Zomato - Can margins and multiples surprise? - ICICI Securities

Our channel checks at 150+ restaurants in 16 cities (7 / 9 from Top-20 / Next-500) hint at three key trends - (1) congruent menu prices across Zomato, Swiggy and direct ordering apps (+14% v/s dine in), (2) potential for surprise on discounts (< Rs 15 / order which is our base case) and (3) increase in delivery fee (Rs 33 / order, +22% YoY). This strengthens our conviction that industry will remain a duopoly with discount / cost discipline and demand inelasticity. Maturing customer cohorts, restaurants (esp. in Next 500) and delivery dynamics will likely lead a 'J' shaped improvement in unit economics over FY21-23E (contribution / order = ~Rs 21 to ~Rs 26). Given street's 'unreasonably' pessimistic margin estimates, we expect a big surprise by FY23 (pre ESOP EBITDA margin = 8%). Steady state EBITDA margin / ROE for the platform will likely be around 38%/20%.

On the back of strong demand tailwinds covered at depth in our food-tech thematic - (link), we expect 46% / 33% revenue CAGR over next 5 / 10 years. Unlock should not have a noticeable decelerating effect like in case of global tech (e.g. Amazon, DoorDash). Our deep dive into the regulatory framework suggests Zomato is one of the least vulnerable internet companies across the world for a regulatory tech-lash. As growth / PAT margins are yet to reach steady state, PEG is better v/s P/E for relative comparisons, in our view. At 0.5x FY24E PEG, Zomato is way cheaper v/s median food services (1.9x), technology (1.8x) or consumer (2.9x) stocks. We value it at 55x 2-year forward P/E, in-line with median consumer discretionary multiple. Upside risk to our estimates and target multiple is likely as discounts turn out to be lower v/s our base case and company scales up in attractive adjacencies. Initiate coverage with Zomato as our high conviction BUY.

- Discount / delivery discipline. Inelastic demand. Innovative SKUs / prices. Menu prices across online channels are noticed to be congruent. Besides, given the inferior UX and poor quality control in direct ordering, we believe concerns of disruption to the duopoly are unwarranted. Online, restaurants are marking up menu prices by ~14% (v/s dine in) before discounting. Given the absence of standardization (on grammage), we noticed innovations like new SKUs / prices by restaurants on Zomato / Swiggy with quantity change in the 'just noticeable' range.

Both aggregators are showing good discipline on discounts / delivery fee. In the ongoing 60% off sale, average 'best' bargain discount is noticed to be Rs 100 (~25% of AOV, Rs 75 on Swiggy). Subject to longevity of such sales, Zomato's discount share will likely vary between Rs 8-15 / order. The upper end is our base case.

Average delivery fee on Zomato increased sharply to Rs 33 / order (+22% v/s FY21, Rs 37 on Swiggy) with reasonable demand inelasticity. Currently, lower delivery fee in the Next 500 (Rs 24 / order) leaves scope for further increase. Overall, optimization of the delivery (fee & costs) will be a key driver of rise in contribution.

- How do we think about the long-term growth drivers? Given multiple macro and industry tailwinds detailed in our thematic (link), we expect robust 46% / 33% revenue CAGR over FY21-26 / FY21-31. This is without even counting the 65% of the rural population in the addressable market given the supply bottlenecks. Better cohort retention and contribution (vs DoorDash / Deliveroo) allay concerns around India-specific limitations (lower GDP per-capita / aversion to outside food).

Despite limited operational history and network effect, food-tech adoption at 16% in the Next-500 towns (I-Sec est.) is encouraging. With supply interventions and stronger network effect, we see scope for further increase in adoption also given the lower restaurant density here. However, as offices resume and corporate employees return to Top-20 cities, any change in the dynamic of these markets (where Zomato leads Swiggy in market share) needs to be closely watched.

- How can the unlock impact the business in the near term? Contrary to its global peers (DoorDash and Amazon etc.), Zomato witnessed a sharp and artificial drop in key metrics during the first wave. Accordingly, we expect a robust recovery going ahead. This bounce back should more than offset the unlock-led uptick in physical channel activity the near term. Nevertheless, the normalisation of AOVs and increasing bargaining power of restaurants are key variables to watch out for.

- Like the Chinese tech, is Zomato vulnerable to a regulatory tech-lash? Our analysis of the regulatory framework for Indian internet businesses hints at five potential areas of controls - (1) fin-tech, (2) content, (3) personal data protection, (4) anti-trust and (5) gig work. Despite its applicability, Zomato should be unaffected by the former four. A minor impact 'may be' likely due to the gig work issue (e.g. 1%-2% of net revenue contribution to a social security fund). We would rate Zomato as one of the least vulnerable to a regulatory tech-lash. The actions elsewhere can be a key positive as investors indulge in regulatory arbitrage.

- 8% Pre ESOP EBITDA margin likely by FY23 - surprise on street estimates. As noticed in global peers like Doordash and reinforced in our channel checks - maturing customer cohorts, restaurants and delivery dynamics leave scope for lower CAC, higher take rates / delivery fee. As volumes rise sharply, we see scope for further fall in delivery cost. Branding & marketing costs will likely stabilize at 10% of revenue, tad higher v/s FY21 level. Over FY21-23E, we expect a 'J' shaped improvement in unit economics, translating into 8% pre ESOP EBITDA margins - a big surprise on street's expectation of EBITDA profitability by FY25.

While recovery in dine out (43% EBITDA margin in FY20) and pick up in advertising (~20% EBITDA margin in steady state) are key margin tailwinds, increasing share of Hyper pure (low margin) is a risk to watch out for. Our estimates do not factor in (1) investments in any new businesses or (2) 3rd wave-related risks. From FY23E, we assume ETR of 25% in-line with the new regime.

- In our view Zomato is a great value stock, unlike what street believes it to be. Our TP (Rs 220) bets on ~22mn Indians ordering ~4 times / month in FY25E! This is a low bar given that India 'today' has ~35mn / 114mn credit card / Paytm transacting users who likely fall in the super user category / user funnel. We value the stock at 55x 2-year forward P/E, in-line with a median consumer discretionary stock. Initiate coverage with Zomato as our high conviction BUY. Likely lower discounts than our base case (< Rs 15 / order) and scaling up in attractive adjacencies pose key upside risk to our estimates and target multiples.

Shares of Zomato Limited was last trading in BSE at Rs. 139.25 as compared to the previous close of Rs. 135. The total number of shares traded during the day was 5105030 in over 49463 trades.

The stock hit an intraday high of Rs. 141.4 and intraday low of 133. The net turnover during the day was Rs. 706751376.

Source : Equity Bulls

Keywords