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Weak dine-in continues to be a drag

3Q performance was subdued as revenues declined 25% (SSSG declined 24%) despite all stores being operational. However, consistent cost optimization led the reduction in average monthly fixed cost by ~30% (renegotiating rents, reimagining supply chain, variable staff costs, etc.), thereby bringing back margins close to pre-Covid levels. Although the trajectory of improvement of convenience formats (delivery, drive-thru, takeaway and on-the-go – together contribute >50% of revenues) seems promising, recovery of core dine-in business (still at 70-75% of pre-COVID levels in Q3) depends on improvement in consumer sentiment. Longterm benefits from expansion of food service market remain intact. Store additions is a positive (opened 3 stores in Q3). ADD.

* Substantial revenue decline despite all stores operational: In 3QFY21, revenue / EBITDA / recurring PAT declined 25% / 29% / 84%. Westlife reported 24% same store sales decline. However, revenue grew 55% QoQ due to opening of one of its largest state – Maharashtra. Having said that, complete recovery across most of the large channels is yet to happen with McDelivery still at ~90% YoY and Dine-in at ~75% of pre-Covid levels (even lower YoY) even with all stores being operational. Channels like Drive-Thru have almost doubled sales on a YoY basis and On-the-Go channel is witnessing strong MoM growth

* Store expansion to return from FY22: Westlife opened 3 stores and closed 10 McDonald’s stores in Q3, taking the total store count to 304 (43 cities). Store closures are largely due to network optimisation and management guided to no further store closures. A key positive is the return to potential 25-30 store additions from FY22 onwards, as per management. Westlife also added 3 McCafe stores during the quarter taking the total count to 227.

* Structural cost savings leading to lower restaurant break-even point: Better sourcing and cost optimisation limited gross margin decline to just 30bps YoY (to 65.7%) despite lower volumes. Further, gross margins of 65.5% in Dec’20 are similar to Q4FY20 margins. Comparable EBITDA margin declined 190bps YoY to 10.2%, a strong performance given 25% revenue decline, driven by 25-30% reduction in fixed costs and optimisation of some variable cost leading to lower restaurant break-even point. This also led to a flattish (YoY) EBITDA margins of 13.1% in Dec’20, despite 20% lower sales YoY.

* Valuation and risks: We cut our FY22-23 earnings estimates by 1-3%; modelling revenue / EBITDA CAGR of 10 / 22 (%) over FY20-23E. Retain ADD with DCFbased target price unchanged at Rs500. Key downside risks include sustained weak consumer sentiment impacting restaurant throughput and food aggregators impacting economics and profitability in food delivery.

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