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Jubilant Foodworks
Reuters: JUBI.BO Bloomberg: JUBI IN Exchange: BSE Ticker: JUBI
Fresh from the oven; initiating
with Buy
Generating free cashflow
A 65% market share in the under-penetrated Indian Quick Service Restaurant
sector, an exclusive franchisee of a globally successful brand and solid execution
(in terms of both new store openings and robust supply chain) drive a 42%
revenue CAGR (FY11-13E), 70% gross margin, negative working capital (~11% of
revenue) and FY11-13E 60% FCF CAGR. While the near-term valuation factors in
aggressive growth, our FY12E EPS is higher than consensus by 18%. We see
material upside potential: initiating coverage with a Buy.
Exclusive franchisee of a globally successful brand
Jubilant Foodworks (JFL) operates its pizza stores pursuant to a Master Franchise
Agreement with Domino‘s International, which provides it with the exclusive right
to develop and operate Domino‘s pizza delivery stores in India, Nepal, Bangladesh
and Sri Lanka. It is this association with Domino‘s that provides JFL with the
technical, marketing and operational expertise to compete successfully with other
restaurants in the QSR industry in India. JFL has a dominant 65% market share in
the organised pizza home delivery segment in India.
Robust supply chain; ranked top among Domino’s franchisees worldwide
The cornerstone of JFL’s operational success is based on its efficient supply chain
that drives negative working capital. Its operations rank among the top three
within Domino’s global operations. JFL has centralised the sourcing, warehousing
and distribution of its raw materials, as well as the production of dough at its
commissaries. This reduces the storage space required at its stores, thereby
enabling JFL to minimise its store operating costs, without incurring significant
additional expenses at the commissary level. The effects of its efficient supply
chain are reflected in its relatively high gross margins and negative working capital.
Initiate with a Buy and a target price of INR810
Our DCF-based target price of INR810 is based on a cost of equity of 13.6% and
4.5% terminal growth. Downside risks include increase in royalty charge to
Domino’s International and execution risk in the opening up of new stores.
Investment thesis
Outlook
A 65% market share in the under-penetrated Indian Quick Service Restaurant sector, an
exclusive franchisee of a globally successful brand and solid execution (in terms of both new
store openings and robust supply chain) drive a 42% revenue CAGR (FY11-13E), 70% gross
margin, negative working capital (~11% of revenues) and 60% FCF CAGR over FY11-13E.
While the near-term valuation factors in aggressive growth, our FY12E EPS (the basis of our
DCF-derived target price) is 18% higher than consensus.
JFL operates its pizza stores pursuant to a Master Franchise Agreement with Domino‘s
International, which provides it with the exclusive right to develop and operate Domino‘s
pizza delivery stores and the associated trademarks in the operation of pizza stores in India,
Nepal, Bangladesh and Sri Lanka. This has provided JFL with the ability to use Domino’s
globally recognised brand name, as well as operational support for pizza and food technology
(such as recipes), commissary and logistics management support, global marketing and
vendor development know-how. It is this association with Domino‘s that provides JFL with
the technical, marketing and operational expertise to compete successfully with other
restaurants in the QSR industry in India. JFL has a dominant 65% market share in the
organised pizza home delivery segment in India.
Valuation
Our DCF-derived target price of INR810 per share is based on the following assumptions:
Risk-free rate of 6.4% (Deutsche Bank estimate), market risk premium of 7.2%
(Deutsche Bank estimate) and Beta of 1, implying a cost of equity of 13.6%.
Growth in the stable phase of 4.5% (which is the long-term growth rate in the number of
households in India). Our valuation for Jubilant Foodworks works out at INR810 per
share.
At our target price of INR810 per share, the shares would trade at 30x FY13E earnings.
Risks
Significant dependence on the master franchise agreement with Domino’s
International
The master franchise agreement between JFL and Domino’s International was renewed in
September 2009 for another term of 15 years, which will continue until 31 December 2024
and is further extendable for a period of ten years (subject to certain conditions). Should JFL
default on the provisions of the agreement, then Domino’s International would have the right
to terminate the agreement.
Royalty to Domino’s may increase
JFL paid a royalty of 3% on its revenues in FY10. While the agreement with Domino’s is valid
until 2024, it is possible that after that date the royalty may increase. The company also pays
USD5,000 per new store opened.
Key investment positives
Exclusive franchisee of a globally successful brand
JFL operates its pizza stores pursuant to a Master Franchise Agreement with Domino‘s
International, which provides it with the exclusive right to develop and operate Domino‘s
pizza delivery stores and the associated trademarks in the operation of pizza stores in India,
Nepal, Bangladesh and Sri Lanka. Over its 49-year history, the Domino‘s business has grown
into a global network of over 9,000 pizza stores in more than 60 countries, involving more
than 2,000 franchisees. This has provided the JFL with the ability to use Domino’s
International’s globally recognised brand name, as well as operational support for pizza and
food technology (such as recipes), commissary and logistics management support, global
marketing and vendor development know-how. It is this association with Domino‘s that
provides JFL with the technical, marketing and operational expertise to compete successfully
with other restaurants in the QSR industry in India. JFL has a dominant 65% market share in
the organised pizza home delivery segment in India.
Robust supply chain; ranked top among Domino’s franchisees
worldwide
The cornerstone of JFL’s operational success is based on its efficient supply chain that drives
a negative working capital. Its operations rank among the top three within Domino’s global
operations. JFL operates four regional supply chain centres, or commissaries, located in
Noida (Delhi NCR), Mumbai, Bangalore and Kolkata. These commissaries primarily
manufacture dough (pizza bases) and act as warehouses for most of the other ingredients.
The primary raw materials used in the preparation of the pizzas, such as cheese, vegetables
and meat, are sourced and supplied to the stores by their commissaries, except for a few
stores which procure vegetables locally from vendors within their geographic area. This helps
JFL to ensure consistent quality and also ensure timely delivery of raw materials to its stores.
Furthermore, as the purchase function is centralised and the company purchases large
volumes of ingredients and packaging such as cheese, sauce and pizza boxes, it allows JFL
to maximise leverage and negotiate better prices with its suppliers.
For most of its key ingredients, JFL follows a multi-vendor policy to minimise reliance on any
single vendor and has entered into annual agreements with certain key vendors to ensure the
steady supply of ingredients. In addition, JFL has a dedicated fleet of hired trucks at its
disposal to ensure timely delivery of raw materials to its stores. These trucks are refrigerated
to ensure that the ingredients are supplied in a temperature-controlled environment, which is
monitored during transit to ensure quality and minimise wastage. The effects of its efficient
supply chain are reflected in its relatively high gross margins and negative working capital
Effective site selection and project management focusing on ROI
One of the major factors behind JFL’s continued growth has been its ability to open and then
operate most of its new stores profitably. A robust store selection process that takes into
consideration various factors such as location visibility, presence of competition, household
count as well as presence of corporate and other institutions that would enable it to operate
these pizza stores in a profitable manner is a key differentiator between JFL and its QSR
competitors.
As of 30 September 2010, JFL operated 339 stores in India across 79 cities located in 22
states and union territories, and, through a sub-franchisee, DP Lanka Private Limited, five
stores in Sri Lanka. These included entry into 22 new cities in FY10. Domino’s has mentioned
a store target of 700 stores for its India operations. At present, its competitors include Pizza
Hut (~150 stores pan-India), KFC (~50 stores pan-India) and McDonalds (~170 stores).
JFL also conducts a return-on-investment analysis based on projected sales and profitability
to determine the financial feasibility of the store. The company’s internal project management
system is designed to ensure that they purchase standardised equipment from selected
vendors, plan in detail the procurement of the standard equipments prior to lease signing as
well as designing standardised processes for all functions related to store openings. This has
enabled JFL to reduce its store opening time to between 35 and 45 days on average from
the date of possession of the premises for a new store location.
New product introductions and innovative marketing drive
revenues
JFL utilises three distinct marketing platforms, (a) national marketing campaigns on television,
print and radio, (b) local store marketing and (c) customer relationship management. Its
innovative marketing strategy that emphasised delivery within 30 minutes of an order’s being
taken or no charge would be made has become a marketing case study whereby delayed
public services are being compared unfavourably to efficient pizza delivery.
JFL’s local store marketing is aimed at increasing customer penetration by targeting new
customers and increasing the frequency of repeat orders from existing customers. The
strategy includes address mapping of an entire delivery area to precisely identify key demand
areas for a store as well as intensive coverage of households and corporates within a store‘s
sales area using store-specific door hangers and fliers. JFL also utilises details of customers‘
past transactions from its point of sales software system to provide customised
communication including mobile text messages and offers, relevant to each consumer
thereby maximising returns from individual customer relationships by increasing the
frequency of orders.
JFL’s product innovation and value promotions are another driver for footfall frequency. For
example, the company began offering a limited number of pasta dishes at the stores and
launched its own low-cost pizza – Pizza Mania. JFL, on a continuous basis, keeps evaluating
increasing dine-in space at selected existing pizza stores. This is quite apart from periodically
refurbishing its stores, and it intends to continuously upgrade its facilities and general pizza
store ambience.
Expansion using new distribution channels
Traditionally, JFL’s pizza stores have generally been located in neighbourhood markets in
urban areas. As it seeks new ways to grow its business operations, it has sub-franchised two
stores into India’s expanding infrastructure network of airports. In addition, metro stations
offer a distinct new channel for growth. As the company anticipates that its revenues from
these stores would be driven by commuters at these locations, the intention is to use a menu
of off-the-shelf pizzas.
JFL has integrated other distribution channels with its pizza stores‘ operations, such as web
and mobile technology, to expand its sales. In August 2009, it launched – on a pilot basis – an
online ordering facility for residents in Bangalore and it intends to gradually extend this
service to other locations. JFL also opened pizza stores on certain corporate campuses and in
certain food courts.
Cost consciousness driven by employee compensation structure
In line with its philosophy that the store manager is the CEO of the store, the compensation
for its store managers is driven by the sales and profitability of their respective stores. Also,
all costs attributable to a store are charged at the store-level and the store manager has
discretion to take action in order to increase sales or reduce costs. The policy of centralised
sourcing from an optimal number of vendors further facilitates cost efficiencies, enabling the
company to reduce manufacturing costs.
Leveraging its market position to launch new food services
brands in India
JFL has mentioned that it intends to leverage its current market position and experience in
the food services industry to launch new international food services brands in India. These
could include QSR such as Burger King and Starbucks although no formal announcements are
expected until at least the next two quarters.
Negative working capital driven by centralised sourcing
JFL has centralised the sourcing, warehousing and distribution of its raw materials, as well as
the production of dough at its commissaries, this reduces the storage space required at its
stores, thereby enabling JFL to minimise its store operating costs, without incurring
significant additional expenses at the commissary level. The effects of its efficient supply
chain are reflected in its relatively high gross margins and negative working capital.
Efficiency in capex is a driver of FCF
JFL opened 60 stores in fiscal 2009 of which 44 stores were opened in cities where JFL
already had stores and of the 70 stores opened in fiscal 2010, 31 stores were in cities where
JFL already had stores. To minimise additional capital expenditure and ensure quality control,
JFL plans to open new stores in cities and towns that would be located within less than one
day’s travel distance of its existing commissaries. For new stores where JFL cannot serve
efficiently from its commissaries, the company has developed a back-end production facility
model which should enable the company to service two to three stores in a city. These backend
production facilities procure vegetables and other perishables locally. JFL believes that
its future growth will be driven by its new stores in Tier 2 and Tier 3 towns and, therefore, its
back-end production facilities will play a key role in its success in these cities.
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