Quick service restaurants may not get mojo back soon, say analysts

Analysts believe moderation in same-stores sales growth would impact operating profitability and return ratios

The stocks of two quick service restaurants (QSRs), Jubilant FoodWorks (Jubilant) and Westlife Development (Westlife), have gained 5-13 per cent this month, outpacing a 3 per cent rise in the BSE Sensex. The strong earnings boost expected from corporation tax cuts has kept investors’ hope alive for these stocks. Analysts, however, suggest beyond tax savings, the fundamental outlook will be subdued given the moderation in growth in April-June period (Q1) and similar expectations for the September quarter (Q2).

Domino’s Pizza in the US is expected to record slower growth, indicating growth pressure for Indian QSRs in near to medium term. In its September 2019 quarter earnings updates, Domino’s Pizza, the master franchisor of Jubilant, lowered its international same-store sales growth (SSSG) guidance for the next 2-3 years to 1-4 per cent from 3-6 per cent earlier. Though Jubilant’s share in US-based Domino’s Pizza’s international retail sales is estimated at just 7-8 per cent, the news does point to sustained weakness in key global markets and on-going competitive intensity, mainly from online food aggregators.

Jubilant operates Domino’s Pizza in India, Nepal, Bangladesh and Sri Lanka. Westlife runs McDonald’s restaurants in western and southern part of the country.

Even otherwise, there are India-specific reasons to be cautious. According to Priyank Chheda, an analyst at Reliance Securities, “Lower consumer spending for discretionary, higher discounting by food aggregators and higher base achieved in FY19 is likely to keep near-term SSSG of listed QSRs under pressure.” Both the companies had reported double digit SSSG for most of the quarters in FY19.

In Q2, though promotional activities are expected to have partially confined SSSG pressure, significant growth is unlikely. While Jubilant is expected to report 3-4 per cent SSSG, Westlife’s is estimated at 6-7 per cent. In Q1, these companies had clocked 4-7 per cent SSSG.

Worse, slower SSSG could weigh on operating margins. “Moderation in SSSG would lower operating leverage and result in operating margin compression. This is likely to lead to downward trajectory of return on equity, thus making it difficult to command premium stock valuations,” Chheda added. In Q2, price hikes, new lease accounting norms (IND AS 116), however, should provide some support to margins.

Overall, investors should wait for management commentary in Q2 earnings updates despite attractive valuations of 17 times FY21 estimated enterprise value/operating profit for Jubilant and 23 times for Westlife, which indicates a 17 per cent and 45 per cent discount to their long-term average valuations, respectively.