Zomato stock surge: Investor hype or pure growth?

Zomato’s business has changed a lot since its pre-IPO days with business expanding from primarily food delivery to fast-growing quick commerce and its B2B Hyperpure business. But one thing that has not changed is the way bulls and bears remain divided on the stock’s prospects. The range of price targets on the stock has always been as wide as it can be. Even now while the highest target on the street is at ₹320 – 25 per cent above current levels, the lowest target is at ₹130 – 50 per cent below current levels.

In the last three years, both bulls and bears have been vindicated at different points in time. While the bulls initially won with the blockbuster listing, the bears had their time too, when the stock cratered to just above ₹41 in July 2022, nearly 75 per cent below its prior peak (November 2021) and 45 per cent below its IPO price.

Can the stellar returns exceeding 500 per cent in the last two years from the lows of July 22, be taken as a validation that bulls have convincingly won? It’s better to reserve the final verdict as the battle is still on, and the interaction of the following three factors will continue to keep it ongoing for a while.

Revenue growth

On this front, the verdict is decisively in favour of the bulls.  Since pre-IPO year FY21, revenue (FY21-FY24) of Zomato has grown at a staggering CAGR of 82 per cent. Of course, this includes the benefit of inorganic growth that involved dilution for Zomato shareholders – the acquisition of Blinkit. But two factors outscore this point. One, Blinkit has had much stronger growth once under the fold of Zomato and its contribution to revenue is expected to become larger than its food delivery business few years down the line. Further, the valuation at which Blinkit was acquired by Zomato in a share-swap deal, was around 10 per cent of Zomato’s then enterprise value. Today, the valuation for Blinkit business in Zomato’s total value is north of 50 per cent. So the deal has worked remarkably in favour of Zomato investors, and also in favour of the bulls who had bet on aggressive growth assumptions to justify the IPO and immediate post-IPO valuation (when the stock doubled).

Profitability

On this front, both the bulls and the bears have a fair share of the argument. What has worked for the bulls is that the company’s profitability metrics have improved in recent quarters after some disappointment early on after the IPO. The company achieved adjusted EBITDA profitability in Q1FY24 and has consistently improved since then. In Q1FY25, adjusted EBITDA profitability was at 6.6 per cent, a significant improvement from the -13 per cent in Q4FY21. It’s quite clear the company is on a path to improving profitability.

But the bears, too, hold some lever when it comes to this point. From a long-term shareholder perspective, adjusted profitability is not a comforting factor. Only the profits left after moving down from adjusted EBITDA positive to normalised EBITDA to the bottom line called PAT belongs to them and reflects the gains they can harvest. On that front, Zomato reached normalised EBITDA profitability (Adjusted  EBITDA – share-based compensation + rentals paid pertaining to leases) in Q3FY24. To give a perspective of the difference between the two, for Q1F25 while adjusted EBITDA was at ₹299 crore, the normalised EBITDA was at ₹177 crore (margin at 3.9 per cent).

On the PAT front, while the company reported net profit of ₹253 crore, it was entirely driven by other income (primarily interest/treasury income of ₹255 crore). Hence, the net profit attributable to its operation currently remains miniscule. Looking ahead, consensus estimates indicate net profit attributable to core business will be around ₹2400 crore in FY26. That implies Zomato is trading at two-year forward PE of around 95 times — that is, if the stock stays flat for the next two years, it will end FY26 at a PE of 95 times. Growth stocks can trade at high PE, but there is one risk to factor. Consensus estimates indicate net profit margin will be at 9 per cent. That appears excessively optimistic if you take note of the fact that the operating margin for the large and mature North American e-commerce business of Amazon (revenue of $352 billion) is just 4 per cent. It might be a tall ask for Zomato to achieve the 9 per cent net margin by FY26. If net margin is instead at 4 per cent by FY26, the FY26 PE of Zomato is 190 times! Overall, the profitability targets assumed by bulls appear challenging and may disappoint.

Incredible parallel with Amazon

Zomato in a few aspects appears similar to Amazon in 1999. Both companies, early entrants in the e-commerce space, darling of investors, are growing at a staggering pace in an industry with lot of opportunities ahead. But there is one more incredible similarity – Amazon in 1999 reported revenue of around $1.65 billion and had an enterprise value of $27 billion (market cap of $26 billion). Zomato’s last 12-month revenue too is at $1.65 billion and has an enterprise value of $26 billion (market cap of $27 billion). The EV/revenue valuation of Zomato today is exactly similar to that of Amazon in 1999.

How much Amazon has grown since then, we all know (enterprise value of $2 trillion today). But equally important to understand is how it fared in the next 10 years from 1999 to 2009. Its revenues grew at a staggering CAGR of 31 per cent. From zero net profits in 1999, net profit margins improved quite significantly to 3.8 per cent in 2009. Yet, the stock CAGR over the same period was a mere 6 per cent — while revenue went up 1,385 per cent, the stock went up only 76 per cent! EV/revenue had shrunk from 16 times in 1999 to 2.1 times in 2009. And the multiple had shrunk to such low levels, even though revenue was growing at around 30 per cent year after year. Looking back at that 10-year performance and also the fact that the shares of Amazon crashed 90 per cent when the dotcom bubble burst, it is quite clear that the 16 times EV/revenue multiple Amazon got in 1999 was bubble territory valuation. Yet, investors who bought at bubble valuations were validated 20 years later.    

So where from here for Zomato from its current 16 times EV/revenue multiple? We shall know 10 and 20 years later, but one can confidently say it is very expensive and a lot has to go right for the next 20 years for investors to make spectacular returns.