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On track despite (some) Sri Lanka (likely) woes

4QFY22 – India: Decent revenue print (some weakness in Pizza Hut though due to operating restrictions). Growth focus protected operating margin prints despite the gross margin pressure (price hike taken in April).

On Pizza Hut Sri Lanka (SL) (concerns around which have been a headwind for the stock), the situation is not ‘very bad’ (as per management) – (1) While store operations are disrupted by 2-3 hours each day, volume growth is trending well, (2) Currency depreciation impact of 40% should be partly mitigated by good underlying growth, (3) Store expansion plans for FY23E are on track. We believe there will be some decline in FY23E. That said, we believe the situation is still evolving. When a country is faced with such significant economic challenges, a discretionary category is unlikely to escape without at least marginal bruises.

We believe Sri Lanka concerns are priced in. Maintain BUY.

* Decent quarter on an overall basis: Consol. revenue was up 46% YoY to Rs4.97bn. PH performance was slightly muted given high mall salience led to missed sales due to operating restrictions. In terms of SSSG, KFC/PH and SL reported prints of 15%, 3% and 29%, respectively. In 4Q/FY22, Sapphire added 13/60 KFC outlets, 10/57 PH India outlets and 6/25 SL outlets. It re-iterated target to double store count (vs Dec-22) in the next 3-4 years.

* Margins managed well at the operating level: Sapphire has been able to offset inflationary pressure at the operating level while food inflation did take a toll on gross margins (particularly SL). On an overall basis, gross margins were down 175bps YoY to 68.7%. SL gross margin contraction stood out – down 530bps YoY to 64.9%. However, consol. EBITDA margins expanded 370bps YoY to 20.1% with SL EBITDA margins contraction restricted to 190bps YoY. As highlighted in our note (link), it has already taken ~10% price hike in KFC and ~3% in PH. It is also looking to take another 3% price increase in PH. In SL, given the sharp inflationary pressure, price hikes will be lower than the inflation and the quest is to manage operating margins.

* Valuation and risks: We cut our EBITDA estimates by 8%-4% for FY23-24E largely due to impact on Sri Lanka business; modelling revenue and EBITDA CAGR of 32% and 46% respectively over FY22-FY24E. Maintain BUY rating with a DCF-based revised target price of Rs1,700 (was Rs1,800). Key risks: (1) irrational competition due to increased store expansion, (2) failure to turnaround Pizza Hut business and (3) further detoriation in macroeconomic conditions in Sri Lanka.

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