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Devyani’s 2QFY24 performance was below expectations, with operating environment remaining challenging as seen in case of other QSR players too. On the topline front, sales growth was largely driven by store additions, as same store sales for KFC/PH declined by 4%/10%. KFC performance on sales & profitability appears weaker vs Sapphire Foods. PH performance saw further deterioration, as the category is seeing impact of downtrading to lower price point QSR categories and high competitive intensity. This, along with disruption in International business (Nigeria) & margin compression in Costa Coffee, drove earnings miss vs our expectation. While management remains confident of recovery in KFC profitability, PH margin recovery could take more time in current context. On the positive side, store additions remained robust and RM scenario in key brands is benign; however, SSSG recovery will be key in the near term for uptick in profitability. From long term perspective, we believe that opportunity size, execution capabilities, strong promoter backing of RJ Corp and optionality in other brands (Costa Coffee) provide assurance on the growth runway.

* Below estimates - store expansion remains strong; however, SSSG continues to disappoint: Consolidated sales of INR 8.2bn, up 9.6% yoy (store count +24%) and down 3% qoq, was c.4% below our estimate. India sales grew 12% yoy (store count +24%) while International business sales declined 26% yoy (store count +22%), impacted by inflation & currency devaluation in Nigerian business. SSSG saw moderation across brands - PH & KFC saw a decline of 10%/4% while Costa SSSG’s at 8.5% was relatively resilient. GMs improved 61bps yoy (easing of input costs) to 70.8%, but expansion was lower vs Sapphire, due to lower expansion in KFC & compression in Costa/International margins. Scale deleverage resulted in 428bps decline in brand contribution margins to 15.4%. Corporate overheads as a % to sales at 3.8% was lower than trend seen in recent past; hence, Pre-IND AS EBITDA margin compression was lower at 351 bps to 11.5% (JMFe:12.4%).

* Scale deleverage impacts contribution margins across brands: 1) KFC India revenues were up 14.9% yoy (SSSG: -3.9%, weaker than flat SSSG for Sapphire), led by store additions (+28% yoy). ADS was down 9.9% yoy/6.8% qoq, due to higher incidence of vegetarian days, especially in core market of South which sees higher impact in this period. GMs were up 105bps yoy as input costs remained favorable. Scale deleverage resulted in brand contribution margin compression of 210bps yoy to 19.4% (vs Sapphire at 19.2%). Profitability performance was weaker compared to Sapphire, likely due to adverse mix and higher scale deleverage impact. 2) PH India sales grew by 1.5% yoy (SSSG: -10.4%, vs Sapphire’s -20%) impacted by downtrading to lower price point QSR categories and increased regional competition. GM up 120bps yoy to 75.7% due to benign RM; scale deleverage & higher marketing spends, however, resulted in EBITDA margin compression of 928bps yoy to 7.7% (vs Sapphire at 7.6%). 3) Costa Coffee sales were up 57.3% yoy (SSSG of 8.5%, ADS -3.2%). GMs were down 324bps yoy & 86bps qoq owing to RM inflation & adverse mix; contribution margins declined by 481bps yoy to 14.7%, impacted by higher store additions.

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