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Resilient KFC performance while challenges persist for PH

Sapphire Foods’ 2QFY24 earnings print was broadly inline with our muted expectations. Construct of earnings performance was similar to 1Q – sales performance was largely driven by store additions as muted same store sales along with scale deleverage impacted the overall operating profitability. On the positive side –a) KFC delivered another resilient performance with flat SSSG despite higher vegetarian days in the quarter & restaurant margins were healthy at c.19% aided by higher gross margins; b) Srilanka business saw further recovery with ADS up 11% yoy & as well as uptick in margin trajectory. On the flip side, PH business remained inline but quite weak – management attributed the same to challenging demand, increased competition activity and high base. A lot of initiatives (innovation, higher marketing spends, consumer experience & closure of loss making stores) are being undertaken to revive the brand performance. While operating environment has been challenging, we believe a resilient KFC (65% of sales) and recovery in SL should help offset the impact of weakness in PH. Valuations at 19x FY25E EBITDA (pre-IND AS) not demanding; however, pace of recovery in SSSG will be key monitorable.

* Revenue performance inline primarily led by store additions: Consolidated sales of INR 6.4bn, up 14.2% yoy (-1.8% qoq) was 2% below our estimate. India sales grew by 12% yoy (-2.7% qoq), while SL business outperformed yet again with sales growth of 29%yoy (+8% CC & +4.7% qoq). Sales growth was led by store additions (+23.7% yoy). India store count was up 25.8% while average sales/store declined by 12% yoy (-7% qoq) – a function of muted same store sales across brands due to challenging operating scenario & high base (for PH) and impact of higher incidence of vegetarian days (for KFC). GMs were up 231bps yoy (led by easing of input costs across brands) to 68.7%. Impact of scale deleverage was much sharper in PH which was to some extent offset by margin expansion in KFC & SL business. Resultant Pre-IND AS Restaurant/Company EBITDA margins compressed by 67/50bps yoy to 16.1%/10.6% respectively.

* KFC & SL performance relatively better, lot more work needs to be done in PH: 1) KFC India revenues up 19.3% yoy (SSSG/SSTG was flat), led by store additions (+26.6% yoy). ADS was down 6.7% yoy/9.4% qoq owing to higher incidence of vegetarian days. GM were up 230bps yoy to 67.9% led by benign chicken prices & price hike benefit. Store level costs were controlled well, thereby curtailing impact of scale deleverage resulting in restaurant margins still expanding 130bps yoy to 19.2%. 2) PH India sales declined 5.7% yoy. Store additions remained healthy (+24.9% yoy), ADS decline was much steeper at 25% yoy (-7.7% qoq). SSS declined by 20% yoy, albeit on high base (+23% in Q2FY23) – mgmt. attributed it to tough demand conditions and high competitive intensity. GM surprised positively (+140bps/+100 bps yoy/qoq to 76.1%) due to benign RM; however, scale deleverage resulted in restaurant margin compression of 750bps yoy to 7.6%. 3) Sri Lanka sales grew 29.1% yoy (ADS +11% yoy/flat qoq). CC growth was 8% yoy (SSSG +1%). Geography saw 4 store additions after a gap of 2 quarters. Profitability improved sequentially with GM/ Restaurant margins improving 170bps/230bps to 62.2%/15.3%.

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