Quick service restaurants: Spicy stock valuations are here to stay

Rising consumer preference for food delivery, store expansion, and product innovation should support profitable growth: Analysts

Shares of quick service restaurants (QSRs) — Jubilant FoodWorks (Jubilant) and Westlife Development (Westlife) — are likely to continue trading at premium valuations vis-à-vis fast-moving consumer goods (FMCG) companies with similar market capitalisation, which are witnessing demand moderation (mainly in personal and home care segments). 

The current one-year forward valuations of 45x price-to-earnings for Jubilant and 34x enterprise value/earnings before interest, tax, depreciation, and amortisation (Ebitda) for Westlife are 1-2x higher than some mid-cap FMCG players such as Emami, Colgate-Palmolive, and Glaxo­SmithKline Consumer Healthcare, among others.

Rising preference for doorstep food delivery and increasing number of online aggregators are providing good growth opportunities to QSRs like Jubilant and Westlife. The latter’s upward thrust on store expansion/additions are further helping to cash in on these opportunities. While Jubilant’s management aims to open 100 new stores during the current financial year, Westlife targets to add 25 stores. This would follow net additions of 93 and 19 stores by these two companies, respectively, in 2018-19 (FY19).

Additional growth opportunity stems from product innovations and new menus planned by these companies. Innovations such as World Pizza League by Jubilant and ‘spice test’ by Westlife, along with focus on enhancing customer value, should support overall growth for the players, say analysts. In case of Jubilant, its foray into Chinese food (Hong’s Kitchen) in the March 2019 quarter should aid its long-term growth. 

However, there are a few things that investors may want to note. FY19’s high base, wherein Jubilant and Westlife clocked 17-18 per cent same-store-sale growth (SSSG), may confine their overall SSSG in the current financial year. This high-base factor though has already been priced in by the stocks. 

Analysts are currently expecting high-single digit SSSG along with margin improvement for the current year. The upcoming ICC Cricket World Cup 2019, which is kicking off from the end of this month, is also expected to aid SSSG of the two QSRs. “Higher base of FY19 would cap SSSG during the current financial year. But, this has been factored in by the Street. So, SSSG of 7-8 per cent, along with margin expansion, should support the valuation premium for QSR majors over many other FMCG players,” says Vishal Gutka, vice-president, Philip Capital. 

Many analysts foresee around 8 per cent SSSG in 2019-20 (FY20) by these two companies, which, in turn, would drive 60-150 basis point expansion in Ebitda margin. Moreover, the expected improvement in product mix skewed towards high-margin products and cost-efficiency measures are likely to be margin-accretive for the companies. 

The management of Westlife expects Ebitda margin expansion to persist in FY20, given the benign input costs and cost control initiatives. In FY19, both these players had witnessed around 180-225 expansion in their Ebitda margin.

There’s a caveat though. The Westlife’s management, during its March 2019 quarter analysts’ call, had highlighted that it observed some demand weakness in one month during the quarter. While it said that clarity would emerge during the next couple of quarters, it sounded optimistic of achieving 7-9 per cent SSSG in FY20. Analysts at IIFL, thus, believe clarity on demand trends remains the key trigger for further rerating of these stocks. 

Overall, while the abovementioned growth levers remain intact, a high-single digit growth, coupled with margin gains, is what the Street would keep an eye out for. Any miss on these fronts could hurt stock valuation and returns.