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The promise of scale and operational efficiencies

Delhivery’s (D) B2C-heavy business model has a potential profit pool of Rs63bn in India in our view (by FY26E). Our base case assumes D to capture ~25% of the same. We see significant scope of operating leverage with global best practices in distribution, sorting as well as consolidation likely streamlining processes. What helps us to take the leap of faith toward profitability is that D captured ~90% of incremental 3PL ecommerce distribution market (FY19-22) – a rare feat in itself across industries. We expect (ex-ESOPs) PAT of Rs9.4/15.7bn by FY25/26E. Management’s plan is to press for operational efficiencies and pass on the same to customers (partly), thereby meaningfully creating/capturing the incremental market. Given our base case profit estimate, we initiate coverage on the stock with a HOLD rating and a target price of Rs484. Higher share of the profit pool by D is upside risk; slower than expected execution will be the key downside risk.

* Gaining ~90% of incremental 3PL (non-captive) ecommerce volumes over FY19- 22. D has been gaining share through a mix of aggressive pricing and reliable expanding service. The operational efficiencies thus garnered has allowed D to result in 22% reduction in ecommerce parcel yields over FY19-22. We expect similar trajectory to continue (as has been directionally understood from management commentary). We believe D is looking to increase the share of social commerce and D2C driving volumes as well as pricing power (DRHP highlights the same possibly doubling in revenue proportion over FY22-26E). The story of D, through our lens, is to drive relentless profitability in B2C ecommerce segment, and turn the operations profitable enough and create a profit pool that was long considered to be elusive. This profit pool will have the moats of heavy incremental investment (to fund teething losses), scale and operational efficiencies.

* Profit pool analysis – B2B success is key to access a larger profit pool. CY21 witnessed a PBT pool of US$2.2bn (adjusted) or 3% of revenue (revenue was a staggering US$75bn) for the Chinese express delivery players. We have considered 7 Chinese players (listed) engaged in the business of express parcel/B2B delivery/warehousing and supply chain. The revenue pool (universe) for D can only be a fraction of the revenue pool for Chinese players, while competitiveness will be a bit less intense (hopefully). Given the possible Indian 3PL (non-captive) ecommerce revenue pool of US$5-6bn by FY26E in our estimate, profit pool amounts to Rs20.6bn (assuming a 5% PAT margin; none of the incumbents in B2C delivery space will be paying taxes in FY26E). This limited profit pool, as per us, highlights the risk to business model and compels D to look for additional optionalities such as i) PTL (B2B express logistics) and ii) supply chain (3PL). Can the scale that D has been able to create with B2C help them garner volumes in B2B?

* SME drives B2B profitability in India; while large enterprise accounts may help you grow; they neither allow meaningful profit nor working capital headroom. Spoton (S) acquisition (in our view) has been driven to accelerate the SME acquisition, with S’s MD Abhik Mitra being retained as in charge of the operations. What will help D? – Pincode presence with large gateways scattered across the country. How long will the on boarding of SMEs take? We don’t know, but if they succeed, D will be hitting the moat of the express incumbents. We believe the potential profitable B2B express market (road) is set to reach Rs250-260bn over the next 3-5 years, with a potential profit pool of Rs14bn. Here we deviate from assuming RedSeer (Delhivery DRHP) estimates and go with traditional express players’ assessment of the profitable market. We look for disruption and growth stagnation of the listed express players as the potential success indicator for D. D’s Bhiwandi site (Maharashtra) visit highlighted that it has been able to sort out the B2B and B2C mixed distribution puzzle (through the year where B2C ebbs and flows) without sacrificing on any SLA.

* Can 3PL and cross border add meaningfully to the profit pool? If Mahindra Logistics is the precedent to follow, key bottleneck seems the rigidity of the large enterprise account customers (varied) to squeeze out the last profit from the vendors. Absence of SME as a customer set only worsens the competitive dynamics for this industry. With FedEx association, can cross-border profits truly accrue to D or will FedEx take a sizeable share – we don’t want to guesstimate. But on the margin front, the eventual profit pool from this sector, assuming 1% profit margin for 3PL and 3% profit margin for cross border, will be Rs28bn. We do not expect D to capture much of it by FY26E.

* Here we are trying to value a company with Rs63bn worth of profit pool. How much will D capture over the next 3-5 years? If it captures 60% of the profit pool, we see potential of Rs1,139bn market cap and a target price of Rs1,416/share (Rs1,170/share discounted for two years). If it captures, 40% of the profit pool (table 14), we see a potential target of Rs944/share (Rs780/share discounted for two years). If it captures ~25% of the profit pool, the target price amounts to Rs484/share (30x FY26E and then discounted by two years) – our base case.

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