Devyani International Ltd Q2 FY2024 Concall Summary

Key Takeaways

• Seasonal and macro headwinds hit hard: Q2, already a seasonally weak quarter, was further pressured by an extended Shravan period and a severe currency devaluation in Nigeria, leading to lower brand contribution margins across the portfolio.
• Pizza Hut recovery timeline extends: Management now says Pizza Hut's margin recovery will take "a little longer journey" than previously indicated, as the brand cycles out of a promotional comparison and contends with a different set of issues versus KFC.
• KFC margin confidence remains, but path is delayed: Management is confident KFC can return to 20-21% brand contribution levels, but concedes this recovery could take "a few quarters" as new stores mature and macro pressures ease.
• Expansion ambition intact despite near-term pain: The company remains on track to open 250-275 stores this fiscal year and maintains its ambitious goal of reaching 2,000 stores by 2026, with KFC driving stronger store additions.
• What to watch next quarter: Whether the seasonal rebound in Q3 materializes, any stabilization in Pizza Hut's same-store sales growth as it cycles out of a promotional comparison from Q4, and the trajectory of KFC's brand contribution margin as new stores mature.

Brand Health & Margin Trajectory

• KFC margin decline: Brand contribution margin fell 1.7% QoQ to 15.4%, driven by adverse operating leverage from lower average daily sales (ADS) across the portfolio.
• KFC recovery path: Management is confident KFC can return to 20-21% brand contribution levels, a level seen in the past, but says it will not happen immediately and could take a few quarters as new stores mature and macros improve.
• New store dilution: KFC's store count has doubled, and new stores take time to mature to brand averages in both top line and bottom line, impacting the overall mix; old stores are stable and performing well.
• Pizza Hut margin decline: Brand contribution margins fell 2.4% QoQ to 7.7%, impacted by higher marketing spend and ADS deleverage.
• Pizza Hut recovery extends: Management previously indicated Pizza Hut would return to mid-teens margins in a couple of quarters, but now says it might take a little bit longer because of continuous weakness; as ADS improves, margins will move in tandem.
• Pizza Hut SSSG drag: A promotional "fun flavour pizza" introduced around Diwali last year created a tough comparison; the company expects to cycle out of this from Q4 onwards, with things "probably turning from Q4."
• Employee cost pressure: Employee costs rose due to 25-26% YoY store expansion, lower ADS causing deleverage, minimum wage inflation, and a statutory bonus provision now being provided on a regular basis; these pieces will cycle out as the year passes and ADS improves.

Dawar: "Pizza Hut will take a little longer time because at Pizza Hut the issues are slightly different versus the KFC. It will probably take a little longer journey."

Demand & Competitive Environment

• Seasonal drag: Q2 is seasonally the lowest quarter for QSR, and this year saw an extended one-month Shravan period where a sizable part of the Indian population temporarily turns vegetarian, disproportionately impacting Devyani given its strong presence in South India.
• Consumer wallet pressure: Hyperinflation has passed but consumer wallet sizes have remained the same; management sees consumerism setting in, citing the country's savings ratio at an almost all-time low, but the recovery in spending is still awaited.
• Pizza category competition: Local and regional competition is emerging in the pizza category, driven by consumers down-trading to lower entry points within QSR after inflation; management views this as probably temporary.
• Burger category advantage: In hyperinflation environments, consumers downgrade to lower entry segments, and the burger category represents a lower entry point into QSR than pizza.
• Delivery vs. on-premise: The bias remains slightly in favour of delivery for QSR; with people back to working from office post-COVID, home delivery preferences are returning.
• Non-metro opportunity: Trends are very similar between metro and non-metro, and management notes that "hunger and aspiration is stronger in smaller towns," which is a positive for the company given its higher exposure to Tier 2 and Tier 3 cities.

Dawar: "Now that shows the consumerism in the country setting in, because if you go back by 10-15 years, savings probably was one of the biggest priorities as far as the Indian population is concerned."

Nigeria: A Multi-Year Drag

• Currency and inflation shock: Nigeria saw a ~64% currency devaluation in the previous quarter, and fuel prices shot up 4x-5x, severely impacting a dominant import economy with huge transport reliance and contracting local disposable income.
• All-round business impact: The macro shock hit both revenue and margins in the Nigerian business, with lower discretionary spending and consumption.
• Financial support required: Management stated it may have to support the Nigerian business financially for the next couple of years until the local situation stabilizes, though it declined to quantify the extent of support needed.

Jaipuria: "We may have to support our Nigerian business financially, given the local situation for the next couple of years until the local situation stabilizes."

Store Expansion & Strategic Initiatives

• 2,000-store ambition: The company maintains its goal of reaching 2,000 stores by the end of 2026, with KFC expected to see stronger store additions of 120-130 stores every year.
• Pizza Hut expansion moderated: Pizza Hut's store addition guidance has been brought down from IPO-time levels, with a dynamic expansion strategy depending on the environment and brand performance.
• Costa Coffee experimentation: The company is testing new channels including a tie-up with PVR currently in a test market phase, and kiosks at stadiums in Mumbai and Calcutta; rapid store expansion has impacted overall brand performance as new stores take time to stabilize.
• Railway station JV: A joint venture has been formed with a partner experienced in dealing with Indian Railways to bid for food courts as part of the government's railway station modernization program; management declined to share revenue potential or business plans.
• Self-financed growth: Entire organic capex for expansion is being planned through internal accruals, which management says underscores the company's financial strength.

Dawar: "But we have our expertise on somebody who knows the Indian Railway system very well, has a great experience of dealing with the railways, and then we bring in our established brands, and our expertise of running the operations at the food courts. So therefore, it's a win-win situation for both of us."

Franchise Partner Dynamics

• Yum! royalty discussions ongoing: The company is engaged with Yum! on royalty rate discussions, but so far there is no output; Yum! has already pitched in with additional marketing money.
• Collaborative recovery effort: Management emphasized that the Pizza Hut turnaround is a joint effort with Yum!, stating "it is not just that it's only our baby," and that both parties work in parallel to ensure the brand comes back.
• Operational support: The company is working on Dragontail, a Yum!-owned kitchen solution that optimizes delivery times and ensures better-quality pizza with lower delivery time; it will be rolled out simultaneously for the franchise.

Dawar: "It is not just that it's only our baby. I mean, we work in parallel, and we work together to kind of ensure that Pizza Hut comes back."

Guidance & Commitments

Key Metrics