Zomato at the price of a Tomato? A Bleak Future for Food Aggregators

On 15^th February, 2022, for the first time since its market debut, Zomato shares dropped below its issue price.

This was because of relentless selling over the last few weeks.

Investor wealth has plummeted with the recent sell off in new-age tech stocks. The reasons for the decline are earnings disappointments, high valuations, and growing fears of aggressive monetary tightening to curb soaring inflation.

The stock has fallen nearly 35% over the last month eroding its market cap from over Rs 133,000 crores at its peak to under Rs 65,000 crores as per yesterday's close.

The food delivery platform listed with much fanfare last year and never looked back, doubling in just a few days. But recent concerns over loss-making companies have dealt a blow to its prices.

Analysts believe it might be a good time to buy these new-age tech stocks during the sharp correction.

With major plans to expand its business, the outlook for Zomato appears to be positive.

Most analysts believe Zomato is a 'buy' with a price target of nearly double from its current levels within the next 12 months.

But wait!. Before you consider buying Zomato, you need to read this...

Why the Future May Not be All that Bright for Zomato

Let us go back to 2020... the year of the Pandemic.

Zomato experienced rapid growth during the pandemic, as the stay-at-home economy drove a surge in demand for food delivery services.

Restaurants needed customers, and consumers wanted their favourite foods, so Zomato was critical in bridging that gap.

Zomato's revenue from operations surged to Rs 2,118 crores in the year ended March 2021 from just Rs 466 crores in FY18.

But while food aggregators like Swiggy and Zomato were finally set to become sustainable, there was a war brewing between restaurant owners and aggregators.

The National Restaurants Association of India (NRAI) alleged that "onerous terms" imposed by Swiggy and Zomato led to many restaurants having to wind up their businesses during the pandemic.

Commissions as high as 45% of the order value were charged. This squeezed restaurants, particularly smaller ones which were already reeling under pressure so much so that many began to revolt against the food aggregators.

However, this was not the first time these aggregators had been accused of unfair practices.

Way back in 2019, restaurant bodies had accused aggregators like Zomato of indulging in predatory practices and had demanded that excessive and predatory prices discounts needed to be regulated.

Restaurants complained about the excessive control aggregators in India have over them. DoorDash in the United States, for instance, allows restaurants to list on its marketplace for discovery, but still do their own fulfilment.

That's not an option for thousands of restaurants listed on Zomato or Swiggy in India.

Another concern cited at the time was that the customer data which is generated on the online platforms should be shared with the restaurants which supply the food.

Multiple rounds of meetings were held between representatives of food aggregators such as Swiggy, Zomato, Foodpanda, and NRAI and other restaurant associations, with the Ministry of Commerce and Industry hearing out their grievances.

Despite all efforts, after over 15 months they had failed to reach a consensus.

The Great Indian Food Delivery Battle

NRAI filed a detailed probe against food aggregators, Zomato and Swiggy, with the CCI on 1 July 2021.

National Restaurant Association of India (NRAI), which represents more than 500,000 eateries, began running a nationwide #OrderDirect campaign.

This was to encourage others to free themselves from their "unhealthy dependency" on food delivery aggregators. And also to move to platforms which charged lower commissions and imposed less strict controls.

Since then, the wave of resistance has grown from restaurants, helped by direct order platforms that offer to process deliveries for a fraction of the commission.

Direct order platform DotPe has signed up 20,000 restaurants, while Thrive has more than 7,000.

However, experts feel that the scale of Zomato's business makes it highly unlikely that direct order challengers will replace it, or even significantly undermine its business in the short term.

Perhaps a greater threat to Zomato and Swiggy comes from Amazon, which began a limited roll out of food delivery in Bengaluru in March last year, charging half the commission of the incumbents.

But the rebellion against aggregators could still have an impact.

Even with some restaurants shifting to other platforms, revenues for Zomato have continued to grow. Net sales rose 82.47% to Rs 1,112 crore in the third quarter of December 2021 over December 2020.

However, a notable deceleration in the company's growth rate suggests it likely won't see such a perfect operating environment (pandemic) ever again.

The company has acknowledged that the pandemic bump won't last forever.

• The accelerated growth of our business stemming from the effects of the Covid-19 pandemic may not continue in the future." It is difficult to say the historical growth rates are sustainable or can be achieved in the future, Zomato said in its filing.

And this is evident when we compare the sequential quarters of September 2021 and December 2021.

Revenues have grown by just 8.6% from Rs 1,024 crores in the September 2021 quarter to Rs 1,112 crores in December 2021.

Another important metric, Average Order Value (AOV) shrunk by about 3% QoQ, mostly on account of reduction in customer delivery charges.

At the same time, the cost of delivery and manpower has increased over last year. In the second quarter earnings release, the company said the cost of delivery had increased by Rs 5 per order.

This has a direct bearing to the company's bottom-line. Zomato's costs per order are a fixed expense.

For instance, the cost of delivering a Rs 200 burger is the same as the cost of delivering a 1 kg biryani priced at Rs 1,500.

Hence, with costs increasing and the AOV shrinking, there isa lot of pressure on the operating margins.

This is worrisome for investors as Zomato failed to generate a profit, even with soaring revenue in the seemingly perfect operating environment during the pandemic.

Finally, anyone who's ever used a food delivery service, probably knows there's no great differentiator. There is little incentive to remain loyal to one provider.

If consumers are presented with a handful of platforms that do the same thing, the price will be the only difference-maker.

It appears to be a case of several Davids teaming together against Goliath in a struggle that promises to be ultimately beneficial for customers but not so much for investors.

Darker Clouds Loom on the Horizon

The love triangle between food aggregators, restaurants and delivery staff was already complicated - then the government intervened.

Last week, shares of the Chinese food delivery giant, Meituan sank 15%, wiping out US$ 26 bn in market value. This after the government asked platforms to cut charges for restaurants to reduce business costs.

Just like Zomato, the delivery business and fees from restaurants are a main part of Meituan's revenues. This means these rules add uncertainty to the company's financials.

But this is not the first time a government has intervened and issued guidelines asking for food delivery platforms to cut fees.

Earlier in June 2021, San Francisco approved a resolution that would permanently cap delivery fees charged to restaurants at 15%.

In August 2021, the New York City Council had passed a permanent commission fee cap on third-party deliveries. Delivery fees were capped at 15% per order and all other fees were capped at 5% per order except for transaction fees.

Dozens of other cities including Los Angeles, Seattle, and Vancouver had created temporary caps to assist restaurants during the pandemic. They considering making the same permanent.

Restaurants, in these cities have praised these caps as they have long complained about high commissions which cut into revenues.

Most restaurateurs around the world believe food aggregators are predatory. They say the decision to adopt permanent caps is a critically important step toward protecting eateries.

With many countries following suit across the globe, it may not be long before we see this in India. The Indian government might impose its own cap on the maximum fee that can be charged for delivery by aggregators like Zomato and Swiggy.

Zomato & Swiggy charge one of the highest take rates, or overall commissions, among major markets globally, according to a report by CLSA.

Already, the government's proposed changes for the e-commerce sector will impact a wide range of online companies selling goods and services.

The spread of the rules is expected to include platforms across sub-sectors of online commerce.

According to sources, food delivery companies would also come under the purview of the proposed India e-commerce rules.

This could be a result of the restaurant associations complaints to the government against the food aggregators and their practices on discounts and high commissions.

Inflection Point

China's decision shows that the battle between city governments and third-party delivery platforms is far from over.

This legislation could influence other countries like India to adopt permanent caps to help struggling restaurants.

Even with the demand surge through the pandemic, Zomato posted a loss of Rs 8,164 m for the year ended 2021, as revenues surged to Rs 21,184 m.

And that was before the caps with an average 25%-30% commission fee.

The question is: If it's hard to make money on the higher commission structure, how will Zomato ever make a profit with a sharply lower commission take?

Perhaps the most troubling sign that Zomato might face a tough road with caps, is that the world is returning to normalcy.

Since many people are now vaccinated and with the fading fear of Covid, dining out has now become a feasible option.

Consumers look forward to returning to restaurants and individuals have been returning to on-premises dining. This indicates consumer behaviour has not been permanently altered.

And the numbers confirm this trend.

Zomato had 32.1 m monthly active users in FY21, down from 41.5 m in FY20.

The takeaway is that food delivery - which saw a great pivot - may see the pinch of a new pivot away from the aggregators.

Starting off as a boon for restaurants, Zomato is now seen as the big bad bully.

The company needs to develop a business model beneficial for both the restaurants and customers.

Because frankly, you can't deliver food if there's no restaurant cooking for you.

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...