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Strong beat on contribution margin; on track to turn profitable

Zomato reported better-than-expected operating performance in Q2. Food delivery saw adjusted EBITDA break-even in Q2 and contribution as a % of GOV improved to 4.5% from 2.8% in Q1FY23, ahead of expectations. The improvement was driven by efforts across both, cost and revenue metrics, albeit at the cost of moderation in GOV growth (up 3% QoQ). Management indicated that Q2 GOV growth was impacted by its decision to trade low-quality growth for better unit economics which is in line with its long-term strategy of building a high-quality, high-growth business. In the medium term, Management focus is on gradually driving the contribution margin to ~8% of GOV, along with a sustained healthy GOV growth, resulting in adjusted EBITDA at ~4-5% of GOV (0% in Q2FY23); post this, profit growth is expected to come from GOV growth rather than from margin expansion. Contribution margin in Blinkit improved to -7.3% from -17.3% in Q1, driven by revenue growth (44% QoQ; GOV grew 26% QoQ), higher throughput and lower operating costs. Management is confident about achieving adj. EBITDA (ex-quick commerce) breakeven in the next 2-4 quarters. Q2 performance further strengthens our belief in Company’s ability to execute and deliver profitable growth. We maintain BUY with a TP of Rs90/share, based on SOTP methodology, comprising of the OFD business (ex-Blinkit), valued using DCF method at Rs76/share, with the remaining value from cash and other strategic minority investments.

Result summary: Revenue grew 17%/62% QoQ/YoY to Rs16.6bn in Q2, led by growth in the food delivery business (6% QoQ), Hyperpure, and integration of Blinkit. Adj. revenue (includes customer delivery charges) grew by 16%/48% QoQ/YoY to Rs21.1bn, while adj. revenue ex-quick commerce grew by 9%/38% QoQ/YoY to Rs19.7bn in Q2. Adj. EBITDA loss increased to Rs1.9bn (-9% of adj. revenue) in Q2 vs. Rs1.5bn (-8% of adj. revenue), while adj. EBITDA loss ex-quick commerce reduced to Rs0.6bn (-3% of adj. revenue) vs. Rs1.5bn in Q1. Hyperpure adj. revenue grew 23%/199% QoQ/YoY to Rs3.3bn in Q2. Management indicated that by supplying to sellers on the Blinkit marketplace, there is potential to further accelerate revenue growth for Hyperpure. Avg. monthly transacting customers grew 4.4% QoQ to 17.5mn vs 16.7mn in Q1, and management expects the growth to be driven by higher repeat rate of the existing customer base as well as new customer additions. What we liked: better-than-expected improvement in Food delivery contribution margin, Blinkit performance. What we did not like: moderation in GOV growth, decline in monthly order frequency.

Earnings-call KTAs: 1) GOV growth was lower in Q2 due to Company focus on profitability, a weak macro (lower intent to spend on food delivery), discontinuity of Zomato Pro membership and impact of monsoons. 2) Blinkit’s AOV increased to Rs568 vs Rs528 in Q1. Stores representing ~10% of GOV saw contribution break-even in Sep-22, with many more being close to the mark. 3) Revenue from dining out has fallen due to discontinuation of the loyalty program. The new loyalty program launched is live in 12 cities in India and the UAE. 4) Company continues to invest in long-term capability building as well as market expansion initiatives like Hyperpure, Zomato Instant, and Intercity Legends. 5) In Q2FY23, 248 of the >1,000 cities were contribution-positive and contributed ~91% of the overall GOV in Q2. 6) Zomato-Blinkit integration: Company plans to leverage Zomato’s large customer base and has rolled out a grocery tab on the Zomato app. On the supply-chain front, Hyperpure has built a high-quality, temperature-controlled warehousing infrastructure for fruits, vegetables and other perishable items. It has started leveraging this infrastructure for Blinkit. It also started experimenting on delivery fleet integration with Zomato in select locations, and expects a full-blown integration to be more relevant in the medium term.

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