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ADS performance muted, margin delivery surprises positively led by KFC

Sapphire Foods 3QFY23 earnings print was inline on the revenue front, primarily led by higher store additions as ADS was below expectations. Despite that EBITDA performance surprised positively, led by better margins, which is also a function of relatively higher salience of KFC business (which has superior margins) vs others in the quarter. ADS saw moderation across businesses, especially in PH & management attributed the same to moderation in demand post festive, higher store additions & high competitive intensity (in Pizza category).Trends in Jan/feb have broadly remained the same on the demand side. On the RM front, PH margins could see some further pressure owing to inflation in dairy products while KFC margins should sustain as the input cost scenario is stable to moderate. Sri Lanka performance seeing improvement qoq; robust store addition and stability in operating environment points to gradual recovery ahead. In the near term, inflation induced demand weakness could weigh on SSSG & margin trajectory. Store addition remains ahead of expectation which highlights management’s confidence in the scalability of the business model. Valuations at 21x FY24E EBITDA (pre-IND AS), not demanding. Maintain BUY.

* Inline sales, margin delivery ahead of expectation: Consolidated revenues of INR 5.96bn, up 17.5% yoy/5.9% qoq (India & Sri Lanka business revenues were up c.6%/9%% qoq), was broadly inline with our estimate as weakness in ADS was offset by higher store additions. India store count was up 31% while average sales per store declined by 6% yoy/2% qoq. Gross margins declined 210bps yoy (impacted by input cost inflation across India & SL) but up 65bps qoq (led by uptick in KFC & SL business) to 67.1% (vs our est of 66.6%). This along with 22% increase in store level expenses and a c.170bps incentive benefit in base quarter resulted in 390bps yoy decline in Pre-IND AS Restaurant EBITDA/company EBITDA margins to 18%/12.4% respectively. Reported EBITDA at INR1.17bn, was 14% ahead of our estimate led by higher GMs & better control over costs.

* Muted ADS across businesses, KFC India performance relatively better versus PH: 1) KFC India revenues were up 25.7%yoy/9.1%qoq (SSSG:3%), primarily driven by store additions. ADS was down 5.6%yoy and up marginally by 1.5% qoq (vs -4% for Devyani). Gross margins were down 150bps yoy but up 90bps qoq (KFC-DIL GMs declined 30bps qoq) to 66.5%, higher than our expectations. Scale deleverage and 130bps incentive benefit in base led to comparable restaurant EBITDA margin compression being lower at 230bps y/y to 20.2%. 2) PH India business sales grew by 20% yoy (SSSG:-4%) but down 3.3%q/q, driven by store additions largely. ADS decline was much steeper at 9.4% yoy/qoq (vs -8.5/-4.4% for Devyani).Gross margin compression (100bps/30bps yoy/qoq but was lower than PH-DIL) on account of inflation in dairy based inputs, scale deleverage & incentive benefit of 240bps in base, led to comparable restaurant EBITDA margins for declining by 320bps yoy to 14.1%. 3) Sri Lanka sales grew 9.3% qoq (ADS +2.7%, store count +7.5%); gross margins were up 190bps qoq to 57.3% while EBITDA margins stood at 14.6%, down 40bps qoq. 

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