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Sapphire’s performance over the past few quarters has been a mixed bag - SSSG trend has been weak while gross margin has risen steadily QoQ led by a benign input cost environment. In the near term, we don’t see these trends changing materially – SSSG is likely to remain muted with demand challenges continuing for PH and Q2 being a seasonally weak quarter for KFC. That said, the company has undertaken initiatives (value offerings to ensure transaction growth, new launches in premium range, increased marketing spend) to improve brand accessibility/relevance, which, along with the upcoming festive season, should help revive growth in PH. On the positive side, KFC’s (c.65% of sales) brand strength and profitability remain intact; the overall raw material scenario is also stable, which, along with a favourable mix, should support margins. In our previous report, we had highlighted Sapphire’s superior execution (link) and said there was headroom for the discount to Devyani (c.40% on pre-IND AS EV/EBITDA) to narrow over time. Any volatility in the stock should thus be used as an opportunity to add. BUY.

*PH – demand recovery not yet visible: Same store sales and average daily sales (ADS) are likely to remain muted in the near term, as the demand scenario remains challenging in the Pizza category amidst weak macro and high competitive intensity. Given the inflationary environment, consumers are downtrading to value offerings (Flavor Fun range) while the premium range is yet to see a recovery. As a result, the average pay cheque has declined, impacting overall same store sales and restaurant-level EBITDA. Both the Yum franchises have responded by intensifying their efforts (portfolio expansion and marketing spend) to improve brand relevance, which along with upcoming festive season & favorable base should aid growth from H2FY24. Also, store expansion in this format is likely to see some moderation in FY24 (vs. run-rate seen in FY23), although medium- to long-term guidance (doubling of stores in 3-4 years vs. CY21 levels) on store expansion is intact.

* KFC- long-term flavour intact: KFC’s performance has been relatively resilient vs. PH, and among the two franchisees, Sapphire’s execution has been quite commendable - absolute ADS, SSSG and ADS CAGR are higher vs. Devyani over FY19-23. SSSG is unlikely to see a recovery in 2Q, given that it’s a seasonally weak quarter owing to various festivities (in July/August) because of which nonvegetarian consumption is lower, especially in Sapphire’s territories (viz., North/West). From the medium-term perspective, the management remains confident about 5-7% SSSG. Also, KFC’s brand equity in the chicken segment is extremely strong and its differentiated chicken offering provides it an edge over the competition. Hence, store expansion is expected to be higher in this format vs. PH. Further, the raw material environment is stable to benign and the benefit was visible in 1Q, so, barring seasonal moderation in 2Q, achieving c.20%+ restaurant EBITDA margin should not be a challenge in this format. 

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