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Muted H1 trends lead to rating downgrade to ADD

We downgrade Sapphire to ADD (from Buy), on expectation of muted trends in H1FY25 across formats. Mgmt commentary suggests continuation of SSG decline in the KFC/PH India formats (at least for H1FY25) vs. our expectation of earlier recovery. For PH, expansion (that is curtailed), new innovations, and superior experience are showing some initial signs of recovery, though Mgmt remains cautious on higher competition due to Pizza category’s larger size and easier kitchen operations. On the other hand, KFC continues to enjoy cost/marketing leadership in the chicken category, where it focuses on maximizing value & improving customer experience/accessibility via continued network expansion, with ~20% brand margin. But persisting weak demand trends muffle any near-term trigger, prompting our 16%/6% cut to FY25E/26E EBITDA and rating downgrade, with pruned TP of Rs1,600/sh (22x FY26E EBITDA). Faster SSG recovery remains a potential upside to our estimates.

Q4 miss amid no respite for PH; KFC EBITDA largely in-line: KFC’s revenue grew 16% in Q4, led by 26% growth in store count and offset by a 3% SSG dip. Given weak macros, KFC is likely to have outperformed in most QSR categories, with 14%/20% brand EBITDA growth in Q4/FY24. Performance is aided by lower competition, value offering (Snacker@99/Lunch@149) and re-launches (Chizza/Rice Bowls). Efforts for digitization also continued, with Kiosks installed at 163 KFC outlets (38% of network). However, PH sales declined 3% owing to the 15% dip in SSG; impact on growth was partially offset by 12% higher store-count. Launch of Melts@169, Thin/Crispy Pizza, and the Pasta range as part of Company’s brand revival action plan aided in arresting further de-growth. Sri Lanka operating conditions are improving, with 4% SSG reported in local currency and 12.3% EBITDA margin. Overall store additions were muted, at 22 in Q4 (vs 36 on average over 8 quarters), led solely by 23 additions in KFC; PH expansion is likely to see moderation for H1 as well. Gross margin gained by 90bps, led by benign RM costs. However, store margins declined by 260bps to 13.7%, due to a 1,130bps drop in PH brand contribution, whereas KFC/SL saw a relatively lower decline at 40/190bps. Overall EBITDA at 8.6% dipped by 150bps, helped by lower HO costs (down 110bps).

Earnings-call KTAs: 1) The 3-Year plan (given in Dec-21) remains intact for Sales/ EBITDA CAGR of 25%/30%. Doubling of stores is likely to be fulfilled for KFC; however, for PH, Mgmt aims for cautious expansion with 3-5% correction and ~10% refurbishment (5Y+ stores) in the portfolio. 2) Gross margins are likely to remain stable; KFC’S targeted brand contribution remains ~20%, as Sapphire targets re-investing additional gains in expansion. 3) Dragon-Tail solution is now integrated with 100% restaurants and all aggregators. 4) Late-night delivery implementation in PH stood at ~91% of the high street network. 5) Compared to historical trends, the Q1TD ADS is witnessing an in-line sequential pickup for KFC, but the ADS pick-up is relatively better in PH. 6) Transaction decline in KFC/PH is largely in-line, with SSG declines. 7) Capex at Rs3.8bn remained high, despite lower store adds at 129 vs 164 in FY23, due to higher refurbishments and technology investments in FY24. 8) PH store expansion will only catch up when brand ADS achieves the ~Rs55k range and SSG reaches high-single digit growth; till then, SAPPHIRE will continue to focus on brand revival via higher marketing spends (although not at cost of EBITDA loss)

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