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HDFC Securities Institutional Research Desk: Report on QSR Thematic - QSR: Fishing time?

Posted On: 2023-03-27 21:52:54 (Time Zone: IST)

Naveen Trivedi, Institutional Research Analyst, HDFC Securities and Varun Lohchab, Institutional Research Analyst, HDFC Securities.

Global QSR giants entered India and China in the 90s with high hope of massive store network potential, thanks to two large populous hubs. However, the growth trajectory was quite slow in India vs. that in China, which can be attributed to the variance in the economic growth of these two countries. India is still quite an under-penetrated market with ~3 stores per million population vs. China's 13 stores per million (six stores in 2013). India can sustain ~10% store growth for global QSR giants by 2030 (China clocked 10% CAGR in 2013-2022). Domino's and Yum are close to 1,700 stores in India while McD has ~500 stores. The QSR industry saw a yearly addition of 125 stores in 2005-2010, which increased to 300 stores in 2010-2020 and ~475 stores in 2020-2023E. We believe the yearly expansion can sustain 550 stores up to 2030E. It will lead to store metrics of 6 stores per mn by 2030 (link). Thus, most QSR players will be able to grow their store units by +10% over the next few years. The underlying SSSG for most franchises is close to a mid-high single digit, offering overall revenue CAGR in the mid-teens.

QSR, among the other consumer categories, has seen normalisation relatively late post-COVID (particularly dine-in); mobility and pent-up have boosted the growth metric (ADS, SSSG) over the last 15-18 months. It resulted in a sharp improvement in operating metrics (operating margin improved 200-500bps in 9MFY23 vs. 9MFY20). With the normalisation in demand, the impact of weak consumer sentiment and RM inflation, we believe the operating margin will see an impact in FY24 (may also not repeat in FY25 also with rising competition). Thus, despite the recent correction of stocks, we do not believe this is the perfect fishing time. We suggest waiting before we see the full impact of weak demand. On a relative basis, we like Jubilant (investing to further improve its competitiveness) and Westlife (pure play India QSR story). We'd like to avoid Devyani and Sapphire due to potential slippages for the Pizza Hut story (particularly in weak demand). We initiate coverage on Westlife with ADD and on Devyani and Sapphire with a REDUCE rating for each. We upgrade our rating on Jubilant from REDUCE to ADD.

Challenging near-term; pressure on all metrics: QSR companies have seen pent-up demand benefits once the COVID impact started receding. Initially, delivery focus players saw a jump in growth metrics (i.e. Domino's, etc.) and later dine-in players enjoyed the mobility (i.e. McD, KFC, etc.). With a sharp jump in growth metrics, the restaurant margin has improved sharply (200- 500bps in 9MFY23 vs. 9MFY20). With most tailwinds behind, we believe the margin trajectory will largely return to the normal level (similar trend witnessed in Global QSR and Indian consumer companies - link).

Our long-term thesis: (1) QSR is more of a macro story play with India's fast[1]changing ecosystem (internet, mobile, young population, large population, rising hygiene preferences, etc.) driving penetration. (2) QSR store growth is sustainable at 10% with the industry expected to reach six stores per mn population by 2030 from three stores per mn currently. (3) Long-term SSSG to sustain at mid-high single digit (most global QSRs achieved in the US in the long run). (4) Earnings growth driven more by unit growth than margin expansion. (5) Macro will remain favorable (sensitivity is high for QSR).

Rich valuation to sustain: QSR industry has multi-year growth potential and global QSR giants will be fit for the change in India's rapid ecosystem. They have more right to win in India's consumption metric with a rising consumer base, eating-out frequency, quicker delivery and value-for-money proposition. Thus, despite near-term challenges, we believe the long-term rich valuation will sustain for QSR players. Upside risk: GST council allowing an input tax credit for the restaurant sector.

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