QSR- A Quick Bite!

Quick Service Restaurants- QSR

We both (Warren Buffett) insist on a lot of time being available almost every day to just sit and think. That is very uncommon in American business. We read and think.

- Charlie Munger

Most of us, in fact all of us have had pizzas and burgers in our lifetime at least once. Ever wondered about investing in any of them?

Being retail investors the one barrier we all face while investing in sectors such as real estate, engineering goods or the steel sector is that we do not get to experience the actual products they sell. Well, some involved in other B2B business might do, but we as retail investors do not actually get to test the product.

Analysing the scope of our investments hence broadens when we invest in FMCG and consumer durable companies, since we consume their products on a regular basis- here pizzas and burgers of Dominos or Burger King for example! One such we will analyse here today is the QSR sector and certain proxies linked with them.

A QSR is a fast-food restaurant- usually small in size and a eatery for quick consumption (fast). QSR has been a theme well developed and included in our culture compared to a decade earlier. With an increase in household disposable income and major tailwinds favouring home delivery services, QSR’s will indeed benefit.

Source- Nirmal Bang Research Report- QSR

Like any other sector, there has been a phased growth here as well. In the 1990’s organized brands were a very few and majorly included home grown brands such as Haldirams, Bikanervala Honest etc. A structural shift started taking place with organized players started entering the market.

Now when we look at the companies, the first thing to analyse with any retail outlet is if the unit economics is right. Meaning if a single store unit is performing well, because if unit economics is not right and the overall PAT is doing good then most probably it is the situation of groupism- where certain outlets are doing well and the others are just laggards.

Before going any further into the topic, we would like to put forward that this particular blog will only be a detailed analysis of the QSR Sector and the following blog published will be on the two companies that we think will perform well in this space.

Whenever we analyse any sector there are certain terms/jargons that one needs to be familiar with.

Let’s look at them one by one

1) SSSG- Same Store Sales Growth

SSSG in any retail format store helps in understanding relative amount of revenue that has increased or decreased over a period.

For example- Store A had sales of Rs 100 in 2021, and sales of Rs 120 in 2022. Then their SSSG would be 20% for 2022.

Now why SSSG? Knowing what each of your single store is doing in terms of revenue and profits is more important than the overall PAT, because at the company level, during expansion and opening of multiple stores at once, it takes some time for the stores newly opened to mature and gain presence for the sales to stabilise. This is a situation where they need to know how much SSSG is their previously opened stores doing.

Source: Sapphire Foods Annual Report 2021-2022

2) Payback Period-

Payback period is the time frame it takes to recover the cost of investment, or the time taken to make break even.

Example:

Source: Sapphire Foods Annual Report 2021-2022

3) Unit Economics

This is the mantra for any QSR. The capital invested into any store depends on two factors- Size of the store + location (Rent). Pizza Hut for example made the mistake of opening large format stores being a QSR chain. Then since the operating costs were higher due to larger format stores, they were eating up their margins. Then they had to shift to a omnichannel strategy and smaller format stores focused on takeaways.

Source: Sapphire Foods Annual Report 2021-2022

Here unit economics was not kicking in, which Pizza Hut had to change, by shifting to smaller format stores like their peers.

Hence the results, as seen in the chart above average size of a KFC restaurant declined significantly from 2736 sq. ft in 2019 to 1500 sq. ft in 2022. Despite the decrease in the store size, the restaurant EBITDA increased from 12.7% to 19.5%.

4) Average Daily Sales (ADS)

ADS records the sales of all the stores combined on an average doing in a day. It is an important metric to measure because while comparing the peers it is significant to know who has a better ADS.

For KFC- Devyani International Annual Report 2021-2022

Companies listed in this space

We cover only those companies in the sector we like and that we feel are of our circle of competence. With over 6-8 companies listed, we would not cover all of them for you, and only cover those which we are comfortable with and those we feel are great areas of investments.

1) Devyani International

A part of RJ Corporation led by Mr. Ravi Jaipuria. RJ Corporation has two companies listed in the NSE and BSE both being in the consumer durables segment- Varun Beverages and Devyani International.

Varun Beverages-

The sole distributor of PepsiCo and its products in India. After China they are the biggest distributor of PepsiCo outside USA. They produce(bottlers) and distribute a wide range of carbonated soft drinks.

Global footprint- They have their presence in Zimbabwe, Sri Lanka, Nepal, Morocco, and Zambia.

The company has a great competitive advantage being the single biggest sole distributor of Pepsi and its other products in India.

Varun Beverages also acts as a proxy to investing in the QSR theme, since any fast-food product is associated with any soft drinks, the sales of their products also can be impacted positively.

Devyani International-

Also spearheaded by Mr. Ravi Jaipuria, being a recently listed company and 2021-2022 being their maiden year we can expect the management to show their relentless execution skill as seen in Varun Beverages in Devyani International as well.

Brand Portfolio-

Source- Annual Report 2021-2022

Their international presence is there through Pizza Hut and KFC in Nepal and Nigeria.

In detail in the next blog.

Industry Overview

The food service industry is witnessing a paradigm shift, customers preferring convenience channels and in-home consumption, a consequent of the pandemic.

The QSR sector is having a behavioural shift in consumption changing from unorganized to organized players.

Source- SOIC

When we look at the above pictorial representation, one thing we understand is that the organised players have started to get dominance over the unorganised players. How? Back in 2014-2018 QSR provided a range of dishes on their menu, but the problem they did not cater to is- lack of mainstream affordability. QSR is not priced expensive, but moderately priced, but on the flipside when compared to a roadside vendor selling similar items at prices below than Rs. 100, many consumers still felt QSR to be relatively pricier, hence came in the cheaper dishes- for example- stunner menu in Burger King. These are the few steps taken by the QSR to gain dominance from the unorganized players.

Source- RBA India Annual Report 2021-22

Projected Growth Rate: 2020-2025

Source: Sapphire Foods DRHP

Here are the projected growth rates for the different formats, as seen above, QSR’s are expected to grow better than their peers such as fine dining restaurants or casual dining.

Restaurants in the business model of fine dining or casual dining can bring in some changes by focusing on cloud kitchen-based model, because the trend in the future and as seen in the past has been in the hands of QSR’s. One such example is of Speciality Restaurants- Speciality Restaurants is the parent company of fine dining restaurants such as Mainland China, Oh! Calcutta, Sigree Global Grill etc. They have over 20 brands in their product portfolio.

So recently post the covid lockdown, call it a tailwind for the company, they were quick enough to shift from fine dining-based model to cloud kitchens. Since cloud kitchens yielded results and made the company profitable in 2021-2022, the company has started to rely more on cloud kitchens than their traditional business model.

Source- Speciality Restaurants Annual Report 2021-22

The company now likes to call this move of their, as their “competitive advantage”!

Source- Speciality Restaurants Annual Report 2021-22

Where is the money lying?

Source- Sapphire Foods DRHP

Source- Sapphire Foods DRHP

As it is clearly evident, to make money companies need to build and capture the public in the developed cities first. The unorganized market RULES the tier 2 and tier 3 cities. Hence when we talk about growth and opportunities for market penetration, yes opportunities exist very much, but the question arises, will it be easy to penetrate tier 2 and 3 cities? Time will tell the tale. So, when we join the dots and when we look at the stunner menu of Burger King, cheaper items of the QSR’s they were created to truly fit and capitalize on the opportunities available in the smaller towns and cities.

Advertisement Expense and Sales Mix of Peers

Source- Sapphire Foods DRHP

The above data shows the channel mix of QSR brands operating in India. Quite a mix of results and conclusion to be arrived from the above is that, either through takeaways, own app or aggregator the sales has increased for all the four. Dine In has increased for Pizza Hut and KFC ideally because for KFC, the highest sales provider is their Fried Chicken, which through a survey suggested that tastes better when served fresh. Pizza Hut until 2020-2021 were still operating in large format stores, which means things have worked in their favour only, because a company would have large format stores only when they want their dine in sales to increase. The situation mentioned and discussed about reduction in the large format stores of Pizza Hut started from 2021 mid only, hence the dine in sales % would have started to reduce from mid FY 2021-22.

Source- SOIC

Getting the word out there holds significance, consumers need to know that your organization exists, and marketing is important for any retail-oriented company. When we look at the average spend by the company, Burger King has the highest spends on marketing expenditure 8.82% ! Latest FY 2021 all the companies have cut down on their expenses except Dominos, which would have a negative effect on its EBITDA margins.

Source- Sapphire Foods DRHP

Now logically, Pizza’s when compared to burger’s are products with higher gross margins, now it is so because in a burger there are many components. A veg burger needs a different patty when compared to chicken or paneer, the seasoning sauces used are different, you have the bun, lettuce, vegetables. A lot of components attract more costs.

When we look at pizza, overall for a fast food restaurant the cheese and the sauce would remain the same for veg as well as non veg pizzas, only the toppings would differ. Hence the gross margins for Domino’s and Pizza Hut are comparatively higher than Burger King and McDonald’s.

It is equally important to know the narratives like knowing the numbers. Hence, when we analyse say for example the gross margins in a sector across all companies, try understanding the why also. Qualitative and quantitative analysis both are important in equity research.

The above picture gives us the basic idea on the important metrics of all the major QSR players.

Favorable demographies, rising young and working population, changing consumer habits have been driving strong growth. QSR’s have evolved over time to offerings ranging from comfort food, to premium options. High frequency of home deliveries through zomato and swiggy during pandemic resulted in further boost to growth opportunities.On the contrary, the pandemic also had a bad side as well a 53% contraction with operating restrictions and closures. A sharp recovery is expected the industry expected to reach 63 Billion US Dollars in FY 22. Digital platforms are gaining prominence with deliveries and takeaways rising on an average from 13% pre covid to 33% post covid.

Key drivers:

1. Favorable demographic profile- Inc in disposable income, busier lifestyles and high % of young working population.

2. Increase in urbanization and nuclearization of families- Transforming the spending habits and food consumption habits of eating out and home deliveries.

3. Evolving food preferences- Adoption of western culture and increase in travel and tourism.

4. Increasing footprint of food aggregators- App based delivery and doorstep delivery drive growth for this sector

5. Internet and mobile penetration- With jio, cheap internet access, higher penetration.

We expect decent growth in the coming years, companies that try out growing the industry will turn out to be winners and consistent compounders for their shareholders.

Our next blog would be on the companies that we like in this sector and that would perform consistently in the coming years.

Stay Tuned!

Shivam M. Dave