Zomato near-term growth overestimated? HSBC initiates with ‘reduce’; sees 15% downside in stock price

HSBC has initiated Zomato coverage with 'reduce' rating. (Image: REUTERS)

Zomato’s share price has soared 71% from its IPO price within weeks of listing on the stock exchanges. Although many domestic and foreign brokerage firms believe Zomato’s stock price could surge higher, HSBC has initiated its coverage of the food-tech giant with a ‘reduce’ rating. HSBC, in a report last week, said that the food delivery industry in India is about an important change to the product itself —  from homecooked to restaurant food. “Which is why we think, while the long-term opportunity is real, the market may end up over-estimating growth in the near term,” they added. Today, Zomato is trading at Rs 130 per share.

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Challenges remain

HSBC analysts believe that Zomato may not be for calorie-conscious customers or valuation-conscious investors and sees three key challenges for the company. The brokerage firm said that the food delivery sector, unlike most e-commerce segments, will need to see profound cultural evolution to be a success, keeping in mind that Indians have long standing inhibitions against eating non-home cooked food. Apart from this, HSBC said that for Zomato to shift to e-grocery may not be easy, given the cash-burn that the move will involve; and last the “punchy” valuations that factor in aggressive growth.

Although Zomato has improved its unit economics, HSBC analysts believe that these levels are unlikely to sustain. “In the near to medium term (post-COVID-19), volumes may grow strongly as office orders also come back, but that would mean a lower average order value (AOVs),” they said. HSBC is forecasting a 5% fall in AOV in the financial year 2021-22 and another 6% fall in the year after that.

Competition not a problem for Zomato

In terms of competition, analysts do not see a threat for Zomato. “We compared discounting between the two by surveying 150+ restaurants in six+ cities. Swiggy discounts more than Zomato (c300bp more), but consumers aren’t switching significantly,” they said. However, HSBC said that Swiggy’s aggressive discounting on its platform may impact Zomato’s market share, but the evidence of the same is not much at this juncture.

On the other hand, competition from Jeff Bezos’ Amazon isn’t seen as palpable at this stage. “Amazon as of now is only operational in Bangalore and its discounting is similar to Swiggy’s. For Amazon to take market share, then its discounting and cash burn has to be more visible. Also, the customer experience in our view in Bangalore is quite mediocre,” they added.

Valuations lofty

HSBC added that the long term opportunity for the food delivery sector is real and investors may show patience in the near term. The brokerage firm assumes a 26% CAGR gross-order-value growth in the next 10 years. “While Zomato remains a compelling story, we believe the already lofty valuations factor in very optimistic estimates, and a glance at global peers (trading at 1-1.5x 12m forward EV/GMV vs 2.5x FY25e EV/GMV for Zomato) corroborates this,” the report added. HSBC has a target price of Rs 112 per share, implying a 14% downside potential from current levels.