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* SAPPHIRE’s revenue grew 13% YoY (7% miss), led by both KFC and Pizza hut formats. However, revenue in Sri Lanka declined due to the depreciation of LKR. EBITDA declined 2% YoY (8% miss), owing to low SSG, and therefore, negative operating leverage. 2HFY23 for PH was weak.

* The company’s SSSG was weak, with KFC experiencing a growth of 2% and PH declining by 4%, due to the challenging business environment (v/s est. 1% in KFC/ a decline of 6% for PH). As a result of cooling off of inflation, the company experienced a sequrential improvement of 90bp in margins. Further, KFC has taken a price hike of 3.5%, which could lead to margin accretion going forward.

* We reiterate our BUY rating with a TP of INR1,585, given SAPPHIRE’s healthy earnings growth trend and relatively inexpensive valuations v/s QSR peers.

SSSG beats expectations

* SAPPHIRE reported a consolidated sales growth of 13% YoY to INR5.6b (7% miss) in 4QFY23.

* SSSG: KFC up 2% (est. 1%), PH down 4% (est. a decline of 6%), and SL down 3% in LKR terms.

* Net new units (NNU): 16 for KFC and 12 for PH.

* Number of stores as of 4QFY23: KFC at 341, PH at 286, and SL at 114. There were a total of 743 stores as of 4QFY23.

* Consolidated gross margin contracted ~80bp YoY, while it expanded ~90bp QoQ to 67.9% (40bp above est)

* EBITDA (post-IND AS) declined 2% YoY to INR981m (8% miss). Margins contracted 260bp/ 200bp YoY/QoQ to 17.5% (30bp below est).

* EBITDA (pre-IND AS) declined 11% YoY to INR563m with a margin of 10% (v/s 13% in 4QFY22)

* PAT stood at INR1.3b (est. INR106m), led by recognized deferred tax asset amounting to INR1.25b. Adj PAT stood at INR102m (in line)

* In FY23, sales/EBITDA/Adj. PAT grew 32%/40%/2.3x YoY to INR22.7b/INR4.3b/INR1.1b

Highlights from the management commentary

* The management maintained its previous guidance of 130-160 store additions per year and expects to it double in the next three to four years.

* RM inflation has cooled down, hence, the management expects GMs to improve. Starting from Apr’23, the company has implemented a price increase of 3.5% for KFC.

* The company is taking a more cautious approach to expanding its footprint in Sri Lanka over the next 12 months. However, a recovery is expected to drive margin improvement in the next 12-24 months, with the expectation of exceeding 20%.

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