Multiple margin levers ahead for food delivery platform Zomato's stock

Zomato hiked its platform fee for food delivery from Rs 3 to Rs 4 per order in key markets effective from January 1, 2024.

It had begun levying a convenience fee of Rs 2 per order from August 2023, which was subsequently raised to Rs 3 per order.

The resultant convenience fee was a driver of 60 basis points (bps).

The food delivery adjusted revenue grew 21.8 per cent year-on-year (Y-o-Y) in Q2FY24 versus 18.5 per cent Y-o-Y in Q1FY24.

The adjusted operating profit as a percentage of GOV (gross order value), which was at 2.5 per cent in Q1FY24 reached 2.6 per cent in Q2FY24, up 10bp Q-o-Q.

A rough calculation indicates that a higher convenience fee per order will improve adjusted operating profit by around 5 per cent if taken across Zomato’s entire footprint, while it should raise the topline by 1.2 per cent and move the take rate up by 30 bps.

The adjusted operating profit stood at Rs 204 crore in Q2FY24. The total number of food delivery orders stood at 650 million in FY23 and it’s projected to reach 830 million in FY25.

The hike is only in select markets so it could only raise revenues by 0.5 per cent during FY25 unless the hike is phased into other markets with a rise of 2.0-2.5 per cent in the adjusted operating profit in FY25 if it covers half of Zomato’s orders.

Apart from higher convenience fees, strong advertising income and commissions from restaurants are among the key levers to improve the profitability of the food delivery business.

Higher ad income and convenience fee (two months) in Q2FY24 pushed the food delivery take rate by 220bps Y-o-Y.

The higher fee will not significantly impact consumers' wallets.

However, Zomato is also facing a tax notice for allegedly not paying roughly Rs 400 crore towards delivery charges collected by the company from the customers on behalf of delivery partners for the period of 29 October 2019 to 31 March 2022.

This must be for Zomato’s food delivery business (Blinkit was acquired later).

Zomato pays GST on delivery charges collected from customers in Blinkit, so we do not expect any such liability in that business.

In its filing to the exchanges, Zomato said it strongly believes it is not liable to pay any tax since the delivery charge is collected on behalf of delivery partners.

The company will be filing an appropriate response to the show cause notice.

In practical terms, investors would want clarity on the timeline for the case and any remedial measures it may take to avoid such notices in the future.

 If the company does have to pay, it will probably be able to pass the GST burden directly to the end customers. 

If it cannot pass on the GST (or win its case) the direct impact on its food delivery profitability (adj operating profit) basis could be around 0.9 per cent of the GOV in Q2FY24.

This is very significant given an adjusted operating profit margin of 2.6 per cent of GOV. It has a cash balance of Rs 11,800 crore, which means it can comfortably cover the demand if needed.

Blinkit is showing decent GOV growth on the back of improvement in order volume. Quick commerce platforms are catching on and competing with unorganised retail in Tier 1/2 cities.

The hyperlocal arm could achieve an adjusted operating profit break even as early as Q1FY25 if all goes well.

The stock is trading close to its 52-week high at Rs 130.6. It has gained 130 per cent in the last year.