Strong execution under tough circumstances; Maintain Buy

* Sapphire’s Q1 EBITDA beat our estimate by 17-21%, led by better revenue and margins across formats. Q1 revenues grew ~80%, on healthy 35% store growth, price hikes and a low base. KFC/PH/SL brand margins were ~180/180/800bps higher than estimates.

* KFC performance was strong, with flat ADS vs. a seasonally-strong Q3FY22. Price hikes of ~10% in KFC likely helped to offset the seasonal decline in ADS. A successful traction in entry-level Flavor Fun pizzas remains a potential upside to our PH SSG estimates

* bSL performance was better than est. and commentary was encouraging. We now factorin 7-12% EBITDA mix for SL in FY23-25E vs. 3-7% earlier, leading to ~5% EBITDA rise. 37 store-adds were towards the lower-end of the implied annual target of 145-190 adds.

* We expect Sapphire to clock a strong 45% EBITDA CAGR over FY22-25E, with RoIC quadrupling to 27%. Despite considering SL challenges and lower PH opportunity/RoIC vs. DIL in our 2-stage model, we get 30% upside. Retain BUY; revise TP to Rs1,650 (21x Sep’24E EBITDA; 40% discount vs. DIL). Faster SL recovery is a potential upside.

Traction in Flavor-Fun pizzas remains a potential upside: PH/KFC revenue grew strongly by 85-100%, led by healthy store-addition CAGR of ~34%, 5-12% price hikes for PH/KFC and a low base. KFC performance was strong, with flat ADS vs. a seasonally strong Q3FY22. Nearly 10% price hikes in KFC likely helped to offset the seasonal decline in ADS. The dip in PH ADS vs. Q3 was in line with typical seasonality at ~5%. ADS growth vs. Q3 was largely similar to DIL’s, across the KFC/PH formats. A successful traction in entry-level Flavor Fun pizzas (Rs79-149) remains a potential upside to our PH SSG estimates. Among channels, On-premise for KFC recovered fully, while PH saw 85% recovery due to challenges in select pockets (Karnataka). Off-premise sales sustained and are ~100%/30% above estimate for KFC/PH vs. pre-covid. Sapphire added 37 stores across formats in Q1 which is towards the lower-end of the implied annual target of 145-190 additions and in line with our expectations. Commodity inflation has led to an 7-8% increase in capex/store, resulting in an increase in our capex.

Better SL performance drives increase in EBITDA estimates: EBITDA margin (ex Yum! incentives) at 13.3% declined 130bps vs. Q3, led by RM inflation in KFC and SL challenges. However, margins were ~180/180/800bps higher than our estimates for KFC/PH/SL, leading to 3-5% increase in our EBITDA estimates. The core formats, KFC/PH, delivered 20.3%/14.8% brand contribution vs. 22.4%/17.5% for DIL. Lower margins for Sapphire are due to higher share of low-margin legacy stores currently. However, margin-gain potential is relatively higher for Sapphire, led by continued increase in mix for shorter-format stores.

Expect 45% EBITDA CAGR in FY22-25E: Despite SL challenges, Sapphire should deliver a strong EBITDA CAGR of ~45% over FY22-25E, led by a 21% store count CAGR, 9% average SSG, and gradual margin gains. Our improved margin expectations should offset the impact of 7-8% inflation in capex, leading to no major change in our ROIC expectation of ~27% by FY25E. We maintain BUY, with revised TP of Rs1,650 (21x Sep’24E EBITDA; 40% discount vs. DIL). Faster gains in PH and SL recovery remain a potential upside

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