Buy Zomato Brands Ltd For Target Rs.270 by Motilal Oswal Financial Services Ltd
Short-term pain, long-term gain
QC investments to delay profitability gains, but long-term opportunity attractive
* Zomato reported 3QFY25 revenues of INR54b, up 13% QoQ, in line with our estimate of 14% QoQ growth. Growth was led by Blinkit (GOV up 27% QoQ/120% YoY). Food delivery business delivered 17% YoY growth in GOV with a steady increase in margins. Adj. EBITDA as % of GOV margin was up 80bp QoQ at 4.3%. PAT came in at INR590m (est. INR2.7b), down 57% YoY, primarily attributed to increased investments in accelerated new dark-store openings and customer acquisition efforts in the quick commerce (QC) business. For 9MFY25, revenue/adj. EBITDA grew 68.5%/5.1x vs. 9MFY24. For 4QFY25, we expect revenue/adj. EBITDA to grow by 65.8%/70.5% YoY. Our DCF-based valuation of INR270 implies a 13% upside from the current price. We reiterate our BUY rating on the stock.
Our view: Accelerated dark store expansion to dampen profitability
* Investments in QC rebase margin expectations: The company's plans to front-end its investments in QC rebases profitability expectations. Adjusted EBITDA as % of GOV almost broke even in 2QFY25 before reporting a 1.3% loss in 3QFY25. We now expect this loss to widen in the short term, before breaking even in 4QFY26E. As a result, we reduce our PAT estimates by c25% over FY25-27.
* This cash burn is different from food delivery: This “cash burn” is, however, different from the one we witnessed when food delivery was scaling up. Contrary to countless questions on whether food delivery would ever be profitable, the viability of the “dark store model” is now beyond doubt: mature dark stores are already contribution margin positive. New dark stores are reaching breakeven GOV faster (see Exhibit 3). Revenue growth could be higher for longer, as companies unlock new cities, markets, and categories.
* How many dark stores? Our estimates suggest the company may have to add a cumulative 4,000 stores between FY25E and FY30E (exhibit 1). We believe this could meaningfully increase capex/fixed costs (in case of partner-run dark stores) for the company: our estimates suggest fixed costs for Blinkit could grow at a CAGR of 25% over FY25-30e, testing the company's execution prowess in delivering meaningful profitability gains.
* Macro slowdown impacting food delivery: Food delivery GOV growth was 18%, below the company's guidance of 20% sustainable growth; MTUs declined by 2% QoQ as well. A broader slowdown in consumption may be starting to bite Zomato too. Moreover, there is an added risk of rising competition, such as 10-minute food delivery by Swiggy, which is a key downside risk in the near term.
* Short-term pain, lots to gain: We note near-term challenges to profitability from QC expansion; however, we believe Blinkit offers a generational opportunity to participate in the disruption of industries such as retail, grocery and e-commerce. Overall, Zomato is well-positioned to capitalize on this growth by expanding its customer base, increasing the order volumes and values, and improving its unit economics and profitability over the long term.
Valuation and change in estimates
* Zomato’s food delivery business is stable, and Blinkit offers a generational opportunity to participate in the disruption of industries such as retail, grocery and e-commerce. We have reduced our estimates for FY25E/26E/27E by ~30%, driven by the accelerated expansion of the dark store network and uncertainty arising from intense competition. This expansion has led to reduced profitability due to higher capital expenditures and increased investments. Zomato should report PAT margin of 3.5%/6.8%/9.9% in FY25E/FY26E/FY27E. Our DCF-based valuation of INR270 suggests a 13% upside from the current price. We reiterate our BUY rating on the stock.
QC profitability misses estimates due to accelerated investment; QC GOV growth remains healthy
* Zomato reported 3QFY25 net revenue of INR54b (+13% QoQ/64% YoY), in line with our estimate of +14% QoQ.
* Food delivery GOV came in at INR99b, slightly below our estimate of INR103b. Blinkit GOV came in at INR77b (up 120% YoY) vs. our estimate of INR75b.
* For food delivery, adjusted EBITDA as % of GOV margin was up 80bp QoQ at 4.3%, beating our estimate of 3.6%.
* Blinkit reported contribution margin of 3.0% (3.8% in 2Q). Adj. EBITDA margin was -1.3% vs. our expectation of -0.1%.
* Blinkit store count crossed the 1,000 mark, one quarter ahead of its plan. Zomato aims to achieve 2,000 stores by 3QFY26, one year ahead of its earlier guidance of 3QFY27.
* Consol. reported EBITDA came in at INR1,620m (3.0% reported EBITDA margin vs. 4.7% in 2Q).
* Food delivery revenue grew 3.0% QoQ/21.6% YoY (est. 7.7% QoQ). FD contribution margin rose to 8.5% from 7.6% in 2Q.
* QC revenue grew 21.0% QoQ/117.0% YoY (est. 24% QoQ growth). QC contribution margin declined to 3.0% (3.8% in 2Q).
* PAT stood at INR59m, down 57% YoY (est. INR2.7b), primarily attributed to increased investments in accelerated new dark-store openings and customer acquisition efforts in QC business.
* Adj. revenue growth was steady YoY at 58% and continued to trend above the stated outlook of 40%+.
Key highlights from the management commentary
* Food Delivery: YoY adjusted revenue growth was steady at 58% and continued to trend above the stated outlook of 40%+. Currently Zomato is going through a broad-based slowdown in demand, which started during the second half of Nov’24. Notwithstanding the current slowdown, management is positive about a recovery soon and remains confident of its long-term outlook of 20%+ yearly GOV growth in the business given the strong fundamentals.
* Blinkit: Losses in its QC business in 3Q were largely due to the front-loading of growth investments in the business that would have otherwise been made in a staggered manner over the next few quarters. Around 80% of the business comes from the top 8 cities, with growing traction in smaller cities.
* Heightened activity in advertisement: Ad spending rose later in the quarter, driven by the need to promote newly opened stores.
* Food delivery margins improved due to increased platform fees and cost optimizations, with margins expected to stabilize around 5% in the coming quarters.
* District app: Most of the investments from hereon will be focused on getting customers to transition to the new app and growing selection on the platform. It is likely to operate in losses for the next year.
Valuation and view
* Zomato's food delivery business is stable, and Blinkit offers a generational opportunity to participate in the disruption of industries such as retail, grocery and e-commerce. We value the business using a DCF methodology, assuming 12.5% cost of capital. We maintain our BUY rating with a TP of INR270, implying 13% potential upside.
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