Hardcastle Restaurants (HRPL) is the master franchisee for West and South India operations of the McDonald's chain of restaurants. In a proposed scheme, the company will become a direct subsidiary of Westlife Development (WDL) by June-July and focus solely on the McDonald's operations.
HRPL reported a compounded annual sales growth of 38 per cent over 2009-12, fuelled by strong same-store sales (SSS) growth and new store additions. The stock has run up significantly (4.6 times) since the merger announcement in December 2012 but still has juice left due to strong growth prospects, believe analysts.
"HRPL is amongst the fastest growing McDonald's restaurant franchisees in the world, with average same-store sales (SSS) growth of 16 per cent (annually) over the past five years. We value Westlife Development at Rs 4,500 crore, implying 4.5 times FY14 estimated enterprise value (EV)/sales and 34.6 times EV/Ebitda," says Varun Lohchab of Religare Capital Markets. The current market cap of WDL is Rs 1,418 crore.
HRPL's Ebitda (operating income) margin improved from 2.5 per cent in FY09 to 12.3 per cent in FY12, due to higher SSS growth. Aanalysts believe this is likely to expand. Its backward integration efforts have enabled it to keep input procurement costs 50-80 per cent lower than inflation levels. "In FY11, HRPL faced potential margin pressure from food inflation. However, it raised prices by just 3.5 per cent and held up gross margin. Strong supply chain controls enabled the company to take price hikes well below inflation levels. We expect the Ebitda margin to increase by 180 basis points, to 14 per cent in FY15 from 12 per cent in FY12, led by favourable store mix and improving product mix", says Hemant Patel at Axis Capital. Higher store utilisation and strong SSS growth are expected to push margins, too, and return ratios.
The company's strategy is to add new restaurants. Given the increasing trend of eating out among Indians and the value product offerings of McDonald's, the scope is significant. Amit Jatia, vice-chairman of Westlife Development, says: "We believe the bulk of the potential is in six core cities for us - Mumbai, Pune, Bangalore, Chennai, Hyderabad and Ahemadabad. We're saying 60 per cent-plus of store openings will be in these six cities. In FY15, we should be at 250 restaurants from 155 currently."
The company is also considering McDonald's branch extensions, McCafe (coffee-house-style outlets) and 24x7 (stores open 24 hours daily), for adding to growth and improve profitability. "We are working with the government to change regulations so that we can bring our 24/7 brand extension to India. McCafe is also in the pipeline and we have a three- to five-year window for these extensions," says Jatia.
HRPL has a strong cash-flow generating model. Its zero debt balance sheet is also a strong positive. Given the strong cash flow generation, expansion via store additions and robust financial prospects, it is poised for a re-rating, believe analysts. They expect SSS growth of 12-14 per cent annually over FY12-15, likely to drive compounded annual revenue growth of 35-38 per cent over the period. Low competitive intensity and an under-penetrated market will enable the company to hold on to its strong SSS growth trajectory. This, coupled with higher store adds, are expected improve McDonald's overall market share from 13 per cent in FY12 to about 19 per cent in FY20.
While the business model of Jubilant Foodworks Ltd (JFL) is slightly different from that of WDL, analysts believe WDL deserves to trade at valuations similar to JFL, given the high growth potential of the company. "HRPL revenues are 53 per cent of JFL revenues, while net profit is 41 per cent of JFL's. JFL enjoys a market cap of Rs 7,313 crore, while WDL's market cap is around Rs 1,400 crore. The massive gap in valuation indicates that there lies a huge potential for WDL's stock to re-rate," says Abneesh Roy, FMCG analyst at Edelweiss Securities.