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Healthy ADS growth drives the earnings beat

* WLDL reported a better than expected sales momentum in 2QFY23. Even as gross margin was in line, operating leverage led to an 18% EBITDA beat from our expectation.

* The management indicated a gradual improvement in gross margin going forward, led by a further 2% blended price increase in Oct’22 and the return of the high margin McCafe business to pre-COVID levels.

* While WLDL’s prospects are improving, its medium term earnings growth can still be weaker than its peers, given: a) the increase in royalty, and b) the limited room to improve gross margin, with over 80% of its stores already having McCafé outlets. We maintain our Neutral rating.

Outperformance led by the sales beat

* Sales grew 48.5% YoY to INR5,724m (est. INR5,203m). SSSG stood at 40% YoY (est. 25%).

* WLDL opened six McDonald’s stores in 2QFY23, taking the total count to 337 stores.

* Gross margin rose 80bp YoY and 120bp QoQ to 65.5% (in line).

* Restaurant Operating Margin (ROM) stood at 22.7% v/s 17.4% YoY and 21.6% QoQ.

* EBITDA grew 116% YoY to INR959m (est. INR812m). EBITDA margin stood at 16.8% v/s 11.5% YoY (est. 15.6%).

* The company declared an adjusted PAT of INR315m (est. INR173m) as against a loss of INR44m in 2QFY22.

* Average annualized sales per store stood at INR67.5m v/s INR52m YoY and INR67m QoQ.

* Sales/EBITDA grew 72.3%/290.3% YoY to INR11,104m/INR1,832m in 1HFY23. Adjusted PAT stood at INR551m v/s a loss of INR378m in 1HFY22.

Key takeaways from the management commentary

* Sales non-metro towns grew 1.6x as compared to metro towns over its preCOVID base.

* Sales on the McDelivery platform grew 1.7x v/s third-party operators in the pre-COVID period.

* New and premium products: The management is seeing very good traction in meals and premium burgers. As fried chicken is a big imperative in South India, it is present in all the stores there. AOVs in the South are similar to that in West India. Currently, it is evaluating fried chicken in five stores in West India.

* Costs and margin: The management undertook a 2% blended price hike in Oct’22. Even as overall inflation has been moderating for WLDL, milk and wheat saw a continued inflation. Going forward, gross margin will improve from current levels.

Valuation and view

* The beat on our estimates, led by better than expected sales momentum, leads us to revise our FY23/FY24 EBITDA estimate by ~10% each.

* While the management is in talks with McDonald’s Corporation to stagger royalty rate increases beyond FY26, there is still a lack of clarity. A better operating performance in coming years may not present a strong case for further deferment.

* We maintain our Neutral rating, given its: a) fair valuations, b) scheduled increase in royalty rates to 2x from current levels, and c) limited incremental gross margin levers. Our valuation at 30x pre-Ind AS Sep’24 EV/EBITDA leads to a TP of INR805.

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