Part I covered the industry and gave us a template to analyze QSR industries. In this part, we will take up some of these listed businesses and use this template and understand whether they could be worth investing in or not.
Before we begin, we need to understand that FY24 has been a difficult year for QSRs due to a number of issues such as inflation, reduced consumer demand and brand image being hampered due to geopolitical events. Due to this, the businesses have suffered quite a bit; however I think that is why it's the best time to test them because only the strongest can survive such times and actually report growth.
*Due to how long the blog can become, I will focus on the few prominent businesses that I believe will help cover the whole sector.
Recap of template
ADS or Average daily sales: The sales done per day per store. Higher the better! Stores which have a smaller store size might not report higher ADS however, these stores have reduced costs as well so the profitability might stay the same or even increase.
SSSG or Sames store sales growth: Can a store grow their sales by maintaining the same store count? It is a very strong metric as it shows that footfalls are increasing and that profits can increase despite the same costs(Operating leverage!)
Store count: If a QSR can sustainably add more stores, it means that the brand is acceptable and has potential to grow. Second, these stores fuel additional revenue
Concept risks: A lot of QSR businesses introduce new chains and most of these fail. These failures can pull down profits and hence, are not that good for us as investors. However, I don’t want to keep this one sided and hence, Concept risks are also necessary as these businesses need new ideas to grow so they are essential in the longrun, but we should only invest when we can say with some certainty that this new idea can grow!
Lean cost operations: As mentioned above, the demand can be very volatile and hence, it's very important to maintain strong margins at store and company level.
Royalty risk: The global parent company can increase royalty and that will through your margin expectations. Dependence on a global parent makes this a strong risk and should be studied well.
Geographical risks: This is a new risk I thought had to be added. A lot of these QSRs are entering new geographies in Asia and it can be dangerous as not a lot of them have been getting good responses. This is a risk that should be evaluated strongly!
Valuations: Obviously we can’t just pay any price for the business, so valuations are an integral part of identifying what business is worth buying or not. We will use the metrics Price/sales and Price/Cash flow as depreciation eats up a lot of the profits and makes it difficult to evaluate the business
Let's start with the first business
Westlife Development or Mcdonalds India
Westlife development is a listed business that operates Mcdonalds in West and south India through its subsidiary: Hardcastle Restaurants. North and east is headed by a business called Moon beverages!
Let's look at the template and analyze the business!
ADS and SSSG
Mcdonalds does not give ADS but it gives a similar metric, Average sales per store which is basically ADSx working days. The average sales have been on an increase from FY21 to FY23! However, this year has not been that good for the business. However, I see that as a win because despite a lot of headwinds, the business has been able to maintain its average store per revenue! 9M FY24 revenue stands at 6.4 crores while FY23 was 6.62 crores.
SSSG though( the % number on top), is a concern. SSSG has been slowing down and such a sharp drop this year is not a good sign. The reason I believe is because Mcdonalds has been trying to premiumise its menu but the current situation demands value offers, which is what led to Mcdonalds suffering. However, they have added value meals from this quarter onwards and expect signs of recovery soon.
Store count
Mcdonalds has been able to open new stores consistently and maintain good average revenue! Mcdonalds has steadily increased its store count from 322 in FY22 to 380 in FY24 and is planning to be at 580-630 stores by FY27. This proves that there is a lot of potential in Mcdonalds in india and that the brand is accepted well.
Lean cost structure
Mcdonalds is probably one of the best in terms of margins. It has maintained a very good strong margin. The reason it has been able to do so is because of its premiumisation strategy in which they are offering premium products and increasing sales on the chicken side in south India. Moreover, McCafe has been a huge hit for Mcdonalds as they have been able to command margins above 75%! The revenue per sqft from McCafes is very high as the additional setup cost is negligible.
Moreover, Mcdonalds has been very successful in maintaining company level margins, at around 16.8% for 9M FY24
Royalty risks
Westlife currently pays a 4.5% revenue but it is set to increase to 8% by FY27. This will be a cause of concern if they fail to increase their ebitda margins by the same basis points because it will directly eat into their profits.
Concept risk and geographical risk
Westlife does not face any of these risks as they stick to their tried and tested concepts and have not taken any geographical risks as well.
Valuations and conclusion
Westlife trades at a premium of 5.38 Price/sales and 36.8 Price/Cash flow. Due to the sectoral slowdown, the numbers seem elevated because the margins and profits are depressed. However, I believe the business is fairly valued or is a little on the premium side.However, I consider it a very strong business with good execution and brand image, it has the potential to lead the QSR flock and emerge as a strong market leader.
Restaurant Brand Asia or Burger King India
Burger King India started its operation in 2014 and exclusively heads the Burger King franchise in India and Indonesia. It also has the exclusive franchise of Popeyes in Indonesia.
ADS and SSSG
Burger king has been good at maintaining its ADS, in fact it has increased from 119,000 in FY23 to 121,000 in FY24! Even though its not much compared to Mcdonald’s 187,000 ADS in 9MFY24 the stability the business has shown despite the headwinds is commendable
Store count
Burger king has been exceptional in terms of store count. From 315 in FY22 to 451 in FY24 is not easy. They aim to increase their store count from 450 to 700 by FY27. We can’t say for certain if they will be able to achieve this, but the growth with which they are going ahead certainly makes it possible and quite likely!
Lean cost Operations
Burger king has been successful in increasing their gross margins to compete against Mcdonalds. Even though Mcdonalds is at 70%+, Burger King has improved from 66% to 68% in the last two years. We can attribute this success to increased store openings and the launch of BK cafe. BK cafe like McCafe commands high margins and hence helps boost the overall margin of the business. Moreover, the rapid expansion of stores( and the stores actually becoming successful) has allowed more pricing power in terms of raw material and spreading costs such as administrative and marketing costs thinner.
However, Burger king lags behind in terms of company level EBITDA margins compared to Mcdonalds! The company EBITDA margins at 6.8% for Q3 FY24 while its 16.5% for Mcdonalds! That's a huge difference and Burger King has a long way to go to compete.
Royalty and concept risks
Burger King does not come under such risks as the royalty is fixed at 5% till 2040 and they do not experiment with new concepts as well!
Geographical risk
Burger King India is doing very well, but it's the Indonesian branch that is pulling down, I could write a whole article on everything wrong about it but I will try to contain myself. The company acquired the Indonesian branch and is attempting to turn over the business. It is currently loss making and the company is shutting down the loss making stores to improve capital allocation.
The gross margins too are at 56% which is not good compared to its indian counterpart.
RBA does not see a lot of opportunity in store openings and hence is focusing on profitability at the moment and this branch will pull the profit and loss statement of the business for a while. However, Popeyes is turning out to be a promising Chain as the ADS is 3x more than Indonesian Burger King and has higher gross margins too!
Valuations and Conclusion
I believe that Burger king has the strongest potential amongst all to expand and increase its profits. However, what concerns me is its margins and if it will be able to convert its sales to cash flow. This concern is reflected in its valuations as well because the Price/ sales is 2.15 but Price/Cash flow is 40.7! Mcdonalds is a stronger business and hence RBA at Price/Cash flow seems highly overvalued but the story is opposite when it comes to Price/sales. What will make or break this investment will be the Indonesia turnaround and how efficiently it can manage its cost in the future.
Jubilant foodworks or Domino’s India
Jubilant foodworks is the master franchise of Domino’s India and is the biggest food service company of India. Apart from India, it operates Domino’s in Turkey, Sri lanka, Bangladesh, Azerbaijan, Georgia. It operates Popeyes in India, Bhutan, Bangladesh and Nepal. It operates Dunkin donuts in in India and has its own chain called Hong’s kitchen
Before we begin, my analysis will mainly focus on Domino’s India as more than 90% of revenue and 95% of stores are Domino's in India.
ADS and SSSG
Despite the resurgence in FY22 and FY23, Domino’s has failed to increase its SSSG. This is mainly because domino’s has reached a saturation point where it is very difficult to expand the existing brand. Moreover, the ADS has fluctuated 5-10% in the last three years. This is an indication that the stores have matured and not a lot of growth or downfall can be expected.
Store count
Domino’s has increased its stores from 1520 to 1928 from FY22 to FY23. this is a very strong growth for a big business like this as the base is quite large. However, it is difficult for the brand to expand at a similar pace without sacrificing ADS and SSSG. It remains to be seen how will Domino’s fuel its growth in the coming year.
Lean cost operations
Domino’s is extremely good at maintaining its margins. The margins, although have reduced from its FY22 highs but are still at around 76%. Pizza businesses in general have higher gross margins and hence Domino’s is bound to have margins higher than the discussed burger chains. The EBITDA margins too are quite good but have declined from 25% in FY22 to 19% in FY24. Domino’s has faced the brunt of rising dairy prices and hence has taken a hit on its margins.
Royalty risk
There is no royalty risk as such because the royalty is fixed at 5% for the next decade or so.
Concept and geographical risk
To ensure growth, Jubilant foodworks aggressively expanded into multiple countries and multiple QSR chains. It will be a difficult task to maintain a strong growth from countries such as Bangladesh, turkey, sri lanka etc as the consumer behavior is highly favorable in India compared to them. Moreover, Jubilant already faced losses in trying new concepts such as ek dum biryani and right now are experimenting with Hong’s kitchen. It could be a concept risk.
Popeyes can be the next lever of growth as it's a strong brand and presents good opportunities but it will take time for us to confidently say so.
Valuations and Conclusion
The business trades at a Price/sales of 5.4 and a price/ cash flow of 28.2. I believe that the business is overvalued because I do not see a lot of growth potential in the business. Mcdonalds and Domino’s command the same valuations to some extent but there are multiple risks in Domino’s(concept and geographical)+ difficulty to increase sales. I believe that there could be derating in the future, but it depends on how Domino’s finds ways to grow in the coming years.
QSR is a vast ocean of opportunities and there is a lot to learn in this industry. I attempted to analyze three businesses which are some of the biggest in the industry and teach a lot about the template that I talked about last week. However, there are other listed players such as Devyani, Sapphire and Barbeque nation that I could not analyze due to the length of the blog. However, if you all do wish to see the analysis on these businesses, please let me know and I will work on them accordingly.
Until then, I hope this blog taught you all a lot and helped clear any confusion that there is regarding the sector.!
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