Weak demand environment to delay recovery in quick-service restaurants

Long-term trends in the hospitality sector indicate that fast food chains or Quick Service Restaurants (QSR) chains are likely to see faster growth over the next several fiscals.

However, Q4FY24 may be weak with store sales down, and intense competition cutting into margins.

While competition is intense, growth has seen non-vegetarian options starting to outpace vegetarian. KFC, for example, has an 85 per cent contribution from non-vegetarian. Popeyes, with a launch in South India, is creating a new category in fried chicken.

Chains are trying to cash in with combos and discounts and new products.

Organised players like KFC, McDonald’s, Popeyes, Burger King are looking for market share gains led by network expansion, increased disposable income from GenZ and millennials.

Some of the weakness is cyclical, with growth driven by events like IPL and World Cups, and festival seasons. Same store growth across QSR is expected to be weak or flat with marginal improvement in Q4FY24 vs Q3FY24. Note that there’s an extra day due to leap year, and IPL adds some momentum but Ramzan would have some negative impact. Operating profit margins are expected to contract.

But there is an apparent long-term growth trend. A key upside could be stronger gross margin in future due to corrections in raw material input prices. However high competition could also lead to irrational outcomes if there’s price wars during periods of lower demand.

QSRs have kept store addition plans largely unchanged so far, hoping for a demand pick-up and trying to take market share in view of the long-term opportunity. Aggressive store additions have also hurt FY24 profitability.

Some store addition moderation is likely. For example, Jubilant added 175-180 Domino’s stores in FY2024 versus initial guidance of 200-225. It’s possible that Devyani International (DIL) and Sapphire Foods (SF) may moderate Pizza Hut (PH) store additions, given milestone-linked incentives as per agreement with Yum. Westlife also needs to tighten costs and focus on operating leverage gains, commensurate with the 25-30 per cent rise in average daily sales in the last three years.

A weak quarter may present an entry-point for the long-term. Over FY23-28, there’s high potential for store penetration and growth. Players like DIL and SF offer multi-brand QSR (KFC and PH) and multiple countries (Thailand, Sri Lanka, Nepal, Nigeria).

One analyst models 18 per cent revenue annually over FY23-28, led by penetration – QSRs accounted for just 7 per cent revenue of food services (FY23). User additions will be a bigger driver than pricing and frequency.

Other important economic, demographic drivers include organised players getting more market share, rising disposable income, rise in nuclear families, and food aggregators like Swiggy/ Zomato. Chicken QSR may overtake pizza as the most important category.

Multi-brand players could do well. Devyani has KFC, PH, Costa Coffee, Vaango, and The Food Street in India, KFC and PH in Nepal, and KFC in Nigeria and Thailand. SF has KFC and PH in India, Taco Bell and PH in Sri Lanka and Maldives.

Various analysts have buy recommendations on Westlife, Devyani, Sapphire, Burger King and Jubilant. This suggests a shotgun approach (wider selection of stocks) in a sector with conflicting short-term versus long-term trends with analysts being unable to distinguish clear winners in the early stages of what could be a multi-year secular up-cycle.