Decoding Zomato’s Valuation - A Deep Dive

Introduction:

If you're a regular reader of my newsletter, you've likely noticed that I conduct thorough research on companies before making investment decisions. My strategy involves long-term investments, often spanning a decade or more. If you're new here, I recommend exploring my fragility series, which delves into the intricacies of my investment methodology. 

In this post, I'll delve into one particular aspect of investing that concerns all of us. Is the company worth the share price we are paying for? I’ll use Zomato as an example for this.

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Zomato’s business model

Business model comprises of 3 divisions

Food Delivery -

Operates a technology platform that provides customers with a convenient, on-demand solution to search and discover restaurants, order food, and have it delivered reliably and quickly. Orders placed on its platform are fulfilled by a last mile delivery fleet comprising of independent delivery partners. 

Hyperpure -

Hyperpure is B2B supplies offering for restaurants in India. Company sources fresh, hygienic, quality ingredients and supplies directly from farmers, mills, producers and processors to supply to its restaurant partners, helping them make their supply chains more effective and predictable, while improving the overall quality of the food being served. 

Quick Commerce (Blinkit) -

Blinkit is a quick commerce marketplace delivering everyday products to customers within minutes. 

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Arriving at Intrinsic Value

Zomato as of Aug 2023 is valued on stock market at ~ Rs 100 per share with a market capitalisation of ~Rs 84000 Crs.

While it is difficult to arrive at an exact value for a company (this is one of the reasons why stock prices fluctuate), we can try to arrive at a conservative  estimate for intrinsic value of a company below which we get sufficient conviction to invest in the same. 

For Zomato, lets try to value the company by trying to value each division separately.

Food Delivery

One starting point for valuing this division is gross order value on the platform for the entire year. Gross Order Value means the total value of food ordered by customers on Zomato from various restaurant partners. 

Total gross order value in FY2023 is ~Rs 26,300 Crs and in FY22 is ~Rs 21,300 Crs. Remember this is the value of food ordered and not the revenue for Zomato. Out of this value, the actual revenue earned by Zomato (i.e. commission from restaurants, delivery fees, etc) is Rs 4,533 Crs in FY2023 and is Rs 3,415 Crs in FY2022.

While prima-face revenue appears to grow by 33%!!, if we recall, first quarter of FY2022 was affected by the second wave of COVID. Hence, the 33% growth figure is not a true representation of growth. The actual growth in FY24 might end up much lower. 

The company did not earn any profit from the division in FY2023 and incurred a loss in FY2022. 

If we look at the presence of the company, I feel the company’s market is already saturated and doubt whether any further steam left for the growth in the near future. Already nearly 1.7 Crs families are ordering from Zomato which implies ~5 Crs population which is equivalent to tax filing population. 

Further, whether the company can take advantage of operating leverage considering that delivering each order involves a lot of variable cost as well.

We can arrive at valuation through PE if the company is earning profit. Here, the company is yet to turn profitable. You might have come across lot of news chatter on Zomato making profit in June’2023 quarter. But if you actually look at the numbers, the profit earned for all three divisions is Rs 2 Crs and it is actually negative Rs 179 Crs if we exclude interest income of Rs 181 Crs earned on Fixed Deposits held by the company (unutilised money received through IPO!!!)

However, if we assume that somehow Zomato’s food delivery business does breakeven, then if we safely assume a profit margin of 10%, then on the present turnover of Rs 4533 Crs, profit can work out to ~Rs 450 crs. I would not pay a PE of more than 20 considering that the market might actually be saturated (as population ordering is equivalent to population filing income tax returns). Going by this assumption, the food delivery division should be worth Rs 9,000 Crs which I feel is still an aggressive estimate considering the division is yet to turn profitable.  

Hyperpure

This is a relatively new division and earned a revenue of Rs 1506 Crs in FY2023 as against revenue of Rs 538 Crs in FY2022. While there is scope for growth in revenue, whether the division can turn profitable is to be seen considering wafer thin margins in trading business (hyperpure is equivalent to trading) and also considering perishable nature of items.

The adjusted EBIDTA margin for FY23 is -ve 13% vs -ve 26% in FY22. The division is yet to turn profitable. As per the company’s Annual Report FY2023,

Quote

In March 2023, our oldest city Bangalore turned profitable (before allocating central corporate overheads). 

Unquote

Oldest city Bangalore is still loss making if central corporate overheads are subtracted!!

Again, as food delivery business, even if we assume that Zomato turns this division profitable and if we assume a profit margin of 2% (inline with trading businesses) considering it is simply a trading business of groceries and goods are also perishable, then out of 3 year forward revenue of Rs 10000 Crs, the profit works out to Rs 200 Crs.

If we assume a PE of 20 for this division. Going by this assumption, the Hypercure division should be worth Rs 4,000 Crs. Since this is based on 3 year forward PE, by discounting at 15% for 3 years, same works out to ~Rs 2500 Crs which I feel is still an aggressive estimate considering division is not yet profitable.

Quick Commerce (Blinkit)

The company got this division through Blinkit acquisition. The turnover in FY2023 is Rs 806 Crs and loss incurred is Rs 503 Crs. I have my doubts that this division will ever turn profitable as people will look for alternatives like deferred delivery of 2 to 3 days (like say bigbasket) instead of quick delivery if the delivery costs increase above a certain threshold. This limits the profit earning capability of the division. Even competition like Swiggy Instamart,  Zepto, BBnow are still burning cash and none of them are profitable. Even if Zomato is successful in turning this division profitable, at this juncture, conservatively, it is better not to attribute any value to the same from investment perspective.

However, if we have to value this division, one starting point is ~Rs 4500 Crs at which Zomato acquired Blinkit in June 2022. However, market did not take the news positively.

Shareholders give thumbs down to Zomato-Blinkit deal- The New Indian Express

Considering market view is not positive on the amount paid, wont a 50% discount on the amount paid is conservative estimate? If we go by this, then value of this division works out to Rs 2250 Crs

Apart from value of the three divisions, company has Cash in books of ~ Rs 4700 Crs (unutilised IPO money).

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Intrinsic Value

After decoding all the three divisions of Zomato plus unutilised cash, we arrived at an aggregate value of Rs 18,450 Crs (i.e. ~Rs 21 per share price) for the company. 

Compared to this, the market is valuing the company at ~Rs 84,000 Crs (at share price of Rs 100 per share) as of Aug’2023!!! Lowest ever valuation given by market for the company post IPO in June 2021 is ~ Rs 40,000 Crs in July 2022

Assume you are a recruiter. In an on-campus recruitment drive, will you recruit a student who has backlogs or a student who cleared all his/her exams. We have to note that all three divisions are still loss making and Zomato is yet to prove its worth. Zomato is like a student who has backlogs. Even if we give the benefit of doubt that itll turn profitable someday, then the value being arrived at is Rs 18,450 Crs (i.e. ~Rs 21 per share).

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Relative valuations

Zomato’s partners deliver food on 2 wheelers. The company i.e. Hero Motorcorp  with 34% market share in 2 wheelers in India and earning yearly profit of Rs 3000 Crs and has cash in books of Rs 11000 Crs is valued at ~ Rs 58,000 Crs vs Zomato’s valuation of Rs 84000 Crs which is loss making at various levels!! While comparison of the value of a company which manufactures 2 wheelers vs value of a company which delivers food on those 2 wheelers is not appropriate. This is just to give sense of scale of Zomato’s valuations.

Info Edge which has 14% shareholding in Zomato is valued at Rs 58000 Crs. If we subtract Zomato’s value from the company, then the valuation of Info Edge minus Zomato is Rs 46000 Crs (i.e. less Rs 12000 Crs - 14% of Rs 84000 Crs).

Info Edge comprises businesses like Naukri, Jeevansathi, 99 Acres, etc. Even if we ignore all other businesses and only consider Naukri for valuation purposes,  Naukri earned a revenue of Rs 1749 Crs in FY2023 and a profit of Rs 1027 Crs. This has been profit making and growing since the past many years. Naukri is a monopoly business (Linkedin is trying hard to enter but yet to be successful) unlike Zomato which has competition like Swiggy, ONDC, etc. The revenue of Naukri grew from Rs 669 Crs in FY2018 to Rs 1749 Crs in FY2023 at a growth rate of 22% y-o-y. Naukri has been consistently earning a profit margin of 55% to 60% for the past many years. And the market is valuing Info Edge (minus Zomato)  at Rs 46000 Crs vs Zomato valuation of Rs 84000 Crs!!

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Conclusion

Its hard to arrive at a valuation of loss making companies. I generally prefer staying away from such companies altogether as they are yet to prove their worth. I prefer to wait for such companies to turn profitable. Here, we tried to arrive at valuation for one such company with lots of assumptions. 

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Stocks discussed in this newsletter are not recommendations and are for education purposes only. 

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