J.P. Morgan - Westlife Development

Westlife Development Weak SSG trends (-10.5% in Q4) sustain; focus on cost mgmt/new formats remains

Westlife Development (WLDL, not covered) primarily focuses on operating quick service restaurants (QSR) through its subsidiary Hardcastle Restaurants (HRPL). HRPL is master franchisee for McDonald’s for India’s southern and western regions, and operates 184 restaurants with an employee strength of over 8,000. Current store split: Maharashtra (47%), Karnataka (23%), Gujarat (12%), Andhra Pradesh (8%), Tamil Nadu (7%), Kerala (2%) and Madhya Pradesh (2%).

WLDL’s results highlighted continued weak demand trends being faced by the QSR industry. Same store sales growth (SSSG) continued to worsen, with WLDL registering SSSG of -10.5% in Q4 (vs -9.8% in Q3, -5.5% in Q2 and 0.5% in Q1).

Figure 1: WLDL SSSG trends Source: Company

Figure 2: WLDL - Quarterly restaurant additions Source: Company

WLDL registered a revenue decline of -1% in Q4FY14. However, it did well on gross margins (+320bp y/y) due to efficiency in product management, better mix and menu pricing. Despite the decline in SSSG, new restaurant openings and higher staff (+180bps y/y) and occupancy costs (+520bps y/y) led to a -410bp y/y contraction in EBITDA margins. WLDL added five new restaurants in Q4FY14 (three in Karnataka and two in Gujarat).

Key takeaways from the management call:

Consumer demand worsened in 2HFY14; expect muted consumer sentiment over next the 6-12 months– The company noted that consumer sentiment remains weak and will take some time to revive. Mgmt highlighted that sentiment worsened in 2HFY14 relative to the first half. Given the impulse purchase nature of the QSR category, higher footfall in malls and the high street generally translate into higher sales. However, barring the discount season, footfall at present in malls and the high street remains under pressure.

Expansion plans maintained – Despite a challenging environment, WLDL guided for 70-100 McDonald’s store openings every two years. It also plans to take the McCafe (in-store café) count to 75-150 over the next three to five years.

Focus on improving gross margins – WLDL highlighted its focus on improving gross margins over the medium term driven by better product mix (premium burgers, beverages), supply chain efficiencies (increasing farm productivity) and pricing.

Focus on loyalty not discounting – Mgmt categorically stated that it does not intend to use discounting as a means of attracting customers (which is the strategy currently being employed by most other QSR players to drive sales in a challenging environment) and would instead focus on loyalty programs (loyalty cards, etc.) in order to reward and incentivize repeat customers.

McCafe progressing well; lower payback period – Mgmt highlighted that the McCafe brand extension has received a healthy response since its launch in Oct’13. Payback period here is lower relative to McDonalds’s stores, as the in-store café is not only able to benefit from existing customer traffic, but it also draws customers during lean time periods (lunch, etc.). Also, higher margins for the beverage category benefit the overall margin profile.

Drive-through format provides a competitive advantage – WLDL opened stores under the drive-through format in Rajkot in Gujarat and Palakkad in Kerala. Mgmt highlighted that the response to this format has been encouraging, and provides WLDL with a first-mover competitive advantage. The store size here is ~3,500-4,000sq ft.

Online delivery format – The online delivery format serves as a brand extension and has been progressing well since its launch. Since consumers are in control of their order, ticket size generally tends to be larger. The format is seeing healthy growth and mgmt sees this becoming a significant contributor to sales over the medium term.

Current stores ramping up slowly – Given the subdued environment, current stores are seeing relatively slower initial sales. New stores generally reach sales of Rs40-50mn by the third year and the payback period is around four years.

Higher openings in larger cities – Some 70-75% of store openings will continue to be in the larger cities with smaller towns accounting for the remainder.

Store shutdown/relocation – Six stores were closed/relocated in FY14 and 10-12 stores over the last 15 years.

Price hikes in the region of ~5-6% are expected annually.

Re-imaging stores – Mgmt highlighted that they have been re-imaging stores in order to drive better customer experience and satisfaction. Re-imaging/refreshing of a store generally takes place once in five years.

Limited threat from El Nino – Given a well developed supply chain (irrigated farms) the threat to raw material prices from a potential El Nino does not seem material at this point, as per management.

Royalty set to increase by 1% in FY15.

Table 1: WLDL – Consolidated quarterly financial summary (Rs mn)

	Mar'13	Jun'13	Sep'13	Dec'13	Mar'14
Sales	1,767	1,971	1,818	1,777	1,762
Other operating income	24	17	16	18	14
Total income	1,792	1,989	1,834	1,795	1,776
Operating costs & expenses
Food and Paper	797	870	806	779	738
Purchase of traded goods		4	-	-
Employee benefit expense	158	162	157	152	191
Royalty	57	62	58	57	55
Occupancy & other operating expenses	515	667	584	550	605
General & admin expenses	127	106	104	106	121
Total	1,654	1,871	1,709	1,643	1,711
EBITDA	138	118	125	151	65
Margin %	7.8%	6.0%	6.9%	8.5%	3.7%
Other operating income/(expense), (net)	41	4	10	9	36
Extraordinary expense	3		12		15
Net Financial expense	4	5	11	13	17
Depreciation	98	94	106	107	127
PBT	75	23	6	40	(57)
Income tax	(0)	1	(4)	(0)	1
PAT	75	22	10	40	(59)
Gross Margin	54.9%	55.7%	55.7%	56.2%	58.1%
SSSG	7.2%	0.5%	-5.5%	-9.8%	-10.5%
Restaurant operating margin			12.5%	14.3%	11.3%
% of Sales
Food and Paper	45.1%	44.1%	44.3%	43.8%	41.9%
Purchase of traded goods	0.0%	0.2%	0.0%	0.0%	0.0%
Employee benefit expense	9.0%	8.2%	8.7%	8.6%	10.8%
Royalty	3.2%	3.2%	3.2%	3.2%	3.1%
Occupancy & other operating expenses	29.1%	33.8%	32.1%	31.0%	34.3%
General & admin expenses	7.2%	5.4%	5.7%	6.0%	6.9%
Growth y/y
Sales		20%	11%	4%	-1%
EBITDA		-20%	-16%	-1%	-53%
PAT		-72%	-88%	-76%	-178%

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