Zomato shares have risen about 20% in a month, compared to a 5% drop in the benchmark Sensex. Edelweiss, a domestic brokerage and research firm. Moreover, has maintained its positive stance on the stock based on the core business, citing the long growth runway and path to profitability.
“On a standalone basis, unit economics of instant grocery delivery are weak. Even so, food delivery platforms world over are foraying into this space in search of increased order density. And consequently lower cost per delivery”. The brokerage said.
Zomato shares rise 20%
Given its long growth runway and path to profitability in core business, the brokerage house has maintained a ‘Buy’ tag on Zomato shares. Thus, with a target price of 80. Failing execution in grocery continues to be a major risk, according to the report.
“A relatively weak quality of network effect in food delivery necessitates delivery cost leadership for success. Swiggy’s success in grocery has given it an upper hand. Hence, the Blinkit acquisition at reasonable valuations and successful strides in grocery delivery are crucial for Zomato to stay competitive,” the note stated.
The brokerage is neutral on Zomato’s acquisition of Blinkit. Lest, assuming valuations are reasonable (around $600 million) and the company can generate around 5% synergies from lower delivery costs.
“Also, we prefer Swiggy’s strategy of combining grocery. And food delivery in a single app, something which has resulted in higher stickiness for global companies. Zomato’s management has assigned an upper bound of $400 mn towards quick commerce investment for the next two years (CY22, CY23E). Any deviation from this would be a key risk to our hypothesis,” Edelweiss added.
According to Zomato, the acquisition of Blinkit is a necessary evil. Since, cost leadership is critical for success in a business with weaker network effects. Swiggy has established a strong grocery delivery franchise by leveraging its existing delivery fleet, and Zomato will look to follow suit through Blinkit’s acquisition.
“We do expect Blinkit’s valuation to reset at a lower level. Than the USD 1 bn in the previous round. Considering correction in valuations in this space. We note a 5% reduction in cost per delivery is possible with the Blinkit acquisition. Which, ceteris paribus, can lead to 70bp higher contribution margins. As % of AOV and 11% higher valuation if these benefits are sustained”. Edelweiss’ note said.