It’s all about the category
Q4 results have largely been in line with the management commentary of Q3 investor calls. Usually this is a sign of a stable industry where the management is able to foresee what challenges they can run into and to what extent these challenges can be handled proactively. The big takeaway of the Q3 call was that consumer discretionary follows a similar trend to consumer staples, only with a lag. If inflation hit FMCG giants towards the beginning of FY23, it started impacting the demand outlook and pricing power of consumer discretionary category towards the end of FY23.
At the same time, not all categories are equal in QSR. We have always believed that aspirational global brands are much easier to rollout and scale profitably compared to local cuisine brands. In the food business it is easy to run a few restaurants very well, it is not so easy to run 300+ stores equally well across the country. Pizza was one of the first “junk” categories to enter India, as early as the late 90’s. It was one of the only few things one could order over the phone till a decade ago, it more or less dominated the late night stay at home meal category. With the rise of food aggregator platforms that can deliver a multitude of cuisines today even at midnight, the pizza category no longer has the sheen it once had.
The trend of Q4 results and the management commentary around it has been clear –
- Chicken as a category (KFC, Popeyes) offers a differentiated, aspirational experience for most Indians. It is much easier to keep margins intact here in the face of inflation, also much easier to scale. Urban Indians clearly need an alternative to tandoori chicken and chicken biryani, fried chicken is filling this white space in our cuisine
- Pizza as a category has seen a clear dip in sales numbers & gross margins in FY23. Higher competition in this segment compared to fried chicken
- Burgers as a category continues to do very well, these stores offer annual store revenue of almost 3x the other categories at better margins. McD and BK have been aggressively focusing on cross selling and in dine experience compared to all the other categories, it shows in their numbers too
- Almost every business is now focusing on a range of offerings across value and premium – INR 99 as a price point has been launched by both the burger franchises, Jubilant Food has launched an INR 49 entry level price point in an effort to compete with other categories in the “snacking” segment
- On premise channel salience has come back strongly after the COVID scare of FY21 and FY22. On premise channel offers the possibility of building and executing a cross sell and up sell culture compared to the pure delivery channel. It works the same way as with banks, branches become cross sell centers from customer acquisition & service centers over time
- All managements hint at inflation effects bottoming out in H1 FY24, FY24 may see healthier margin compared to FY23. Minimal price hikes were taken in H2 FY23 to ensure demand does not fall off
- Capex plans remain unchanged, new stores take 2 years to season and meet the ADS number. SSSG should be 4-6% p.a. for most brands over the medium term. 60-70% of the capex in a year is towards new stores with the remaining going towards store upkeep and modernization
- Most businesses here are working capital negative and generate free cash flow beyond a scale. Westlife Foodworld has now put in place a 25% dividend distribution policy
- Most businesses are focusing on building a D2C connection through their own app, Devyani & Sapphire have a lot of distance to cover on this front. Pizza Hut has been a laggard in this regard
We like the unit economics of the QSR segment provided the basic conditions are met. In the unlisted market too, many new chains are able to raise money at healthy valuation. The F&B market in India is ripe for a sustained movement towards organized national brands over a long period of time. However, the best unit economics will be in categories that are built around aspirational global brands; these offer a differentiated experience to customers compared to franchises that are built on local cuisine. It is tough to charge a premium for local cuisine even as a large, organized chain in India.
Westlife Foodworld is clearly the most impressive business right now but it is priced to the brim. Jubilant Food optically appears to be cheap but we have our own doubts about whether it is cheap. We like what BK India is doing but the Indonesia business will continue to be a drag through FY24 and a part of FY25. Devyani and Sapphire have a good growth runway over the next 3-5 years, operating leverage should play out in their favour over the next 24 months once the effects of inflation stabilize.
No big concerns on this segment, just that we need to be choosy about valuation.