I love hanging out with my friends, and our go-to places are Burger King, McDonald's and Pizza Hut. As a kid, I remember ordering Domino's with my grandfather and having KFC with my father. These restaurants are called QSR restaurants(Quick service restaurants), and we all have memories of our favourite food items from these restaurants. Not only have they made their marks in our lives, but they are set to create immense wealth in the coming years. As something I love and something that can benefit us as investors, I decided to make the first Sectoral blog on QSR restaurants.
Industry Overview
The food industry in India is valued at 4 trillion Indian rupees or 50 billion dollars as of FY20, where organised QSR chains took up 10% of the market or 5 billion dollars worth of the market. Unorganised restaurants dominate the market, accounting for around 40% of the whole market. The food industry is set to grow at a CAGR of 8.8% and reach a market value of 6.4 trillion. However, the fastest growth amongst the lot is of organised chains, from 5 billion dollars to nearly 12 billion dollars in five years, with a CAGR of 19.5%. The growth rate is more than twice that of the whole industry, which makes it a favourable place to invest. However, what's causing this jump?
Source: Statista, 2024
Favourable macros and demographics
Urbanisation: Urbanisation increased from 20% in CY00 to 34% in CY20 and will increase to 38% by CY25. Urbanisation leads to an increase in disposable income, which leads to discretionary spending and significant changes in habits, favouring eating out and American food.
Young population: India has a very young population, with a median age of 28.7 as of CY22 vs. 38.4 for the USA and 38.7 for China. The growing working population is a key factor in increasing the number of times people eat out, as such a population does not dedicate much time to preparing food at home.
Cultural changes: Over the years, the culture of India has been evolving, which has led to increased dine-ins per week and reduced dependence on occasions to eat out. An average individual between 15-24 eats out 2.4 times a month and orders one time a month. Cultural preferences, which tend to favour hygiene, adopting a Western lifestyle, rising aspirational levels, etc., are the leading advantages for QSR restaurants as they are beating the industry average by a considerable margin.
Rise of delivery: Zomato and Swiggy have had a huge impact on the whole industry, which has led to increasing revenue from delivery and takeouts. Organised restaurants have been able to take strong advantage of this by spreading their discount costs across multiple restaurants and elevating their brand presence.
What differentiates QSR from a conventional restaurant?
Speed: One of the biggest differentiators of a QSR as a restaurant is its service speed. It's much faster than a conventional restaurant.
Pricing: On average, A QSR will have lower prices than a restaurant and, hence, have a lower average revenue per customer. However, lower priced items + speed allows the QSRs to have a higher volume of customers served, which helps them spread costs at a more extensive base.
Operating costs and setup costs: The set-up costs of a QSR are cheaper than those of a conventional restaurant as a restaurant's store size is bigger, and they rely on dine-in more than delivery. A restaurant's operating costs are higher than those of a QSR, and a QSR requires less manpower than a restaurant.
Scalability: Due to their inherent structure, QSRs are more suited for scalability. This allows them to invest in branding and differentiate themselves. Moreover, as an investor, QSRs are suitable for growth and hence a good way to invest money.
Standardisation: A substantial advantage that helps a QSR scale is the standardisation of taste and menu. I know how a McDonald's burger will taste; it does not matter if it's Mumbai, Delhi or Ahmedabad.
Setting up a QSR restaurant
What are the biggest costs of a QSR restaurant?
Rent and leases: QSRs prefer to be in a prime spot in the city they operate in. Such locations don't come cheap and hence command significant rental payments from the restaurants. Rent is a fixed cost that takes up a big chunk of revenue from these restaurants. For McDonald's and Burger King, around 25-30% of their revenue on a restaurant level goes towards rent.
Food and packaging: This is a given. A restaurant will spend quite a bit on raw materials and packaging. Again, we use McDonald's and Burger as an example; these restaurants use 30-32% of their revenue on raw materials for their food.
Employee cost: Employee costs at a QSR restaurant are generally lower than those at a conventional restaurant. For the same companies discussed above, they are around 9-10% of a restaurant's revenue.
Initial setup costs: QSR restaurant chains set up their restaurants( most of the time), and that requires substantial capital. It ranges typically around 3-6 crores per outlet.
Marketing: On a company level, most of the QSR restaurants spend 5%-8% of their Revenue on marketing and brand building. A company that can grow its revenue despite reduced marketing costs is good!
Royalty cost: There might be a misconception that McDonald's USA is the one building these restaurants in India, and that's very wrong. Most of these global chains do not set up their restaurants everywhere in the world; instead, they hire master franchisees who will build these restaurants in that specific region and take the profits from their operations. In return for using the brand names McDonald, Domino, KFC, Burger King, etc., they pay these brand companies a royalty, which the original companies set. For example, Jubilant FoodWorks operates Domino's in India and pays 3% as royalty fees. RBA, or restaurant brand India, operates Burger King, paying 5% of their revenue as royalty. Westlife Development operates McDonald's in the West and South and pays 4.5% of the royalty, but it is set to increase to 8%.
Now that we know the costs of a QSR restaurant, let's explore what matters when investing in one.
Key things to look for
ADS, or Average daily sales, is a key metric in the sector. Most of the businesses that we will discuss emphasize this metric. This metric is important as it's an indicator of how popular the brand is. Are more people coming to the store? The higher the average daily sales, the better.
SSSG or Sames store sales growth: the name explains what it means. This measures the development of the same existing stores a company owns. This is probably the most critical metric. Let me explain why! Let's assume I made one crore in revenue last year with profits of 20L; this year; I registered an SSSG of 20% or 20L increase in revenue. So my revenue is 1.2 crores, but does that mean my profits increase by 20%? No, it's much more. The costs, such as rent, employee cost, and utility( to some extent), stay the same no matter how much revenue I make. The only cost that jumps as much as sales is the cost of raw materials. Due to this, my profits will not increase by 20%, but maybe even 40%. This is why it's a critical metric.
Store count: How else can a QSR company grow if not SSSG? Well, of course, we should just set up more restaurants. Keeping track of the stores of a QSR chain is very important for two reasons. First, it helps us evaluate the company's growth ambitions and how fast it can grow in the next few years. Second and something that is not widely discussed, Store count gives us an idea of the acceptance of a business. If a QSR can grow its store count threefold and increase its revenue accordingly, that means that the business has some strength and that people like the taste. Similarly, if a business fails to open more stores, it could signal that the QSRs penetration has peaked and will struggle to open more restaurants in new cities.
Size of an outlet: It is essential to understand why this matters. Suppose I run a restaurant and rent a 5000 sq ft outlet while my opponent rents a 2500 sq feet outlet. For me to set up such a big restaurant, there are multiple disadvantages. I will need to spend a lot more on interiors; the utility bills will be high, the rent cost will be high, etc. For my opponent, most of the expenses he/she incurs will be cut in half compared to mine. I am already at a disadvantage. You would expect that double the size is double the revenue, but that is not true. Delivery is a crucial part of revenue and does not depend on store size. Moreover, the revenue also depends on the area; some areas can not handle huge stores. Hence, revenue per sqft will mostly be higher for smaller stores and help these stores become more profitable.
Things to be careful of in a QSR
Concept risks: Not all concepts work, but the ones that work make a killing. The odds of a new concept as a QSR working are low, but if they do work, they can be replicated 100s of times. Jubilant FoodWorks, the master franchisee of Domino's, is working on Hong's kitchen as a new concept. This could be a risk. It has already shut two of its concepts, which led to losses and a toll on its profit margins! So the rule of thumb is to avoid concept risks as they barely ever work and stick to what works.
Higher costs: The revenue of any restaurant is not predictable and can fluctuate quite a bit. Hence, it is very important to keep lean operations and focus on cost cutting. Pizza Hut India suffered due to its big store sizes and actually benefited by shifting to smaller stores. Moreover, Westlife Development, which runs McDonald's in Western and Southern India, is very efficient in terms of costs and commands a premium valuation due to that.
Royalty: Royalty is a straight cut from a company's profit. Most( except one) of the listed QSRs in India pay a royalty to their global counterparts. These can be risky because they depend entirely on these brand names, and the international companies can increase the royalty after their contract. Westlife is seeing its royalty increase from 4% to 8%. RBA, which runs Burger King, is safe as the royalty is fixed at 5% for the next decade. However, it can be a risk and should be evaluated.
Dependence on Zomato or Swiggy: As the industry giants consolidate their positions and focus on profitability, commissions are rising. QSRs, which rely on these giants for most of their revenues, will suffer because they can easily eat away at their margins.
Reducing ADS or store count: Reducing ADS is 99% always bad. It does not mean that the company is bad, as it can be triggered by other things, such as floods, but it's never a good thing. Reducing Store count is a sign of the brand peeking out, and hence, little to no growth in the coming years. These metrics are important to track as they signal the health of the business on a restaurant and corporate level and give indications of the future ahead.
Things that concern me about the QSR industry
We discussed the things powering the industry, metrics necessary for the success of a QSR chain and what can destroy a QSR investment. Let’s end this blog with what we should be careful of when we talk of the industry as a whole
Inflation: This is kind of a short term problem but must be addressed as it can be a recurring problem for the industry. Raw materials of a QSR restaurant are very volatile and hence, can significantly eat the margins of the business.This can cause troubles in the short run and should be made aware of. For example, Jubilant foodworks has been troubled by the rising dairy and cheese prices and hence led to decreased margins.
Mean reversion of consumer demand: FY23 was a great year for QSRs where they reported SSSG of 20%+. However, demand has slowed down and it could be because people are reverting back to their normal lifestyle instead of aggressive consumption and spending that happened in the form of revenge spending post Covid. We can’t be very sure of what will happen next, if the demand has actually slowed down or its just a phase, investors should track the SSSG of businesses to know.
Increasing competition: Zomato and swiggy has made it possible for a lot of home kitchens to be set up which can be a local challenge for QSRs. Moreover, there are a lot of entrants that have recently started their chains and are competing against the listed ones such as La pinoz, burger singh etc. It could be that the rate of new restaurants being set up is more than the QSR growth rate. I think I have completed my attempt to help you understand the crux of the QSR industry. This marks the end of the first part of the QSR sector, where I explain the whole sector. The next blog will evaluate the listed QSR restaurants based on the above-mentioned metrics! Until then, shoot me a message about your favourite QSR brand in India!
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