February 2021 Sector Report Retail f cus QSR: The Right Combo Nihal Mahesh Jham Abneesh Roy Prateek Barsagade +91 22 6623 3352 +91 22 6620 3141 +91 22 4063 5407 Nihal.Jham@edelweissfin.com Abneesh.Roy@edelweissfin.com Prateek.Barsagade@edelweissfin.com Edelweiss Securities Limited Retail Contents Executive Summary ........................................................................................2 Story in Charts ................................................................................................8 Industry Outlook .......................................................................................... 10 o Food service industry: Overview .......................................................... 10 o Chain QSR market: Fastest-growing segment ...................................... 13 o Online food delivery spurt to continue ................................................. 22 o Covid-19: A blip, but an enabler as well ............................................... 25 o What’s the secret sauce to success? .................................................... 27 Outlook & valuations: Factoring opportunity and profitability .................. 29 Appendix: Global corporations - Business models ...................................... 31 Initiating Coverage: o Burger King India ................................................................................... 35 Company Update: o Jubilant Foodworks ............................................................................... 66 o Westlife Development .......................................................................... 79 Edelweiss Research is also available on www.edelweissresearch.com, Bloomberg - EDEL, Thomson Reuters, and Factset Edelweiss Securities Limited Retail Executive Summary “There is no sincerer love than the love of India’s appetite for QSRs seems insatiable even after more than two food.” -George Bernard Shaw decades of the segment’s presence in the country. A combination of favourable demographics (millennials), India-centric value priced offerings and the recent spurt in food delivery aggregators have led to the market clocking a 19% CAGR over FY15-20. We expect their dominance on the Indian palate to gain further flavour and estimate the QSR chain market to be the highest growing sub-segment--23% CAGR over FY20-25E-in the entire food service market as chains deepen penetration in tier II/ III cities. Covid has, in fact, become an enabler boosting preference for QSRs. However, it’s not all a cake walk. Despite its popularity, success and return structures remain divergent. Most QSRs, except Dominos, are still tweaking their business models even as they keep expanding. In our view, key ingredients for success of QSRs are: a) A well-established brand. b) Menu adaptability–most important. c) Favourable store economics. d) Well-defined store location criteria. e) Regular adaptation to counter brand/menu fatigue. f) Established supply chain. Comparing major QSR companies, Jubilant Foodworks (JFL) ranks the highest on all these parameters despite lower store expansion potential. JFL, thus, remains our top pick in the QSR space (BUY, TP: INR3,575) spearheaded by Dominos, given the potential for store count to jump ~40%, imparting four-five years of visibility. SSSG, despite a mature network, remains industry leading, further reflecting the brand’s popularity. Moreover, Domino’s delivery plus digital leadership bodes well in the post-covid era. Burger King India (BKI), the last major QSR entrant in India so far, has aggregated a compelling recipe for success--strong brand, a favourable master franchise agreement, reasonable store economics and a customer proposition focused on value and wide offerings. Store addition potential (~4x) is the key plus in its favour, but demanding current valuations compel us to initiate with ‘HOLD’ and TP of INR143. QSR chains: Robust growth; international brands gaining flavour The QSR sector in India gained mileage post the entry of Domino’s and McDonald’s in 1996. Even after more than two decades of presence and growth, India’s chain QSR sector has clocked 19% CAGR over FY15-20--one of the fastest-growing consumer discretionary categories, driven by: a) younger demographics; b) India- centric offerings and value pricing; c) online food ordering and food delivery; and d) strong marketing push. Global QSR chains have captured a much higher market share (Top-5 hold ~50%) due to: i) popularity and brand pull is already established and much higher; ii) their fast food cuisines have been perfected globally; and iii) expansion into tier II/III cities. Delivery/aggregators fuelling exponential growth While delivery operations had always been around, a quantum leap in Platform-to- Consumer segment/aggregators (100% CAGR over FY16-20) has helped expand the 2 Edelweiss Research is also available on www.edelweissresearch.com, Bloomberg - EDEL, Thomson Reuters, and Factset Edelweiss Securities Limited Retail overall market exponentially. The segment currently accounts for 47% of the total delivery market (FY16: 6%). The industry is thriving due to development of the online ecosystem (mainly from Swiggy and Zomato), attractive promotions & discounts, a variety of new offerings and cash-back offers. Online aggregators also influence consumption behaviour and lead to significant increase in ordering over the long term. Moreover, aggregators have boosted sales of restaurants 30% on average, a significant driver considering the fixed cost nature of the business. Covid, while a blip, is a longer term enabler QSRs took a heavy knock from covid-19, especially the store/non-delivery focused players. Fortunately, these chains had the infrastructure and process for delivery services in place long before the spread of the pandemic, which enabled them to adapt swiftly to government regulations. Hence, while the entire food service market plunged 82% YoY in H1FY21, organised QSRs (Domino’s, Burger King, McDonald’s – West & South) contraction was restricted to 45% and by September recovery was already at 85%. More importantly, chain QSRs have been on target in meeting customers’ heightened requirements with regards to food quality, service standards, etc., and have successfully captured the opportunities thrown up by consumers’ cautious dining habits. Momentum to sustain; QSR’s to be fastest growing food segment India’s chain QSR sector has reached sizeable scale (FY20: INR188bn), but still forms mere 4% of the total food service market (FY20: INR4.3tn, global average 20%). In addition to existing enablers (demographics, value pricing, online ordering) increased penetration in tier II & III cities, facilitated by improved supply chains, innovation and customisation in operating models and store sizes, will also fuel growth. Over FY20-25, the QSR chain market is estimated to be the highest growing sub-segment--23% CAGR--of not just the chain market, but also the entire food service market. Despite opportunity and brand presence, return structures divergent Despite their global popularity, success and return structures of QSRs in India remain divergent. Domino’s is by far the most profitable and successful QSR in India driven by: a) high store throughput and margins riding its popularity and dominant market share; and b) limited store capex driven by its smaller store size as business is delivery driven. Burger QSRs have larger store sizes due to: a) more kitchen space requirement; and b) dine-in focus; this drives store capex higher and returns lower. In recent years, with most companies having established their presence, focus of mature QSRs is shifting from expansion to store economics and profitability. This has been the case especially with Westlife Development, which has initiated ROP2.0 in 2016 to improve store return ratios. Global QSRs (brand owners) though work on a different model of primarily franchising (See Appendix). What’s the secret sauce to success? In our view, key ingredients for the success of QSRs are: a) A well-established brand. b) Menu adaptability–most important. c) Favourable store economics. d) Well- defined store location criteria. e) Regular adaptation to counter brand/menu fatigue. f) Established supply chain. This has played out on the global front as well-- KFC in China, Dominos in Australia. Also, penetration of various QSRs remains focused on top-8 cities, signalling a long growth runway. Our preferred menu (picks) When we compare the three major QSR companies across these parameters (see Exhibit 2 below), we believe all have attractive product propositions and have been at the forefront of innovation and localization, which has helped them become Edelweiss Research is also available on www.edelweissresearch.com, Bloomberg - EDEL, Thomson Reuters, and Factset Edelweiss Securities Limited 3 Retail respective category leaders (Domino’s 80% share of pizza market, McDonald’s 36% of burgers & sandwiches and Burger King 16%) with an established supply chain network. JFL’s dominance and reach is by far the highest, but that to an extent has also limited incremental growth opportunities for the company. On this parameter, BKI leads the pack given its late start and also wider geography area compared to Westlife Development (WDL). It’s in delivery where JFL has a strong presence, much better than peers. Also, the salience of pizza to delivery has been traditionally higher. Jubilant Foodworks (JFL) has been the bell weather of India’s QSR space and also its success potential. Potential to expand Domino’s store count