Edelweiss:Jubilant Foodworks - expensive pizza; Sell target Rs 361

Jubilant Foodworks (JUBI IN, INR 475, Reduce)

n  EBITDA margins close to peak; muted sales growth from FY13-14

With JFL’s margin improving 470bps during FY05-10, we believe further upside is limited and historical data of international players like Starbucks, McDonalds Corp, and Dominos Australia indicates the same. Post 42% CAGR sales growth during FY05-10, we believe the company’s growth rate will dip to 20-25% CAGR during FY11-20E with EBIDTA margins slipping by almost 200bps.

n  Economic environment to drive volumes rather than consumption

We believe that a strong economic environment has higher impact on demand of QSR rather than growth in discretionary income. SSS growth of 6% during FY09 compared to an almost 18-22% growth during FY06-10 indicates that strong corporate profitability along with better economic environment are of paramount importance to drive volumes growth rather than growth in personal income.

n  Increasing competitive intensity

We expect competition to increase as other organised players (Pizza Hut, KFC, McDonalds) increase their presence in tier 2 and 3 cities. We also believe that due to the limited potential of number of stores in a small town, returns will be dilutive going forward.

n  Tax benefits on accumulated losses will exhaust in FY11

JFL has not created def tax assets for the accumulated losses incurred in earlier years; no tax charge is required against current profits. However post FY11; PAT margin growth will subside with exhaustion of accumulated tax losses.

n  Outlook and valuations: Expensive; initiate coverage with ‘REDUCE’ 

With an expected 15% average SSS growth during FY11-13, 210bps improvement in EBIDTA margins and PBT margins of 12-13%, our DCF model suggests a value of INR 361 for JFL. We believe at current valuations (FY12E – 2.7x EV/Sales, 15.0x EV/EBIDTA, 30.3x PE) the market is factoring in 15% SSS growth during FY11-20 or more than 30% sales growth during the same period. We anticipate the ROAE to dip to 38% in FY12E against 48% in FY10. Future associations like Starbucks will take time to generate normal business returns (pizza business turned PAT positive after nine years). Based on DCF valuations, we initiate coverage on the stock with a‘REDUCE’ recommendation and target price of INR 361.