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Capitalising strongly on penetration-led growth opportunity

The penetration-led growth runway in India’s QSR industry remains strong within the overall consumption space and Devyani has been at the forefront in capitalising on it. Hence, store expansion has been Devyani’s priority, which is clearly visible from its aggressive store additions over FY19-23 vs. other QSR peers (Exhibit 1). To that extent, SSSG expectations on steady state basis are relatively lower (in mid-single digits) vs. high single digits for Westlife where pace of expansion is not that aggressive. Among the core brands, the operating environment for PH remains challenging and recovery is likely to be gradual. On the positive side, KFC‘s (c.59%/64% of sales and brand contribution) performance has been relatively resilient, and given the brand’s dominant position and superior unit economics it is well placed for a rapid scale-up. Costa Coffee, although smaller in scale currently, remains an attractive franchise with superior profitability and good execution on this front can create another key earnings driver for Devyani in the long term. While SSSGs are likely to be muted in 2Q and recovery is expected from 2H onwards, favourable business mix (higher growth in KFC and Costa Coffee) and stable RM scenario should cushion the impact on profitability, in our view. The long-term flavour (large TAM, strong brands, execution capabilities) remains intact; any volatility in stock price should be used as a buying opportunity.

* KFC – competition is not a challenge, profitability metrics remain healthy: Among the core brands, KFC’s performance has been relatively resilient (Exhibit 3/4) as the brand continues to leverage its strong equity and differentiation in food preparation. Also, given the higher degree of quality & hygiene element involved in non-veg food offerings, the customer stickiness for branded players like KFC is higher and this provides it an edge over local competition. Further, Devyani continues to build on its first mover advantage and superior store economics to capitalise on penetration opportunity in the chicken QSR segment. This is visible from strong store additions (Exhibit-2) by the company, highest among the listed QSR peers, and innovations (introduction of value layer to increase presence across dayparts). Despite the near-term challenges (sequential seasonality in ADS in 2Q), the management remains optimistic about growth in the segment. Also, the input cost scenario for key ingredients (chicken, oil, packaging) is stable to moderate, which, we believe, should help it maintain the 20%+ brand contribution margin for the format.

* PH – operating environment challenging: The demand trend in the pizza category has remained challenging (Exhibit 5/6) as seen in the past few quarters – a combination of high base, relatively higher average order value in the pizza category vs. other QSR segments and higher competitive intensity/aggressive expansion from both regional and national players. To that extent, the company has calibrated its store addition plan (from 100 stores earlier to 70-75 now). Further, the focus has been to improve relevance, retain consumers and build transactions for the brand; hence, the company introduced a value layer and increased its marketing investments. In the interim, this does dilute ADS and brand contribution margins, but the initiatives around building a premium portfolio (launched 10 new pizzas) and likely moderation in inflationary pressure should help a rebound in margins.

* Costa Coffee – attractive franchise with superior profitability: Post renewal of the agreement in FY22, Devyani has dialled up its efforts behind the brand and the results are clearly visible in terms of strong store additions (doubled over the last 1 year), and uptick in ADS and contribution margin (Exhibit8/9). The headroom for scale-up is immense (store count at 123 vs. 348 for Starbucks as of Jun’23) and with unit economics in place the company plans to adds 60-70 stores p.a. and is targeting an ADS of INR 40,000 (ADS for FY23 was INR 35,000) in this format over the medium term. We expect store count acceleration to continue and grow at a CAGR of c.43% over FY23-25E. With uptick in ADS and stable margins, we expect restaurant operating profit to grow at a CAGR of c.57% over the same period.

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