Margin pressures may take a slice out of Jubilant's profit

Aggressive expansion, raw material inflation, and competitive pressures to hit QSR player’s profitability

After a sharp 22 per cent rally in the last week of May, the stock of India’s largest quick service restaurant player, Jubilant Foodworks, has shed a third of those gains. While an aggressive store expansion plan and appointment of a new chief executive officer (CEO) are positives from a growth perspective and clear the leadership overhang, margin worries could sustain the downside pressures on the stock in the near term. These concerns have led to a revision of profit estimates by brokerages.

Analysts, led by Anand Shah, of Axis Capital have cut their 202223 (FY23) earnings estimates of the company by 16 per cent and reduced their target price from ~750 to ~630 after the Januarymarch quarter (fourth quarter, or Q4) results. The downward revision is on account of sharp inflation in raw material and cut in same-store sales growth (SSSG) estimates for FY23.

The company reported an operating profit margin of 25 per cent in Q4 of 2021-22 (FY22). This was up 73 basis points (bps) year-on-year (YOY), while falling 158 bps on a sequential basis. Some of the gains YOY were on account of operating leverage, with the company cataloguing 13 per cent sales growth.

The company’s outgoing CEO Pratik Pota in an investor call highlighted that the company faced intense and broad-based inflationary headwinds across commodities, fuel, and other costs during the past quarter. However, this was offset by driving business efficiencies and productivity, lower and more targeted discounting, and calibrated price increases.

The company took a 5-6 per cent price hike in the Octoberdecember quarter and repeated a hike of a similar quantum in April this year.

The management believes it can maintain the current margin trajectory (given the stable commodity costs), increasing investments for network expansion across brands in its portfolio notwithstanding.

Macquarie Capital Securities’ Avi Mehta and Shashank Krishnakumar are, however, not convinced of the management guidance of a flat margin performance (at current levels) in FY23. They cite historical trends, store expansion, and dine-in recovery to back their contention of margin pressures in the future.

The last food inflation cycle (2011-12 through 2016-17) saw sharp price hikes and competitive pressure driving moderation in transaction volumes and, in turn, forcing the company to re-evaluate its SSSG and margin guidance, they point out. A 10 per cent-plus price hike typically signals the start of margin moderation, they add.

What could add to costs is the acceleration in store additions. After a record 80 Domino’s Pizza store additions in the quarter, taking the total store count at the end of FY22 to 1,567, the company is planning to add 250 more stores to its pizza network in FY23. The additions will add 15 per cent to its existing base. The company is also adding 25-30 stores of fried chicken brand Popeyes in the current financial year (FY23).

Jubilant has a medium-term target of reaching 3,000 stores double the existing network. The rapid expansion is unlikely to see moderation, given competitors ramping up their presence.

After opening 250 stores in FY22, Devyani International (franchisee of Pizza Hut, Kentucky Fried Chicken) has guided for 200250 stores in FY23.

Similarly, Restaurant Brands Asia (formerly known as Burger King India) is increasing its store count by 50 per cent by 2023-24 (FY24), from the current 315 stores.

Favourable rental deals, demand shift from the unorganised to the organised, and expansion into new towns and cities offering healthy demand prospects have prompted these expansions, reveals Elara Capital.

However, Axis Securities believes there will be some drag in the operating profit margin due to aggressive store expansion guidance of 250 Domino stores and 20-30 Popeyes stores (lower throughput in the initial years).

Given the rapid expansion, the Street will also keep an eye out for execution under a new CEO Sameer Khetarpal.

Normalisation of costs, with recovery led by the dine-in segment (as compared to deliveryfocused model of Jubilant), besides increased competition, could weigh on margins that are near lifetime highs, believe analysts.

At the current price, the stock is trading at 53x its FY24 earnings estimates.

While sales on the back of store additions and price hikes are expected to be strong, investors should await profitable growth/improving margin trends before considering the stock.