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Sapphire’s Q2 EBITDA was 3-7% lower than our estimates, owing to lower KFC margins. While KFC SSG at 15% was similar to DIL’s at 13%, the PH SSG was relatively better at 23% vs. 3% for DIL. In our view, a higher dine-in focused store mix led to a better SSG performance for Sapphire. Store additions remained robust, with net adds of 42/79 stores in Q2/H1FY23, and Sapphire retained its outlook of doubling the no. of stores over the next 3-4 years. KFC’ gross-margin decline of 310bps was higher than our expectations of 150bps, but operating leverage/cost cuts helped restrict the comparable brand margin decline to 80bps. While RM prices remain elevated (YoY), Sapphire expects to recoup brand margins with operating leverage. Encouragingly, Sapphire continued to deliver Rs100mn brand contribution from SL, despite the ~40% currency depreciation and high inflation in Q2. Capex/store in H1 reduced by ~16% YoY to Rs23mn, but was higher than the ~Rs14mn/store for DIL. We retain our EBITDA for FY24/25E, led by retention of near-term outlook. We expect Sapphire to deliver a strong EBITDA CAGR of ~45% over FY22-25E, led by a 21% store-count CAGR, 10% SSG, and gradual margin gains. Maintain BUY with TP of Rs1,650 (21x Sep-24 EBITDA).

Result summary: KFC’s revenue grew by 36%, led by SSG (15%) and rest through new store adds. PH revenue gain was 60%, led by 23% gain in SSG with the balance via new store additions. Among channels, on-premise for KFC/PH saw faster growth, at 50-100% vs. 14-30% growth in the off-premise channel. With new menu launches, marketing initiatives and deeper penetration, Sapphire expects higher normalized SSG, at 8% for PH vs. 4-5% for KFC formats. Store additions at 42 remained robust, with 20/14 store additions for PH/KFC. Despite operating challenges, Sapphire added 8 stores in Sri Lanka (SL), highlighting its continued growth focus for SL. RM inflation led the 310/110bps decline in gross margin for KFC/PH formats in Q2. However, operating leverage helped restrict the comparable brand margin decline to 80bps for KFC, while PH brand margins saw a 440bps improvement on a low base. SL brand margins declined ~550bps, led by ~1,060 decline in gross margins.

Earnings-call KTAs:

1) Sapphire witnessed RM inflation in the mid-teen range, for which it took 9-10% price hikes in Apr-22.

2) SL’s Q2 SSG of 37% in SLR terms was led by price hikes, while transaction growth was marginal. Operating conditions in SL are at ~85-90% of normalized levels.

3) While commodity prices remain elevated (YoY), Sapphire expects operating leverage to drive the QoQ improvement in EBITDA margin.

4) Based on historical trends, Sapphire anecdotally expects 4-8% improvement in KFC ADS for Q3 vs. Q2, while PH ADS is expected to remain similar due to lower seasonality.

5) Delivery mix via aggregator platforms is 90/80% for PH/KFC.

6) Sapphire does not expect to pay taxes in the near term due to accumulated losses.

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