The India QSR Story: Slice & Bite Institutional Equities This page has been intentionally left blank Institutional Equities QSR Sector Thematic 7 June 2021 Tempting prospects Vishal Punmiya The entry of international brands of Domino’s and McDonalds’s in India during the mid-1990s marked not Research Analyst just the emergence of the Quick Service Restaurant (QSR) format, but also paved the way for the growth of the organized food services industry in India, which was basically non-existent in the country. The QSR [email protected] format seems to be the perfect mix of maintaining decent consumer connect along with being lucrative. +91-22-6273 8064 Thus, over the years it has become an integral part of the industry as depicted by its ~11% contribution to the overall organized segment. Over FY14-FY20, the QSR format (commanding the highest share in the chain market) grew at a CAGR of 19.1%, ahead of the chain market’s growth of 17.6% and much ahead of Videesha Sheth the overall organized market’s growth of 12.9%. International brands have dominated the QSR market with Research Associate +50% share of revenue on the back of (i) brand equity (ii) investments behind increasing geographical [email protected] presence (iii) menu glocalization (iv) value focus (v) ability & agility in keeping up with trends (vi) focused +91-22-6273 8188 marketing efforts (vii) backend integration and (viii) investment in technology. With a healthy demand outlook and surge in investments, the industry is expected to witness substantial growth and operations of large segment of the unorganized market are expected to get streamlined into organized market. Brands with clear strategy, strict focus on capital allocation and steady expansion plans will sustain over the long term. In the near term, there is pain due to the curbs led by resurgence in Covid cases, but due to the resilient convenience channel and stringent standard operating procedure (SOPs) in place, the QSR sector should see faster recovery once these curbs are lifted. To value the future potential of this industry in an optimum way, we are now valuing the QSR companies on DCF basis. Based on which we continue to maintain our Buy rating on Westlife Development (WDL) and remain positive on the its ability deliver strong performance in the medium-term. We also continue to like the market leader, Jubilant Foodworks (JUBI), which operates at scale nowhere close to the 2nd player, has better financial metrics and has also recently taken strides to diversify. We continue to have an Accumulate rating on JUBI. Recently listed Burger King India Ltd. (BKIL), unlike WDL, is a pan-India play. We believe that with its current strategy and margin Sector Update profile, it should become profitable by FY23. We Initiate coverage on BKIL with an Accumulate rating. QSR format will be the quickest to recover in the food services industry: Just as the food services industry was reviving from last year’s curbs (varying from state to state, recovery ranged from 60-80% vs pre-covid level of operations as per media reports), fresh set of restrictions imposed by many states post the resurgence in covid-19 cases have threatened to derail the recovery made so far. Most of these states have allowed restaurants to offer their services only via home deliveries that too in restricted hours. Given that dine-in operations have higher saliency in the overall organized segment, these restrictions will turn out to be a big blow to the already distressed industry, especially small standalone restaurants. This is where the QSR sector, stands to benefit, as the format has transitioned to comfort food across price segments, catering to all income levels/segments benefitting from any downtrading along with addressing the aspirational demand in non-Metro areas. The top players in the QSR space benefit in a big way, since they have the necessary infrastructure, healthy balance sheet and an established convenience channel to cater to the consumer demand. Shutdown of ~30% (as per industry experts & media articles) food service formats in tier I cities/metros (majority belonging to the organized standalone & unorganized segment), due to the pandemic, has shifted demand towards the QSR segment & certain other affordable formats of the chain market, which further strengthens the space. Leading growth within discretionary space: Within our consumer coverage universe, revenue of QSR companies has grown at a CAGR of 19% over the last three years (FY17-FY20; since FY21 was an abnormal year) compared to other discretionary categories in our coverage - Paints and Alcoholic Beverages, which have grown at 10.7% and 5.4%, respectively (our FMCG coverage companies have grown at 6%). This is despite the fact that two leading brands, Domino’s and McDonald’s operated by JUBI and WDL (West & South India), respectively, have existed for ~25 years in the country, thereby making them fairly matured brands. Over FY20-FY23E, we expect the revenue of our QSR coverage companies to grow at 12.1% CAGR on the back of healthy growth momentum led by growing volumes/penetration through value centric customer proposition, premiumization, ramp-up in convenience channel, introduction of innovations & product platforms and store expansion beyond metros & tier-I areas. Multiple legs of growth for the future: (i) International QSRs have struck a chord with Indian consumers through their value proposition by including variety of entry level products, affordable meal upgradation options and discounted prices on combos & meals. Hence, while the average Indian consumers’ ability and willingness to spend on aspirations, experiments and socializing over food have increased, their stickiness in terms of cost-consciousness will continue to drive them towards fast food brands. (ii) While value remains the belly of the market, companies have not shied away from introducing premium offerings to meet customer need of a better indulgence, which aids the company in increasing ticket size as well as margins. (iii) QSR companies have also expanded beyond their core offerings – from pizza to pasta (Domino’s), from burgers to beverages, breakfast, fried chicken, rice bowl, etc. (McDonald’s, Burger King) - to enhance consumer trials and eventually scale up consumption of these offerings. (iv) Convenience channel (delivery, takeaway, drive-thru, on-the-go) is another key driver of growth since it is not just the need of the hour for any QSR brand, but also a significant enabler of the future due to increase in frequency of ordering and a growing user base. (v) Strong growth prospects of the organized food services industry and attractive real estate prices have led to many serious QSR players opting for ambitious expansion plans, especially beyond Metros & Tier-I cities, which will have a direct bearing on their growth. Mcap TP Upside/ EV/EBITDA (x) P/E (x) Pre-tax RoCE (%) Company Rating CMP (Rs) Rsbn $bn (Rs) Downside (%) FY22E FY23E FY22E FY23E FY22E FY23E BKIL Accumulate 60.1 0.8 157 155 -1 32.9 22.4 - 214.8 5.6 14.1 JUBI Accumulate 418.9 5.7 3,175 3,110 -2 34.7 26.4 81.7 53.8 59.1 65.5 WDL Buy 75.5 1.0 485 560 16 28.1 19.7 178.3 60.0 14.1 25.6 Source: Company, Nirmal Bang Institutional Equities Research Please refer to the disclaimer and analyst certification towards the end of the document. Institutional Equities Table of Content Industry Dynamics………......................…………..….……..…………………………...….…...…..........05 Industry poised for growth led by the organized segment..…………….….............................05 Chain segment to pace ahead, driven by expansion in QSR format………......................….08 Value focus and discounts offered through food combos & other promotions will continue to remain key drivers……………………………….................................................……….……...11 Aftermath of the first Covid wave in favour of QSR players; similar pattern likely to repeat post second wave……………………………………….................................................……….13 Burgers and pizzas will continue to be a dominant category for the QSR format……………………………………………………………….......................…….………….17 Prospects of QSR industry beyond metros & tier I cities…………….........................………..19 Online delivery channel - From a supplementary driver, to necessary channel of growth of the food services industry…………………………………................................................…….21 Potential of cloud kitchen & its scalability …………………......................…………..…..…….25 Other offshoots of increasing application of technology on the industry………………………………………………………………………........................…..….28 Advertising & marketing remains important for the QSR industry………..........................…..29 Sector view....……….…..……………………..…………..……….…….…….…….........................……..31 Peer comparison in charts...….………………………………....….…….......................……….32 Global fast-food market...……………………..…………..……….…….…….…….........................……..35 LATAM fast-food market – case study....……………………....….…….......................….……37 Risks for the QSR industry….……..….……..…………………………….……...........................…..…...39 Burger King India Ltd. (Initiate with ACCUMULATE at a TP of Rs155)…….…..........................……..41 Jubilant Foodworks Ltd. (ACCUMULATE; TP of Rs3,110)…...……..…….......................….…....……81 Westlife Development Ltd. (BUY; TP of Rs560)……………...………………......................…....…...…97 4 Consumer Sector Institutional Equities INDUSTRY DYNAMICS Industry poised for growth led