In our IPO note published in our BL Portfolio edition dated July 11, 2021 we had explained why long term investors must avoid the IPO, and further we followed it up with a note on its listing day as to why those listing day gains were unsustainable. With economic conditions now trending worse than what was estimated then, the reasons to avoid it are stronger now.
A time to consider investing in the stock would be when there is better clarity on its path to profitability and valuation is much cheaper than current levels.
Expensive outlier valuation
In an environment where even highly profitable tech/growth stocks are getting hammered globally, Zomato trading at one year forward EV/Revenue of 8.5 times (Bloomberg consensus) seems expensive, and not justified based on fundamentals. Zomato still remains highly unprofitable in an environment where interest rates are zooming northwards. The impact of negative interest rates will be even higher for unprofitable companies as expectations are for profits to be back end loaded in a multi year cash flow model. Zomato’s much larger peer in the US – DoorDash, trading at around $62 is down 75 per cent from its peak levels reached in November 2021. DoorDash now trades at one year EV/Revenue of 2.8 times. And as compared to Zomato – where consensus expectation is that it will continue to burn cash for next few years and remain EBITDA margin negative, Door Dash is expected get closer to breakeven on this metric in CY22. UBER Technologies which is the pioneer and the leading player in the business of sharing/gig economy, and is also a significant player in food delivery business is trading at EV/Revenue of just 1.5 times.
In terms of growth prospects as well, while Zomato’s FY22-24 revenue CAGR is expected at 36 per cent, Door Dash is estimated to report revenue CAGR of 25 per cent for the overlapping period (CY21-23). While Zomato’s growth is expected to be better, it is primarily driven by a lower base and still does not justify its near 200 per cent valuation premium over Door Dash and over 450 per cent valuation premium over UBER.
For example at the end of 2020, Door Dash was trading at one year forward EV/Revenue of 8.4 times – exactly where Zomato is trading now, and its CY20-22 revenue CAGR was estimated at around 45 per cent, even better than Zomato’s next two years CAGR of 36 per cent. Investors who had bet on Door Dash at 8.4 times EV/revenue in December 2020 due to its high growth prospects, are today poorer by 60 per cent in that investment. Thus there isn’t much of a precedent globally of paying such high multiples for unprofitable companies and ending up making money in the listed space.
Bull case stories around new age companies is one thing, those stories getting converted into positive cash flow and public investors benefitting from its cash flows is another thing altogether! Investors must only focus on the latter in the current environment.
Further investors also need to get cautious with current consensus growth estimates and valuations assigned, given severe headwinds now playing out to global growth which could also impact domestic growth. Inflation will also impact spending habits of domestic consumers and cost structure for many companies and hence can likely result in downward revision of consensus revenue and profitability (or the lack of it) for companies like Zomato.
Since its IPO, Zomato has fared well on revenue growth but that has come at a price – increase in EBITDA losses. While in FY22, revenue grew by a solid 110 per cent to ₹4,192.4 crore, its EBITDA losses too increased by nearly 3 times to ₹1,850.8 crore. The EBITDA margin for FY22 was at negative 44 per cent. Adjusted EBITDA margin reported by the company (which company defines as EBITDA-share based payment) was at negative 18 per cent.
Over the last one year, its monthly transacting users have increased from 9.8 million at the end of FY21, 15.7 million at the end of FY22. Another key metric tracked – average order value (AOV) was largely stable at ₹398 in FY22 versus ₹397 in FY21. Contribution margin (similar to gross profit) deteriorated from around 5.2 per cent to 1.7 per cent in FY22. In company’s estimate a contribution margin of 5 per cent would be required to absorb other operating costs and get to EBITDA break even. Based on the current contribution margin, it does appear reaching profitability at EBITDA and then at net profit level are few years away. This can be a big dampener when markets are under pressure.
Over the last one year company also invested some of the money that it had received from IPO proceeds to take small stakes in start-ups which in company’s view were strategic minority stakes. Over the last year it had invested around ₹2,500 crore in such initiatives. With start-ups environment getting tough, funding getting dearer, some of these investments might turn out to be poor allocation of capital. The stock saw some recovery post its Q4 results release and management commentary after they said that minority investments are on pause for now.
While company has few businesses besides food delivery, such as Hyperpure (B2B) supplies, food delivery remains the main stay, accounting for around 85 per cent of revenue. One thing to watch out for would be any progress on a potential merger with grocery delivery company in which Zomato has a stake in – Blinkit. With rival Swiggy seeing more customer stickiness with offering food and grocery delivery in the same app, Zomato might be under pressure to do the same.
June 18, 2022