QSR: Demand supply mismatch

25 Jan 2023 , 11:03 AM

Analysts at IIFL Capital Services expect QSR sector to have a tough year. The sector is at risk from a combination of lacklustre demand and excess supply with inflation (amongst other factors) suppressing demand, while companies have added (and plan to add) record number of stores. History suggests that once slowdown sets in, it does not reverse for a few quarters; and therefore, analysts at IIFL Capital Services feel that consensus downgrade cycle will probably continue for two to three quarters more. Bottomline as well as stock price is sensitive to SSSG, and in past, stock prices have been quite volatile. Analysts at IIFL Capital Services have cut their EBITDA estimates by 3%-16% and have downgraded Jubilant, Westlife and Devyani from Add to Reduce; Sapphire and BBQ Nation from Buy to Add. Analysts at IIFL Capital Services advise investors to stay away from the QSR sector for a few quarters.

Dual headwinds

High inflation and consequent price increases by QSR players, in addition to weak discretionary consumption environment, is likely to result in demand slowdown visible in Q3FY23 results. This coincides with significantly higher store addition pace of high teens versus pre-COVID at 12%. A combination of these factors is likely to put pressure on SSSG of companies. If companies cut store expansion guidance, it is negative as sales growth estimates will be cut; if they do not, it will be negative as margins will be cut.

History is not kind

In the past, whenever there was a 400bps or higher SSSG deceleration from a single-digit starting point, it lasted several quarters barring exceptional circumstances. Moreover, during this period, the stock tends to either stagnate for long periods, or correct up to 30-60%. Also, consensus EBITDA downgrades are to the extent of ~25% and can last several quarters.

EBITDA margin and stock price are sensitive to SSSG

An analysis done by IIFL Capital Services of long history of Jubilant shows that change in EBITDA margin is quite sensitive to SSSG (R=0.85). Moreover, stock price tends to correct in periods of decelerating SSSG.

Do not jump in

While stocks have corrected ~15% over the past three months, analysts at IIFL Capital Services would advise caution given that Q3FY23 is the first quarter of poor sales and typically, the slowdown as well as downgrade cycle takes a few quarters to play out. They have downgraded EBITDA estimates by 3%-16% for FY24/FY25.

DCF suggests further downside

Target Prices of IIFL Capital Services are based on EV/EBITDA, but DCF exercise for sense check suggests even further downside which might play out if the street starts building higher costs of capital (IIFL Capital Services has WACC of 11%). On an average (simple average for the three stocks that have been downgraded by analysts at IIFL Capital Services — Jubilant, Devyani and Westlife) DCF-based Target Prices suggest downsides of 17%.