Zomato has the right execution ingredients in place, for now

Shares of Zomato Ltd have gained as much as 15% since its September quarter (Q2FY24) results beat expectations, especially on growth. Not only did more customers order last quarter, but the order frequency was also higher. This was mainly driven by a loyalty program – Zomato Gold – where members doubled to 3.8 million.

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(Graphic: Mint)

The result is that gross order value (GOV) rose by 9% sequentially in the food delivery business. That’s not all. In Q3, Zomato expects GOV’s sequential growth to be in high single digits. Additionally, its e-commerce business, Blinkit, is on track to turn positive adjusted Ebitda by Q1FY25. The segment was positive at the contribution profit level for the first time in Q2.

But there are two sides to a coin. The rise of Gold members has been a drag on Zomato’s margins. Contribution profit as a percentage of GOV in its core food delivery business rose 20 basis points (bps) sequentially to 6.6%. In Q1 and Q4FY23, the stock grew by 60bps and 70bps, respectively.

This is even because platform fee levy and ad monetization were better in Q2. Ordering Gold is relatively less profitable due to factors such as high delivery cost, priority service for Gold members and cost due to the instant guarantee benefit available to Gold members. Zomato is clearly choosing growth over profitability.

To be sure, increasing Gold members boosts order frequencies and ensures customer loyalty. Interestingly, the company expects the pace of growth in Gold members to slow. Against this background, Nomura Financial Advisory and Securities (India) believes that it will be a challenge for Zomato to achieve double contribution margin with high growth in the long term.

In Q3, the festive season is likely to have a much more positive impact on brisk trade than on food delivery. After a weak Q1, Blinkit posted sequential GOV growth of 29% to 2,760 crore in Q2, although it is still in the red. Blinkit is expanding its network and aims to add 100 new stores in FY24 and the count is expected to stand at 480 stores by the end of the year.

Because of this, analysts at Nuvama Research have increased their revenue estimates but lowered profitability expectations as Zomato will invest to drive growth.

After accounting for the results of the rally post, Zomato shares have doubled in 2023 so far 123.30 each. The good run may continue if Blinkit turns profitable and the food delivery business maintains its growth rates.

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