In Friday’s trading, after release of Zomato’s earnings (released after market close on Thursday), investors weren’t enthused. The stock ended the day down 1.65 per cent. This was after the management had gone out of the way to stress on round the corner adjusted profitability for its core food delivery businesses (66 per cent of total revenues). Compare this with when the stock rallied over 20 per cent in just two days in August 2022 after company’s June Q results. This was after management indicated, in August, at prospects for achieving adjusted EBITDA breakeven earlier than what markets were originally anticipating.  Zomato defines adjusted EBITDA, as EBITDA plus share based compensation expense minus rentals paid.

The management also did something unusual with its December Q earnings release. They went far out of the way to stress that during the month of January 2023, excluding quick commerce business (Blinkit), Zomato had turned adjusted EBITDA positive. In a corporate world where managements  often do their best to reveal less and hide more when it comes to business and financial data, when was the last time anyone started giving monthly profitability insights! Does Zomato management want to be genuinely so transparent, or is this a desperate attempt to influence the narrative?

Waning growth

Headwind coming out of Q3 appears to be slowdown in its core food delivery business. On a sequential basis, Zomato’s revenue for this core segment declined 1 per cent. Q3 is apparently a seasonally strong quarter and revenue must have actually grown under normalised conditions. Further Zomato has been sold to investors as a growth story, and at a time when profitability is in sight (adjusted as it may be be), growth appears to be waning.

Much of the sequential growth during the quarter came from the Blinkit business which Zomato acquired last year.  And this business is heavily adjusted EBITDA negative with margins at -75 per cent.

So Zomato appears to be having a growth versus profitability conundrum. This, though, is not surprising as this is a problem endemic to sharing economy companies across the world. In fact, one of the first sharing economy stocks to get listed (Lyft) cratered to all-time lows of $10 last week, versus listing price close to $80 in March 2019. While the business of Lyft is different, it can also be viewed as a reflection of  business model challenges that sharing economy companies face in general as well. The model is still evolving and may become profitable at some point in time, but the fact that it is evolving needs to be kept in mind.

What should investors do?

The stock of Zomato has corrected 67 per cent from all-time highs and 30 per cent from IPO price. This correction, seen against its strong balance sheet and decent quality of business execution, makes a case to be less pessimistic on the stock, than before.  However trading at 5x one year forward revenue, Zomato is still not an attractive investment to consider given uncertainties on the growth versus profitability trade offs.

US food delivery company DoorDash, which is much ahead of Zomato in terms of profitability, is trading at 2.4x.

Finally, investors also need to treat with caution the buzz around adjusted EBITDA breakeven. Ultimately what is left for investors is the net profits a company makes. The journey from adjusted EBITDA to normal profits will not be a quick linear path and, for some companies, may never materialise.

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