Zomato share price may fall 9%, JP Morgan initiates with underweight rating; premium valuations not justified

Zomato’s premium valuation may not be justified with no significant levers ahead for the stock. (Image: REUTERS)

JP Morgan has initiated coverage of Zomato with an underweight rating, pinning a target price of Rs 112 per share, implying a 9% downside from the current price. Zomato’s premium valuation may not be justified with no significant levers ahead for the stock, said global brokerage and research firm JP Morgan while initiating the coverage of the food delivery behemoth’s stock. “Zomato trades at 21x CY22 EV/Sales which is 4x higher than the average valuation of global food tech companies. We believe the premium is not justified as we don’t see significant levers – either market share gains or AOV expansion”, analysts at JP Morgan said in a note. The brokerage firm has initiated the coverage of Zomato with an ‘underweight’ rating and a target price of Rs 112 per share, citing four key reasons behind the negative outlook.

Headwinds ahead for Zomato

Valuations not justified: Zomato is currently trading at 21x CY22 EV/Sales which is 4x higher than the average valuation of global food tech companies, JP Morgan said. “We believe the premium is not justified as we don’t see significant levers – either market share gains or AOV expansion. We believe with a slew of internet IPOs lined up the supply premium should vanish and the stock could correct given absence of material stock drivers,” they added.

Average order value to fall: Analysts believe the average order value (AOV) of Zomato could mean revert sharply from cyclical factors. Currently, the AOV for Zomato is at Rs 460 (1.6x pre-covid levels) and ahead of Swiggy. JP Morgan analysts believe that any frequency increase in existing customers is likely to come from lower-ticket size customers while new costumers from top 50 cities (tier 2 and 3) are likely to use lower basket sizes where propensity to spend is lower than top 10-20 cities. We believe AOV is the single biggest factor which has an influence on the contribution margin. Lower structural AOV restricts contribution margin expansion and would weigh on long term profitability,” the report added.

Discounts to increase: Subsidies given by Zomato have reduced sharply over the last two years but could now increase again. “We believe discounts will need to rise sharply to drive market expansion, reacquire dormant customers and retain customer wallet share as discretionary spending options rise in a reopening economy,” analysts at JP Morgan noted. The brokerage firm expects discounts to be 6% of AOV by the financial year 2022-23 and 4% in the longer run, hitting profits.

No more market share gain: The duopoly food delivery market is expected to remain the same with Swiggy and Zomato controlling 50% of the market each. “We don’t see scope for Zomato to expand its share over Swiggy on a sustainable basis as we believe both will remain competitive to defend their market shares,” JP Morgan analysts said.

Zomato’s share price has rallied 74% to date from the IPO price of Rs 76 per share to sit at Rs132 apiece on Wednesday morning. The stock has managed to outperform Sensex and Nifty during the said period.

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