zomato's market share dominance.

Zomato could face some volatility as investors take note of Swiggy's potential market debut in 2024 or 2025.

On the flip side, if the IPO is a hit with investors and if valuations are reasonable, there's reason to cheer for Zomato investors as sentiment around the industry might possibly change.

How Zomato Can Justify its Soaring Stock

Zomato's soaring stock price has raised eyebrows and questions about its long-term sustainability. To justify its current valuation and the big rally, Zomato needs to address these key areas.

#1 Path to Sustainable Profitability

Zomato needs to continue optimizing its costs and operations to increase the gap between revenue and expenses. This includes reducing delivery costs, optimizing marketing spend, and negotiating better deals with restaurants.

Zomato currently relies on a small number of high-value orders. Increasing the order base and frequency, especially with smaller orders, is crucial for long-term profitability.

#2 Addressing Competitive Pressures

Swiggy remains a formidable competitor with its strong brand presence and focus on average order value. Zomato needs to differentiate itself through innovative offerings, superior customer service, and strategic partnerships.

The online food delivery market is attracting other new players as well (Amazon and other smaller players).

In Conclusion

Future potential is driving up Zomato's price, but the company must contend with issues like Swiggy rivalry, sustaining earnings, and starting new businesses.

Enhancing unit economics, boosting order frequency, and putting diversification techniques like Zomato Instant and Blinkit into practice are essential for its long-term success.

Sentiment right now is strong as fund managers lapped up Zomato in the previous month. It was among the top largecap stocks that saw massive inflows.

Only time will reveal if Zomato can sustain its success or if interest in its story will fade...

For more, check out Aditya Vora's latest video on Zomato:

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here.