Home >Markets >Stock Markets >Kotak initiates coverage on Zomato shares, with ‘buy’

Kotak Institutional Equities has initiated coverage on newly listed Zomato Limited with a buy rating and fair value of 175. Zomato shares closed today at 141.40. The IPO of Zomato had got a stellar response from investors and as compared to the IPO issue of 76, shares have nearly doubled in value in less than two months.

“Zomato’s leadership position in the underpenetrated food-delivery space will drive healthy revenue CAGR of 36% over FY2021-30. Turnaround in unit economics will lead to profitability by FY2025, leaving Zomato with the bulk of its current $2 billion cash balance intact, which can drive the company’s entry into fresh adjacencies enabling further value creation," Kotak Institutional Equities said in a note, pegging SoTP-based fair value of Zomato shares at 175.

Kotak believes that “Zomato is well-poised to grow at a strong pace over the next decade led by (1) attractive market opportunity and strong management ability to execute and (2) potential cross-sell and up-sell opportunity by adding other value-added services like grocery delivery into the portfolio."

Zomato had recently completed acquisition of 9.16% stake in grocery e-commerce platform Grofers for 518 crore.

According to Kotak, the trend of outdoor eating will strengthen considerably in the years to come as reliance on home cooking declines, tastes and preferences evolve and most importantly income levels increase. 

“We believe there is considerable potential for food delivery companies to: (1) target several new first-time users, and (2) drive significantly higher ordering frequencies among existing users," the brokerage said. 

In addition, Kotak said, India’s food delivery sector has already witnessed considerable consolidation over the past two years as several competitors such as UberEats, Foodpanda, Tinyowl and Scootsy have either been acquired or they have shut their businesses. 

“Swiggy remains a well-funded competitor with total fund-raise of $3 billion till date (actual cash on books currently will be a percentage of this). This is comparable to Zomato’s post-IPO cash balance of $1.9 billion. We reckon that these two well-funded competitors will deploy cash to scale-up the food delivery business by focusing on market expansion and not reckless discounting. They will also use this cash to explore adjacencies," Kotak added. 

Here are key highlights from Kotak report on Zomato shares:

“Rise in income levels, evolving tastes and preferences will drive a greater demand for food delivery in the future. This will manifest in strong growth in users on food delivery platforms as well as in ordering frequencies. We thus model healthy 55% revenue CAGR for Zomato over FY2021-24 and 36% revenue CAGR over FY2021-30."

“Zomato will also continue to explore adjacent businesses which can drive these revenue growth rates further up."

“Our fair value is based on a DCF-based valuation of the core food services business, to which we separately add the value of Zomato’s stake in Grofers and associated value creation and cash. Our FV implies FY2024 EV/adjusted sales multiple of 13X, a sharp premium to global peers, as we expect Zomato’s future growth and potential entry into other businesses to trump revenue growth of peers."

“We ascribe 1,500 crore of valuation to Zomato’s investment in Grofers and the related option value that can arise once Zomato explores synergies between its food delivery business and grocery business. Our valuation implies 13X FY2024 EV/adjusted sales, a significant premium to global peers such as Meituan Dianping (China) and Delivery Hero (Europe)."

Key risks for Zomato

Regulatory scrutiny on take rates and delivery charges earned by food delivery companies is a key risk, according to Kotak. Higher driver wages if mandated by labor law changes could also be a negative while higher competitive intensity and value destructive acquisitions are also risks, the brokerage added. 



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