Should you bid for loss-making Devyani International's Rs 1,800 crore IPO?

The largest franchisee of Yum Brands in India and one of the top operators of chain quick-service restaurants (QSRs) Devyani International is all set to hit the primary markets with its initial public offer (IPO) on Wednesday, August 4.

The company, which operates brands such as KFC, Pizza Hut and Costa Coffee, has priced its IPO in the range of Rs 86-90 per share and looks to raise Rs 1,838 crore at the upper end of the price band. The IPO is mainly an offer for sale, with a fresh issue worth only Rs 440 crore, which it plans to utilise to repay debt worth Rs 324 crore.

At the upper end of the price band, Devyani is offered at 9.5x market capitalisation/sales as per FY21 financial statement, compared to peers like Jubilant Foodworks (15x), Westlife Development (8.8x), Burger King India (14x). The scrip is already commanding a premium of Rs 62 per share or 68-72 per cent in the grey market.

Analysts have largely assigned a 'Subscribe' rating to the issue as they find the company's valuations compelling and believe the company is poised for long-term growth.

We believe the company remains well placed for long term growth considering its portfolio of recognised global brands catering to a range of customer preferences, cross-brand synergies, expansion of store network and EBITDA positive earnings, said Ronak Kotecha, an analyst at Anand Rathi Shares and Stock Brokers.

The company's association with Yum, together with its marketing and operational expertise has enabled Devyani International to establish itself as a comprehensive player in the QSR industry. Analysts note that the fast-food culture under QSR is expected to flourish in India due to the increase in the working-class population and continued urbanisation.

The value sales of QSRs grew by a CAGR of 5.5 per cent between 2015-2020 and are expected to grow at an even higher pace of 12.4 per cent, Religare Broking observed. Furthermore, to leverage growth opportunities, the company is expanding its store network. In H2FY21, it opened 109 stores of core business brands.

"We note that the business model of QSR is quite impressive, as each restaurant franchise starts generating significant RoE (return on equity) at restaurant level once it reaches utilization level of >90 per cent, which bodes well for the long-term investors. Additionally, the superior cash flow generation ability of the business offers comfort. Hence, we recommend 'Subscribe' to the issue," Reliance Securities' senior research analyst Vikas Jain said.

The red flag remains in terms of profitability. The company is loss-making in the last three reported years, although EBIDTA margins are at a satisfactory level of 17.3 per cent over FY19-FY21. Additionally, the company's cash flow generation has been impressive with cumulative OCF and FCF of Rs 820 crore and Rs 180 crore, respectively over FY19-FY21.

"DIL will utilise Rs 324 crore to the repayment of debt which in turn will aid the company to improve net profit margin. OCF margin also remained at a healthy level at 20 per cent during FY19-FY21. With the strong boost in revenue, cash flow generation is expected to remain healthy also driven by likely improvement in margin and favourable working capital cycle," noted Choice Broking.

Considering the discounted valuation and likelihood of strong business growth going forward, the brokerage also assigned a subscribe rating to the IPO.