HSBC sees 19% downside in Zomato stock; cuts rating to reduce

After a stellar listing in July that saw its market-capitalisation (market-cap) hit the Rs 1 trillion mark, analysts now seem to be turning cautious on the stock of food delivery major Zomato. In a report dated August 4, HSBC has cut its rating on Zomato to ‘reduce’ and has maintained a price target of Rs 112 on the stock, translating into a downside of Rs 26, or 19 per cent, from the current levels.

Food delivery investors in India, according to HSBC, face three key challenges. First, unlike most e-commerce segments, food delivery will need to see profound cultural evolution, as there are longstanding inhibitions against eating 'non-home-cooked food'. Secondly, diversification into e-grocery may not be as easy as it seems given cash burn. Lastly, HSBC believes the current valuations are 'too punchy' and factor in aggressive growth forecasts.

The evolution of average order values (AOVs) along with growing volumes will be the most critical moving part in the unit economics of Zomato, HSBC said. Volumes stood at around 1.5 million per day in pre-Covid times for Zomato, the report said, with an average order value (AOV) of Rs 280. However, in just one year, AOVs have gone up to Rs 400.

As life normalises post-COVID, HSBC predicts a sharp growth in volumes, led by office orders coming through. However, that would also mean AOVs moderating. (See table below) HSBC forecasts a 5 per cent fall in FY22e and another 6 per cent fall in FY23e in AOVs.

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“We assume a 26 per cent CAGR gross-order-value (GOV) growth in the next 10 years. Zomato is trading at 20x FY30e EPS and c2.5x FY25e GOV while its global peers are trading at 1-1.5x 2021e GOV, despite better growth in the past two years. Initiate at Reduce,” wrote Yogesh Aggarwal, head of research for India at HSBC in a coauthored note with Abhishek Pathak, their IT services and internet analyst.

From a long-term (10-15 years) perspective, however, growing per capita income, improved supply, a growing share of working women, and lower inhibitions against non-home-cooked food could prove to be catalysts for the stock; and investors, hence, could look through the near-term concerns. Competition in the form of Swiggy and Amazon, HSBC said, is still manageable.

Going ahead, HSBC believes a large positive or negative surprise for Zomato may come from adjacent businesses or expansion in newer areas such as Dine-out listings and Hyperpure – a kind of B2B grocery business for restaurants. HSBC pegs the total addressable market (TAM) for Zomato's Dine-out listings at $2 billion and forecasts revenue for Zomato to be around $105 million in this business in FY25. On the other hand, it sees the TAM for Hyperpure at around $15 billion.

Average order value

AOV sensitivity