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  • May 24, 2022 - Zomato Comes Close to this Value Investor's Buy Price...

Zomato Comes Close to this Value Investor's Buy Price...

May 24, 2022

It was July 2021. I was sitting on a cozy couch ordering my favourite burger from Burger King.

Up popped a notification saying Zomato shares make a blockbuster debut, surging over 60% on the first day.

There was a time when Zomato's market value was more than Tata Motors, Coal India, and Vedanta. All these are Nifty 50 stocks, the elite club of 50 bluest of bluechips. It had a marketcap more than 1 lakh crore. This to a company reeling under intense financial pressure.

With a history of net losses for 2018 through 2021, but with strong revenues to boast od, began the journey of the food delivery platform.

Ten months later, the company is facing a dilemma and has serious questions to answer. It has eroded more than half of its marketcap since listing.

For investors in Zomato, the company is delivering sweets to your home but has failed to provide sweet gains to your portfolio.

Yesterday, the company gave another blow to shareholders by posting Rs 3.6 bn in quarterly losses, up over 300% on a YoY basis.

For the full year too, losses rose from Rs 8.2 bn in fiscal 2021 to Rs 12.2 bn this year.

It's at times like these when I'm reminded of Aswath Damodaran's valuation rationale and whether he was right after all.

About Aswath Damodaran

When it comes to valuations, it's hard to not mention Professor Aswath Damodaran, a foremost authority on valuations.

Damodaran is a disciple of intrinsic value investing. He is currently a professor of finance at NYU's Stern School of Business.

Damodaran is widely respected as one of the foremost experts on corporate valuation. He has published several books on equity valuation and corporate finance.

The valuation guru's 'true value' for Zomato

As soon as shares of Zomato listed on the bourses, the valuation guru wrote in his blog that Zomato's true value should be just Rs 41 per share.

That's right.

The true value of Rs 41 per share was at a sharp discount of 70% from Zomato's share price of Rs 138 back in July 2021.

This was not an out of the box or any random figure which Damodaran arrived at. It was based on calculations and valuation math.

Damodaran analysed the online food delivery market in India and arrived at a valuation of US$ 40 bn in 10 years. From this US$ 40 bn market, Zomato is expected to get 40% market share.

Here's an excerpt:

    With my upbeat story of growth and profitability, the value that I derive for equity is close to Rs 394 billion [or, Rs 39,400 crore], translating into a value per share of Rs 41.

    That may seem like a lot to pay for a money-losing company with less than Rs 20 billion in revenues in the most recent year, but promise and potential have value, especially when you have a leader in a market of immense size.

Others abide on how Damodaran can be right

It was not just Damodaran who justified his concerns about Zomato's market value.

I mean how can a loss-making company with revenues less than Rs 20 bn have a marketcap more than Indian Hotels and Jubilant Foodworks? These companies have bright prospects.

Big bull Rakesh Jhunjhunwala has not shied away from making ferocious statements against the food delivery platform company.

Jhunjhunwala has said his concerns around new-age tech companies stem from valuations and not from their business models.

  • What I buy is very important, at what price I buy is the most important. Let Zomato be worth Rs 99,000 crore and Tesla be US$ 600 bn or US$6 tn. I am not going to buy these stocks.

And there's more...

In an interview with The Economic Times, Shankar Sharma also expressed his concern:

  • I have no interest in looking at these companies because their business models are all rubbish. There is nothing proprietary or business-wise, any edge in these businesses.

    Understand this, everybody keeps talking about one Amazon which survived and went on to become a US$2 tn company out of the wreckage of hundreds or thousands of such companies in the dotcom bust.

    We look at one survivor and say wow! That is the potential of the internet, but we forget that in any game there will be one survivor.

What about Equitymaster's editors?

When Zomato came out with its IPO, our editors at Equitymaster also expressed concerns.

Here's what Aditya Vora, analyst at Hidden Treasure had to say about the Zomato and other 'platform' businesses...

  • These days, a lot is being spoken about valuing the so call 'new generation business' which have been in existence for barely a decade.

    The street is divided on what valuation methods to assign to them. They have carved out an industry in itself - Platform Business.

    Take Zomato for example. Its IPO is currently open for subscription.

    The management of Zomato acknowledges the fact that discounts are an important part of the business strategy and is likely to continue.

    The naysayers have their arguments ready. How can a loss-making business with no time line for profit, be valued?

    Also isn't it magical that Zomato's valuations have gone up 75% in 4 months from US$5.2 bn to US$9 bn i.e. the IPO valuation.

Read the full article here - Zomato: Worth a Bite?

Aditya went a step further and explained why you shouldn't buy Zomato even after its crash. Here's him:

  • Even if Zomato halves from the peak, it's still 40% more expensive than what it was 5 months ago.

    A fall of 50% looks good. But if you look at it holistically you are still paying 40% more without any material change in fundamentals.

    Now I know, you would say the market moves based on liquidity.

    I agree. But this is a time when everybody is talking about tapering and the end of free money era.

    I'm sure you would be aware of what is happening in the Nasdaq and tech stocks.

    The same is with many newly listed companies. They don't have a strong enough business to list at the valuations they did.

Read the entire piece here: Why You Should Not Buy Stocks Like Zomato in this Market Crash.

Meanwhile, Richa, our smallcap expert, believes you don't need to invest in Zomato to play the food delivery megatrend.

She says there is a better and unique backdoor way...

  • I'm glad to share, for this month's recommendation, we have found a business that could be a big beneficiary of another growing trend - the rise food delivery services.

    No, I'm not referring to the upcoming Zomato IPO.

    For all the hype, a loss making and cash burning business is not what I would be comfortable recommending, that too at the time of its IPO.

    However, it's obvious that an increase in food delivery networks will lead to higher demand for packaging products as well, especially specialised packaging - pizza boxes, paper cups, spoons, forks, and so on.

    This industry is expected to grow in double digits over the next few years. It will be one of the growth drivers for this smallcap stock I will be recommending.

    The business is one of the most profitable in its niche. It has shown great resilience in a pandemic and is likely to get stronger from here.

    With the introduction of new products and an expansion in capacity, I expect its profits to grow four times. The stock could potentially more than double in less than three years.

Read Richa's piece here.

So, was the valuation guru right in his valuation techniques after all?

It was a bold statement to make at that time. When the markets seemed to be in a bull run and there was not stopping these stocks.

But was Aswath Damodaran right in valuing Zomato at just Rs 41 per share?

Rs 41 seems like a big understatement, given its name rhymes with Tomato, which is available between Rs 50-55 per kg. That started the phrase - Zomato at the price of a Tomato. Earlier this month, Zomato's stock price officially traded lower than 1 kg of Tomato, from which its name was derived.

It appears Damodaran's price was justified after all as shares of Zomato nearly came to the levels he suggested.

Have a look at the chart below which will show you the journey of Zomato since listing.

Investors in Zomato have sighed a relief today as Mr. Market has rewarded the stock with 18% gains. All this despite raking in huge losses.

In intraday trade today, Zomato rose over 19% to Rs 67.6, its biggest rally since listing. Once again, Zomato's market value is back above Rs 500 bn.

Today's rally could be due to various reasons including brokerages posting positive views and raising their target prices.

Another reason could be the company's management commentary, where investors are expecting Zomato to lay out big growth plans.

An analysts' call is scheduled today at 5:30 PM.

Key takeaways from Zomato's Q4 results

In its Q4 results, Zomato's revenue surged sequentially as new customers propelled a surge in order volumes.

During the quarter, Zomato's gross order value (the total value of all food delivery orders placed on the platform) surged a massive 77% to a record high, while average monthly transacting customers were also at an all-time high of 15.7 m.

Here's Deepinder Goyal, Zomato's CEO, soothing investors:

  • We think our growth trajectory is back on track, and we don't foresee "post-Covid ramifications" affecting our growth rate anymore.

Zomato is now present in 1,000+ towns and cities across India, with more than 300 city additions during the quarter under review.

Another positive for the food delivery company is the recent cut in taxes on fuel prices. In an exchange filing, the company expressed concerns that elevated fuel prices were weighing on the contribution margin as it is not fully passed on to customers.

The tax cut is good news for Zomato as it will reduce its delivery costs.

Investors are now waiting with bated breath about what the company has to say in its first earnings call.

Is it time to take a plunge owing to growth prospects?

Zomato has a sizeable market share with top two players (Zomato and Swiggy) dominating the segment.

Though Amazon and others have planned to enter this space, it will take some time before they reach the higher level and compete with Zomato and Swiggy.

Another growth prospect for Zomato is it operates in a largely untapped market.

While this may sound appealing, remember that Zomato is still a loss-making company. It has been posting cumulative losses for the last five years.

That's the problem with new age tech companies. They may have a very bright future where big profits await them. But now, they are burning a lot of cash.

Happy Investing!

Here are Links to Some Very Insightful Equitymaster Articles and Videos 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...

Yash Vora

Yash Vora is a financial writer with the Microcap Millionaires team at Equitymaster. He has followed the stock markets right from his early college days. So, Yash has a keen eye for the big market movers. His clear and crisp writeups offer sharp insights on market moving stocks, fund flows, economic data and IPOs. When not looking at stocks, Yash loves a game of table tennis or chess.

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