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India business drives overall profitability

Sapphire Foods 1QFY23 earnings print points to healthy start to FY23 as operating performance surprised positively despite inflationary pressures and sharp deterioration in Sri Lanka business performance (due to challenging macro-economic scenario). Key positives from India business were – a) continued strength in KFC business (recovery in dine-in sales and delivery sales holding up well) and b) strong restaurant operating profitability for Pizza hut (PH). While challenges in Sri Lanka business remain, management does not expect further deterioration vs 1Q levels. India business remains on strong footing with benefits of internal initiatives (right-price its menu, right-size its stores, higher menu innovations and scale up the omni-channel), playing out well. We maintain our positive stance and believe discount to peer (Devyani) is unwarranted despite near term concerns on Sri Lanka business. Maintain Buy rating on the stock.

* Healthy start to FY23: Sapphire Foods reported consolidated revenues of INR 5.5bn, up 10% qoq driven by 6.4% and 3.9% qoq growth in store count and average sales per store respectively. The growth was primarily driven by India business on account of normalized store operations in the quarter. Revenues were up 19% qoq which was partially offset by 29% qoq decline in Sri Lanka business. Gross margins (ex-other op inc) declined 259bps yoy/86% qoq to 67.7% due to input cost inflation and lack of commensurate price hike (especially in Sri Lanka business). However, benefit of operating leverage resulted in healthy qoq expansion in restaurant EBITDA margins for India business, which along with control over corporate overheads resulted in 13.5% q/q increase in Pre-IND AS EBITDA to INR 722mn, with a margin expansion of 42bps q/q to 13.3%

* Led by strong India business performance: 1) KFC India continued to strengthen its performance with revenue growth of 19% qoq with strong recovery in Dine-in and delivery sales remaining largely stable. ADS was up 9%q/q (vs 12% for Devyani) aided by price hikes (c.9%) to offset the impact of input cost inflation. Gross margins (down 200bps/60bps yoy/qoq) for the format were impacted by higher input costs (14-15% inflation) and weaker mix (lower delivery channel salience where pricing is higher). However, operating leverage and cost efficiency measures resulted in restaurant EBITDA margin expansion of 130bps q/q to 20.3%. 2) PH India business sales grew by 18.1% q/q. ADS was up 11% qoq (vs 7% for Devyani). Dine-in sales (85% recovery vs FY20) are below pre-covid levels largely due to weakness in Karnataka and certain mall stores. Healthy GM (+50bps q/q) and operating leverage resulted in restaurant EBITDA margin expansion of 330bps q/q to 14.8%. Store mix benefit is playing out well for PH format, with compact stores opened post April 2018 clocking high teen margins. 3) Sri Lanka business performance was weak on account of challenging macro-environment and steep currency depreciation. Sales were up 17% y/y, gross margins declined by 810bps (due to sharp inflation of c.30-40% & lack of commensurate price hikes) thereby impacting the overall profitability for the geography

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