Devyani International Ltd

NSE:DEVYANI

Earnings Call Analysis

Revenue Growth Amidst Expansive Ventures

The company reported a revenue growth of 7% quarter-on-quarter and a standout 57.4% year-on-year growth. Expansion of new stores drove this growth, albeit with a slight decrease in gross margin to 76.3% and lowered brand contributions to 14.6%, attributed to the stores' time to stabilize. Optimism remains high for further stabilization. The quarter is expected to be strong due to festivals like Diwali and Christmas. Additionally, a joint venture targets opportunities in the modernization of Indian Railway stations, indicating potential high traffic revenue, though specific financials are not disclosed.

Investment in Ambition and Growth Plans

The company remains steadfast in its vision to expand in the Indian Quick Service Restaurant (QSR) market, targeting 2,000 stores by 2026, a testament to the strong demand for its brands. This bullish growth plan is supported by the company's financial strength, with the bulk of expansion costs anticipated to be covered through internal accruals. This strategic growth is balanced with a commitment to sustainably increase Return on Capital Employed (ROCE), ensuring long-term shareholder value.

Store Expansion and Revenue Growth

Costa Coffee's rapid growth continues, with 23 new stores propelling the count to 146 and contributing INR 14 crores in revenue this quarter, though margins were slightly down due to the stores stabilizing. This, combined with a revenue increase of 57.4% year-on-year, illustrates the brand's robust expansion efforts despite initial dips in brand contribution during store maturity.

Stable Raw Material Costs and Strategy for KFC

KFC's raw material and packaging costs have remained stable, with slight tailwinds. To reach untapped demographics, the company introduced value layers, tested KFC Lunch, and the Snackers range, demonstrating its strategic approach to growth without significant concern for gross margins currently.

Navigating Challenges in Same-Store Sales Growth (SSSG)

The company experienced a decline in SSSG from minus 1% to minus 4%, with variances across geographical regions attributed to seasonal and regional influences. Despite these fluctuations, the company remains confident in its differentiated marketing strategy to adapt and potentially outperform as the market improves.

New Ventures and Opportunities

DIL's joint venture aims to capitalize on the Indian Railway's modernization plans, leveraging high-traffic areas for food courts. The company is poised to take advantage of this development through thorough preparation and existing expertise within the railway food service domain, though the specific future plans remain under wraps due to ongoing public tender processes.

Marketing Initiatives and Expectations

To counter current market challenges, initiatives such as new menu introductions, premiumization, and increased marketing spend have been deployed. The company believes that these efforts will yield proportionally greater results when the market recovers, demonstrating their proactive stance in the face of adversity.

Brand Profitability Prospects

A scenario where Average Daily Sales (ADS) return to previous higher figures would likely yield similar brand contribution levels as before. The company's management is optimistic that profitability could recover to former levels for both KFC and Pizza Hut if the ADS returns to such levels.

Price Adjustments and Equity

Costa Coffee has steered clear of price hikes despite increases in milk prices over the last six months. This restraint reflects a broader pricing strategy aimed at fostering consumer loyalty and expanding the brand's market share in a period marked by overall consumer spending constraints.

Employment Costs and Store Performance

As part of its expansion strategy, the company's employee costs rose by 26% year-on-year, aligning with the increase in store count. Though this has momentarily affected leverage with higher costs outpacing revenue growth, it is anticipated that this ratio will improve as revenue grows and the company implements further cost control measures.

Strategic Store Openings and Performance Trends

Trends across different states and cities remain consistent, with Pizza Hut expected to have elongated recovery due to various brand-specific challenges. Both brands will likely witness the potential for margin expansion in line with improvements in SSSG, painting an optimistic picture for the company's future performance.

Collaboration with Yum! Brands

The ongoing partnership with Yum! Brands is intrinsic to the company's strategy, evidenced by shared marketing investments and collaborative efforts on menu development. While there are discussions regarding the support from Yum!, such as royalty adjustments to bolster strategic growth, there have been no conclusions yet.

Earnings Call Transcript 2024-Q2

[Operator]

Ladies and gentlemen, good day, and welcome to Devyani International's Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded.I now hand the conference over to Mr. Anoop Poojari from CDR India. Thank you, and over to you, sir.

[Anoop Poojari]

Thank you. Good afternoon, everyone, and thank you for joining us on Devyani International's Q2 FY '24 earnings conference call. We have with us Mr. Ravi Jaipuria, Non-Executive Chairman of the Company; Mr. Raj Gandhi, Non-Executive Director; Mr. Virag Joshi, CEO and Whole Time Director; Mr. Manish Dawar, CFO and Whole Time Director; and Mr. Rahul Shinde, CEO, Yum Brands and Whole Time Director of the company.We will initiate the call with opening remarks from the Chairman, followed by key financial highlights from the CFO. Post that, we will have the forum open for our question-and-answer session.Before we begin, I would like to point out that some statements made in today's call may be forward-looking in nature, and a disclaimer to this effect has been included in the results presentation shared with you earlier.I will now request Mr. Ravi Jaipuria to make his opening remarks.

[Varun Ravi Jaipuria, executive]

Good afternoon, everyone. I warmly welcome all of you to the earning conference call to discuss the business performance for the second quarter and H1 of the financial year 2023-2024. I'm pleased to share that DIL has maintained its store opening at pace.We opened 115 new outlets in H1, taking the store count to 1,358 as on 30th September 2023. Out of 115 stores in H1, we have opened 68 stores in quarter 2 across our brand portfolio. We are making consistent progress in investing in our core brands and expanding our reach to cover our target customers to capitalize on the available growth opportunity in India.We are now present in more than 240 cities in India. The consolidated revenue for DIL stood at INR 819 crore for the quarter with a growth of 9.6% on a year-to-year basis. India business witnessed a growth of 12.4% over the same period of the previous financial year. For H1, the consolidated revenue was INR 1,666 crores with a growth of 14.7% over H1 of the previous year.Quarter 2 is seasonally a low quarter for the QSR industry. Apart from that, quarter 2 also saw an extended 1 month of Shrawan -- Sawan period where a sizable part of Indian population turns to vegetarian food consumption for a temporary period of time.As you are aware, Nigeria, one of the countries we -- that we operate in, saw very significant currency devaluation in the previous quarter. As a result, we have seen an all-round impact on Nigerian economy. The devaluation has led to a contraction in the local disposable income levels and hence lower discretionary spending and consumption. We may have to support our Nigerian business financially given the local situation for the next couple of years until the local situation stabilizes.We continue to introduce a range of new menu additions and innovative campaigns for our core brands. The market response and consumer acceptance to these new offerings is positive. Our innovation pipeline remains healthy and strong. High inflation across industries and categories from a macroeconomic perspective has led to a short-term impact on consumer sentiment and depressed consumer spending in the last few quarters. Despite this, our performance is resilient and we continue to invest in the business for long-term growth.Looking ahead, we are hopeful that the rebound in consumer spending will take place in the next few quarters. We are poised for success in the dynamic and evolving QSR landscape by optimizing menu pricing, reducing wastage, cost controls and improving operational efficiency.To sum up, our store addition strategy stands as a testament to our belief in the long-term potential of the Indian QSR industry. As we actively grow our presence, we are strategically positioned to tap into the vast opportunities, ensuring sustainable growth and value creation for our stakeholders with the ambitious goal of reaching 2,000 stores by 2026.We are on track to inaugurate 250 to 275 new outlets in the current fiscal year. This ambitious expansion coupled with our commitment to customer satisfaction and innovation positions us for success in the dynamic and evolving QSR landscape.With this, I would like to conclude my address and now hand over to Manish for the financial highlights. Thank you.

[Manish Dawar, executive]

Thank you, Mr. Jaipuria. Good evening, everyone. A warm welcome to all of you and thanks for your valuable time for attending DIL's Q2 FY '24 earnings conference call, our ninth such call since the listing in August '21. In Q2 FY '24, we opened 68 new stores across our brand portfolio.We now have a footprint of 1,279 stores across our core brands with a total store count of 1,358 stores across DIL. This consists of 594 stores for KFC, 539 stores for Pizza Hut, and 146 stores for Costa Coffee in our portfolio as at the end of quarter 2 FY '24. Our store distribution in India continues to remain marginally in favor of non-metro destinations with 51% of the total store count.Operating revenue for quarter 2 FY '24 stood at INR 819 crores, representing a 9.6% Y-on-Y increase. This was supported by a strong growth in the new store openings. Indian business witnessed a growth of 12.4% over the same period of the previous financial year.As you all know, for the QSR industry in general, Q2 is seasonally a low quarter. Apart from that, Q2 saw an extended 1 month of Shrawan because of the lunar calendar adjustment. During this period, the consumption of meat comes down in the country. Further, there is competition emerging in the pizza category at the local and regional level.We are also seeing some marginal consumer preferences shifting in favor of non-pizza category within the largest QSR space. This is being observed mainly, because of the aftereffects of inflation where the consumers have tried to balance their wallets and down trade to lower entry points within the QSR industry. In our view, this phenomenon is probably temporary in nature.The Nigerian economy, where we have DIL operations, is currently in a difficult phase. The local oil prices have shot up multifold coupled with very significant currency devaluation in the previous quarter. This has resulted in a contraction in the local disposable income levels and hence a dent on discretionary spending and consumption.This has led to an all-round impact on our Nigerian business performance as far as the revenue and the margins are concerned. We may have to support Nigeria business financially given the local situation for the next couple of years until the local situation stabilizes.All of the above has impacted the overall consolidated performance of DIL. Slightly lower SSSG and ADS numbers have resulted in lower brand contribution margins in quarter 2 FY '24 at 15.4% versus 18.2% in the previous quarter, because of the de-leverage. Reported EBITDA post IND-AS for Q2 of the current financial year was INR 159 crores with margins at 19.4% versus INR 173 crores in the previous quarter.Company operating EBITDA on a pre IND-AS basis was INR 95 crore versus INR 111 crores in the previous quarter. Operating EBITDA margin at 11.5% for the quarter was lower by 1.7% on a quarter on basis.During the quarter, we also got the final approval from NCLT for merger of our 2 wholly owned subsidiaries and the financial results of these subsidiaries have been consolidated into the standalone results. Because of this consolidation, we've had to take some impairment of goodwill appearing in the subsidiary books and the same has been reflected as the exceptional item in the current quarter P&L.At the same time, this consolidation has also resulted in a one-time gain arising out of the defer tax recognition as part of the tax expense line in the P&L. Profit before tax for the quarter stood at INR 19 crores versus INR 13 crores in the previous quarter.Taking the discussion to our core brands, KFC in India added 30 new stores in quarter 2 FY '24, reaching a total count of 540 stores at the end of the quarter. Average daily sales for quarter 1 FY '24 was INR 109,000 versus INR 117,000 in the previous quarter. Sorry, my pardon, it was quarter 2 actually. Revenues at INR 509 crores grew 14.9% on a year-on-year basis.Gross margin for KFC at 69% were consistent. Brand contribution margin at 19.4% for the current quarter was lowered by 1.7% on a quarter-on-quarter basis, mainly due to adverse leverage arising out of lower ADS across the portfolio. On premise consumption was 61% versus 63% in the previous quarter.During the quarter, Pizza Hut added 14 new stores. Revenues at INR 184 crores was flat quarter-on-quarter and grew 1.5% on a year-on-year basis. ADS was slightly lower at INR 39,000 for the current quarter.Gross margins for the quarter came in at 75.7% with an improvement of 0.8% versus the previous quarter. Brand contribution was INR 14 crores for the quarter with the margins at 7.7% which was lower by 2.4% on a quarter-on-quarter basis, mainly due to higher marketing and ADS deleverage impact.Costa Coffee added 23 new stores during the quarter, reaching a cumulative store count of 146 stores as of September 20th. Quarter 2 FY '24 revenue was at INR 35 crores with a growth of 7% on quarter-on-quarter and 57.4% on a year-on-year basis, driven by expansion of new stores. Gross margin was 76.3%, slightly lower versus the previous quarter, because of slightly marginal adverse mix.Quarter 2 FY '24 brand contributions stood at 14.6%, lower versus the previous quarter. The new stores take some time to stabilize and reach the maturity level. Hence, the rapid expansion of Costa stores has impacted the overall brand performance. We expect this to stabilize as we go along.To conclude, we want to reiterate our commitment to our ambitious growth within the Indian QSR market. We have a target of reaching 2,000 stores by 2026, a milestone that signifies the tremendous potential and demand for our brands.We would like to highlight that the entire organic CapEx required for this expansion is primarily being planned through our internal accruals, our ability to self-finance growth underscores the financial strength of DIL.Furthermore, despite our aggressive expansion, we have remained focused on maintaining strong financial performance. As we continue to expand, we remain committed to sustainably increase the ROCs, reflecting our emphasis on prudent financial management and creating a long-term value for our shareholders.On that note, I would like to request the moderator to open the forum for any questions or suggestions that you may have. Thank you very much.

[Operator]

[Operator Instructions] We take the first question from the line of Tejash Shah from Spark Capital.

[Tejash Shah, analyst]

My first question pertains to the demand environment in general. You specifically called out pressure in pizza category, but just wanted to know post Adhik Maas and then Shrawan, have we seen any revival? And I just want a qualitative comment if you can. And the whole expectations which were built up around QSR category getting boost from World Cup and all, have you seen any of those materialize in any form for the sector?

[Manish Dawar, executive]

Tejash, see, obviously we will not be able to talk about the specific numbers. But if you look at, let's say, quarter 3 versus quarter 2, it's seasonally a very strong quarter compared to quarter 2. We are having a World Cup which obviously is having some impact whenever the big matches are there.At the same time, we have Diwali in this quarter, we have Christmas in this quarter whereas, let's say, in the previous quarter, while, let's say, Adhik Maas not only impacted the non-vegetarian category, but you also know that the -- I mean, the population, they typically try and consume the food inside the home, so that also there is a small shift which kind of impacts the overall performance. So therefore, from an overall perspective, quarter 3 should be a better quarter than quarter 2.

[Tejash Shah, analyst]

Sure. And second on KFC, when we see the gross margin expansion versus -- or gross margin movement versus EBITDA margin movement, it slightly looks not in tandem. So just wanted to know is there any one-off or is there any additional cost headwind that has come in that particular franchise?

[Manish Dawar, executive]

Tejash, there's no headwind as such. If you remember our previous comments, we had said that as far as KFC is concerned, the basket on raw material and packing materials is very stable. If at all it's probably slightly in our favor, but at the same time, in the last quarter, we had also said that as we continue to open more stores, we need to address the population which is not currently covered by KFC.And, therefore, we need to introduce the value layers and we talked about a test market on KFC Lunch, we talked about a test market on the KFC Snackers range. So, it's a little bit of mix, but, overall, there is nothing to worry as far as the KFC gross margins are concerned.

[Operator]

The next question is from the line of Saurabh Kundan from Goldman Sachs.

[Saurabh Kundan, analyst]

Yes. The first question is on KFC. The -- your SSSG went from minus 1% in the previous quarter to minus 4%, but when we look at the other KFC franchisees, they were 0% last quarter and 0% this time as well. So, could you help us understand the deterioration in your case? And I'll come to my next question later.

[Varun Ravi Jaipuria, executive]

Sure. Saurabh, as you know, I mean, we have different geographies between the 2 franchisees carved out and we are very strong in South. And, typically, the Shrawan month -- Shrawan, the traditional month, or Shrawan period has a higher impact in South India versus the other parts of the country.Because in West, it's probably lower versus even the rest of the country, because what we've seen typically it's South followed by North and then that's where the West and South comes in. So, because of our presence in South and the mix of the stores depending on where they are located, that's the reason you see a differentiated performance between the 2 franchise partners. So, this is, in our view, obviously, so therefore that is how it is.

[Saurabh Kundan, analyst]

Sure. Sure. Understood. And, sir, the next question is on this JV announcement that you have done. I know, it's a bit early, but still if you could just share with us maybe the revenue potential or whether the economics of these food courts are going to be similar to your current store P&Ls or are there going to be any additional cost lines involved? Anything that you can mention on the JV will be appreciated?

[Manish Dawar, executive]

Saurabh, we'll not be able to share the business plan as of now. But, you know, that the government has announced a modernization of Indian Railway stations. And if you look at the intent from the Indian Government, they want to modernize the railway stations to match with how the airports look and feel is. And, therefore, given that announcement and the fact that there are so many introductions of fast-moving trains and the entire train racks are getting upgraded, we see this joint venture to be giving us a big opportunity.And we also know that as the railway stations modernize, government is going to be allocating space for the food courts on the railway stations. And that's the reason we formed this JV with somebody who had great experience as far as working with the railways is concerned.They have their existing businesses, and it's going to be a big asset and big plus for us. But again, remember that all of this, there is a public tender process that is going to be conducted by Indian Railways, and therefore we will have to bid each and every railway station and food court as it comes along.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 we bring in our expertise of running the operations at the food courts. So therefore, it's a win-win situation for both of us.So depending on when the announcement takes place, as far as the modernization is concerned in terms of the specifics that I'm talking about and when government tenders out in what shape and form, so that's the reason we are not able to kind of give you the exact numbers. But to your other question, in terms of will this -- in terms of topline be in line with the rest of the food court portfolio, we think it could be in line or it could be slightly better because of the captive very high traffic.

[Saurabh Kundan, analyst]

Right. Understood. One last question on Pizza Hut. Are we now -- I understand your performance is actually better than the other franchisee and -- but the question is, it's still negative, and are there any initiatives that you are going to take or we are more or less relying on the macro to turn for Pizza Hut to start posting better or positive same store sales growth?

[Manish Dawar, executive]

See, we've taken initiatives in terms of the new menu introduction, in terms of premiumizing the overall menu that we have. We've taken some initiatives in terms of additional promotions, in terms of value layers, in terms of additional marketing spends.So obviously, I mean, we cannot sit quiet in the current situation, and therefore we expect that, let's say, when the market turns, we will see better than the proportionate results because all of these initiatives are kind of getting rolled out, and they would start showing the results as we go along.

[Operator]

The next question is from the line of Nihal Mahesh Jham from Nuvama.

[Nihal Jham, analyst]

Manish. The first question was, I think the opening comments you mentioned about pricing. So has there been any pricing adjustments in either of the brands?

[Manish Dawar, executive]

There's no pricing adjustment, Nihal, in the current quarter.

[Nihal Jham, analyst]

That's helpful. Taking another question on Pizza Hut itself, what I noticed is obviously there's been a significant deceleration in the brand margins and that is very much commensurate with what we've been highlighting about the competitive intensity and maybe a preference shift away from where we're seeing more preference towards some of the other QSR categories. But if I had to ask you that, even when I compare, say, versus the market leader, the deceleration in the SSSG or maybe the ADS performance has seen a much sharper fall. And that in a way points to a much sharper market share loss for Pizza Hut as a whole whether looked at for you or for the other franchise. So what are those specific aspects beyond competition and the category which would have impacted the overall market that is specifically impacting Pizza Hut in your opinion, Manish?

[Manish Dawar, executive]

Nihal, see in our case if you remember, around the same time last year or little later, we had introduced this fun flavor pizza and therefore the comps are a little different. So, as that 1 year anniversary kind of goes out for the fun flavor pizza, we will start to see the improvement on the SSSG numbers.Because it was -- the fun flavor got introduced when the inflation was almost at its peak, we saw a huge downtrend or a downshifting for the consumers from premium category to value layer category. And as we kind of go along, we've tried to address that. We've tried to bring down the mix of the fun flavor. We've introduced the new menu through the premium pizza. So all of that is showing results and therefore we expect in the next couple of quarters, it should kind of get [ finalized ].

[Nihal Jham, analyst]

That's helpful. Just one final question was, you did announce the cost attire with PVR in the middle of the quarter. Just would it be significant in terms of how the potential could be? I'm assuming it will be a lower margin business given it's still a B2B arrangement, but just your comments on the same.

[Manish Dawar, executive]

Yes, it will be slightly lower margin business as you allude to, Nihal. Right now, we are in the test market phase because PVR also wants to upgrade in terms of their offerings at the food counters that they have within the prime. So right now we are in the test market phase which will continue maybe for the next couple of months and then we will take a final call, and then we can discuss our plans also in detail.

[Operator]

Thank you, sir. The next question is from the line of Ashish Kanodia from Citi.

[Ashish Kanodia, analyst]

So the first question was more around demand. So, you know, 2Q and again this time 3Q both will have, you know, some one-off impact. So 2Q had Shrawan and then 3Q we will have, you know, Shradh month as well. But -- and, you know, that is why maybe a Y-o-Y comparison is difficult, but just wanted to get your sense that, you know, when you look at just the pure underlying demand on, you know, non-festive days and non-Shradh days or non-sawan days, you know, what are you picking? Is it that the demand environment is, you know, muted similar to what it was maybe a quarter or two back? Is it deteriorating or is it kind of improving? Just, you know, wanted to get more sense around the, you know, underlying demand rather than more from a festive period or a Sawan perspective?

[Manish Dawar, executive]

Ashish, see there are 2 ways to look at it. I mean, on some specific days, obviously we see some big numbers coming in and that shows the indication that the consumers are there, they are -- they form their habits and they're wanting to come back and so on and so forth. At the same time, if you see on an overall basis, there was this announcement on the savings ratio in the country and the savings are currently sitting at almost all time low.Now that shows the consumer -- the consumerism in the country setting in because if you go back, let's say, 10, 15 years, savings probably was one of the biggest priorities as far as the Indian population is concerned.So therefore, now the spends are higher on the durables, we are seeing the premium category doing well, the savings are lower. So, all of that is kind of positive. At the same time, we also need to understand that we've come out of hyperinflation and the consumer wallet sizes have remained the same.So, it'll take a couple of quarters for the consumers to fully come back and we are still seeing some job losses in the IT sector. So overall we are very bullish. But obviously there are these, as you call it or as I call it, the minor irritants or the bumps which are there, which will get sorted out as we go along.

[Ashish Kanodia, analyst]

Sure, Manish, that's helpful. The second thing, specifically on KFC, you know, if I look at the ADS between the on premise and off premise, you know the on-premise decline in ADS, you know, both on a quarter on quarter basis and on a Y-o-Y basis is much severe versus, you know, what you have seen in the off-premise ADS. So any specific thing or is it just, you know, a seasonality or something like that?

[Manish Dawar, executive]

See, we are in the middle of World Cup and the other things. Obviously leading up to that, people start to kind of order and you will see even in the current quarter also, that delivery ratios will be slightly higher. So depending on how many weekends are there or what kind of festivals are there or what kind of particular days are there.But otherwise as I have kind of pointed out in the past, I mean, for QSR, the bias remains slightly in favor of delivery because, see, it's a fast-food consumption item. And if let's say we are fully back to working from office post the COVID phase and all, the preferences are coming back as far as home delivery is concerned.

[Ashish Kanodia, analyst]

Sure, Manish. And, you know, just last week, you know, you talked about financial support for Nigeria. So just wanted to get a sense in terms of, you know, right now, what kind of, you know, financial support, you know, you are kind of building in from a, you know, year-to-year perspective?

[Manish Dawar, executive]

See, we will not be able to give the exact numbers, Ashish, because we don't even know the extent of how deep the deep is. So -- because Nigeria, if you look at the fuel prices, they've shot up by almost 4x to 5x. The currency has got devalued by almost about 64% in the previous quarter. And Nigeria is a dominant import economy and there's a huge amount of transport reliance.So, all of that has kind of impacted the consumers a lot, but the business continues. So the profitability of the business has come down. Because of our small store expansion requirements, we are just kind of putting a line in place.So, it's not going to be big amounts. It will be a small amount in the overall context of the DIL size. But since in the past we've stated that Nigeria is completely self-sufficient and therefore we are pointing it out very clearly that Nigeria could need some financial support for the next 1 or 2 years.

[Operator]

The next question is from the line of Devanshu Bansal from Emkay Global.

[Devanshu Bansal, analyst]

Best wishes for the upcoming festive season. Sir -- Manish, we have maintained that we'll be continuing the expansion through internal accrual. So wanted to check on what kind of margin recovery is built in our model for KFC and Pizza Hut for the upcoming years?

[Manish Dawar, executive]

Devanshu, see, if you look at, let's say, the good days of KFC, we used to get to a brand contribution level of 20%, 21%. And let's say once the entire situation is stable, these -- I mean, the overall macro started to fire back. We are pretty confident that we'll be able to get back to those numbers. I'm not saying it will happen immediately. It could take a few quarters, but we are confident that KFC can get back to those numbers.

[Devanshu Bansal, analyst]

And for Pizza Hut, Manish?

[Manish Dawar, executive]

Pizza Hut will take a little longer time because Pizza Hut, the issues are slightly different versus the KFC. And therefore, Pizza Hut probably will be a little longer journey.

[Devanshu Bansal, analyst]

Got it. Manish, we also have a higher rural exposure versus the rest of the [ pack ]. So wanted to understand how is the trajectory among rural region versus the urban region? Any color that you can provide here?

[Manish Dawar, executive]

So, Devanshu, let me slightly correct you that we do not have any exposure to as we define the rural areas, so...

[Devanshu Bansal, analyst]

Okay.

[Manish Dawar, executive]

Because, I mean, I agree with you that we have higher exposure as far as non-metros or maybe Tier 2 or Tier 3 cities are concerned, but we are not even close to touching rural. Because if you look at, I think, overall QSR industry, we are probably addressing about what 15% to 16% of the population and -- which is far away from where the rural India is. So -- but having said that, if you were to ask me is there a differentiated behavior between a metro versus a non-metro, it is not so much. The trends are very similar.And if at all the hunger and the aspiration is stronger in smaller towns and that's a good situation for us. So -- because if you see, I mean, if India has to develop, the non-metros have to develop faster and the smaller towns have to develop faster and therefore the way we look at our business, we are absolutely well positioned to capture that growth phenomenon.

[Devanshu Bansal, analyst]

Fair point, Manish. Last question from my end. Sapphire sort of indicated implementation of this kitchen solution called Dragontail. Any outlook here as in -- do we also sort of plan to implement this going ahead?

[Manish Dawar, executive]

So we are also working on that and it's an overall solution. Dragontail, I'm sure you must be aware, is owned by Yum!. And they had acquired Dragontail a few years back, which kind of obviously optimizes the delivery times and the time it takes for a rider to come to the store versus the handing over of pizza to the -- which kind of ensures that we are able to deliver a better-quality pizza to the consumer with a lower delivery time. So we both are working on that initiative and it will get rolled out simultaneously for the [Technical Difficulty].

[Operator]

Thank you, sir. We take the next question from the line of Shirish Pardeshi from Centrum Broking.

[Shirish Pardeshi, analyst]

2 questions. In the beginning, when we see there is a consumer sentiment which are weaker, the burger segments are doing little better than the pizza category. So, does that mean that if the last year Diwali or quarter 3 was weaker? So base is absolutely benign. And I'm giving the context because last 5 quarters, Pizza Hut has seen a consistent decline in ADS and also in the -- in terms of the SSSG. So in that base and given these events and the festive season and momentum which is picking up, do we think we will report a positive SSSG in quarter 3 or we will be still in a negative territory? I know it is too hypothetical at this time.

[Manish Dawar, executive]

See, I will not be able to give you any numbers as far as the current quarter is concerned and...

[Shirish Pardeshi, analyst]

No, will it decline further or will it remain less than 10%? That's what the question is.

[Manish Dawar, executive]

So, well tried, Shirish. But see, overall, as I said, I mean, it was around the Diwali time. I think probably -- I'll have to just check my exact timing, we had introduced the fun flavor pizza and it was part of the quarter and therefore we will be able to cycle out of this whole thing from quarter 4 onwards. And that's where we see that things will probably turn.But otherwise, on a macro level, there's nothing wrong with the pizza category. If you see any of the environments where hyperinflation has taken place, not only in India, but any part of the world, people try and downgrade to the lower entry segment. And that's the reason why we are saying, as you pointed out, that's the burger category because that's a lower entry point into the QSR segment and therefore the consumers have switched into that.But on an overall basis, there's no reason because if you look at the entire concept behind premiumization and upgradation and all, so we are very confident that the population or the consumers will come back. It's only a temporary piece that we are seeing.

[Shirish Pardeshi, analyst]

Okay, that's helpful. My second question on the post in this EBITDA, we are around at 19.9%, but in this quarter, particularly when I look at, our employee cost has gone up by 26% and other expenses ahead of our revenue growth. So is there any one-off? And how should we look at the employee cost for the rest of the year? Because other expenses I can understand, that could be temporary.

[Manish Dawar, executive]

See, there are multiple things which is happening in the employee cost, Shirish. One is obviously as we continue to expand in terms of the number of stores. So if you look at, let's say, a year-on-year comparison, our stores would have gone up I think by almost about 25%, 26% and the employee cost will not go in the same proportion, but there is a large component of the employee cost increase which is because of the overall store openings. And because of the lower ADS, obviously the deleverage sets in and your ratio looks kind of slightly adverse versus where it would have been.Secondly, between, let's say, the year-to-year numbers, we've also seen an increment cycle, not only for the supervisory and the management staff, but also for the team members because of the minimum wage inflation. So, that comes in as an increment. And if you remember last time, quarter 4 we had said that we've taken a provision on account of statutory bonus because of the Payment of Bonus Act and now we've started providing for that on a regular basis. So that is the other impact which is setting in.So, therefore, if you have to ask me what is that one-time, there's no one-time as such, but the moment, let's say, we kind of cycle throughout, let's say, once this whole year passes and we've started providing for the statutory bonus on a monthly basis, all of those pieces will kind of cycle out. And as we continue to kind of see the improved sentiment in macro and the ADS numbers improve, we will see the ratio getting better as far as the employee cost is concerned.

[Shirish Pardeshi, analyst]

Wonderful. Just last question on the JV with R.K. Associates. Now this has happened between DIL and R.K. Associates. So that means more than Yum! brand, we are also looking at opening food courts with the other brands, our own brands also.

[Manish Dawar, executive]

See, if you look at, Shirish, our current food courts also like, for example, we operate a food court at the Mumbai airport, we operate food courts in Delhi, some of the highways and all, we do deal with the brands outside the Yum! portfolio. And we've taken specific approval from Yum! for dealing with these brands and therefore that will continue into a new setup as well.

[Operator]

[Operator Instructions] We take the next question from the line of Deesha from Ankhonia Advisors.

[Deesha Jain, analyst]

I just had a question on Costa Coffee. I wanted to understand if you have taken any price hikes on your products considering the price in -- price of milk in the last 6 months?

[Manish Dawar, executive]

No, last 6 months, Deesha, we've not taken a price increase. Obviously, the milk prices have strengthened in some pockets which has impacted the margins. We've seen a very small similar phenomenon on the coffee beans also, but we've not taken a price increase as yet.

[Deesha Jain, analyst]

Also, just could you elaborate your pricing strategy? Does your pricing strategy of Costa differ from region to region? And also, is there any room to increase the prices of coffee considering that a millennial is willing to pay or is willing to afford today?

[Manish Dawar, executive]

See, we do not have a region-based pricing, but we do have a pricing which is based on the channel. So, for example, the airports could see a premium pricing versus the normal Costa outlet. At the same time, for example, if you are present in a premium mall, that could see a slight premium versus the normal pricing and we are indexed to Starbucks as far as the pricing strategy is concerned and we try and maintain that.But at the same time, we also need to balance out because, as you know, I mean, the consumer sentiment is weak for the last few quarters because of hyperinflation. And we've seen the overall impact on the QSR industry as well. So hence, we are kind of holding ourselves back as far as the Costa pricing is also concerned. Because, in any case, we want to address the deeper market here. We want to kind of enlarge the consumer base for Costa coffee. So, therefore we've not taken any price increase yet.

[Operator]

The next question is from the line of Devanshu Bansal from Emkay Global.

[Devanshu Bansal, analyst]

Manish, sequentially there is a significant drop in head office cost for us. So is it a usual phenomena where Q1 sees a higher sort of head office cost and then things normalize in the rest of the quarters?

[Manish Dawar, executive]

See typically in quarter 1, you have the impact of increments which is there, but otherwise there's nothing specific. And as kind of -- things kind of go along, it normalizes. So -- but otherwise there's nothing specific to call out as far as corporate office is concerned.

[Devanshu Bansal, analyst]

Okay. So current levels are -- should sustain, right?

[Manish Dawar, executive]

Yes. I mean, we are hoping as, let's say, the ADS comes back, the leverage will be better because it is a fixed cost as you know. And therefore as a ratio, it should start to increase and plus, we do have to take some cost initiatives also that is what we are currently working on.

[Operator]

We take the next question from the line of Dhiraj Mistry from Antique.

[Dhiraj Mistry, analyst]

So, I would like to ask the question, I am aware that you have guided for 2,000 stores by the end of 2026, but the mix change like the store addition between KFC and Pizza is going to be similar or it would be different from the long term as well as from the near-term perspective?

[Manish Dawar, executive]

See, we've talked about this in the past. KFC is going to see a stronger store addition and we've talked about that KFC in terms of the net new stores will see almost 120 to 130 stores getting added every year whereas Pizza Hut we've brought down the guidance from where it was around the IPO time because obviously we are seeing and we've always said that we have a dynamic store expansion strategy. So, depending on what the environment is and what is happening on the brand, we continue to adjust that, so...

[Dhiraj Mistry, analyst]

Okay. Second question is regarding profitability of Pizza Hut. So if our ADS goes back to, like, 2 quarters back like somewhere around INR 46,000 or INR 48,000, our profitability is likely to improve by 10 -- to get back to 10% or it would remain in single digit only?

[Manish Dawar, executive]

See, we would not like to speculate on where the ADS numbers could go, but what you're saying and the scenario that painting -- that you're painting, if the ADS numbers goes back to the same numbers, you can see the similar brand contribution levels getting achieved.

[Dhiraj Mistry, analyst]

Okay, the reason why I was asking that is that because of you highlighted that there's a downtrading which has been witnessed in Pizza Hut. Will that materially impact the profitability if -- even if the ADS goes back to the original level?

[Manish Dawar, executive]

See, we've taken steps to kind of address that mix because when we introduced this, we see -- we saw a rapid mix in favor of the fun flavor or the lowest price category because we're in the middle of a hyperinflation scenario. We've taken conscious steps to kind of bring consumers back to the premium category. We've taken some price initiatives also.We've taken some mixed initiatives also. So therefore -- and again, let's say, INR 47,000 is not going to happen overnight. So, by the time we hit that number, we think things should be normal and we should be able to hit close to the same brand contribution levels or similar brand contribution levels.

[Dhiraj Mistry, analyst]

Okay. Sir, next is regarding last quarter, you highlighted presentation on Vaango also. And in this quarter, you have discontinued that. Can I -- can you highlight some reason for that?

[Manish Dawar, executive]

See, Vaango is a small business of the -- compared to the overall DIL size. I mean, it is about -- I think about less than 3% of the overall DIL. So, there was a strong demand from the analysts and the investors that we would like to see the Vaango numbers. So it's not that we are not going to be showing the numbers, but what we thought maybe once every few quarters we'll be able to give you the Vaango numbers so that you are able to see how the business is progressing.So, it's not that we've completely stopped. It could well be once every year or coinciding with the year end that we will give the Vaango performance regularly. And if you see in terms of the store numbers, we've kind of given the Vaango store numbers also.

[Dhiraj Mistry, analyst]

Yes.

[Manish Dawar, executive]

So, since it is a small part and that's the reason we thought that, I mean, from analysts and the investor perspective to save their time.

[Operator]

Thank you, sir. The next question is from the line of [ Maroof Chowdhury ], an individual investor.

[Unknown Analyst]

Hi, team. Can I ask question in Hindi? Hello? Am I audible?

[Manish Dawar, executive]

[ Maroof ], you're not very clear. So, I think maybe you need to bring your phone closer to you.

[Unknown Analyst]

Okay. Now, am I audible?

[Operator]

[ Maroof ] sir, are you on a speaker phone?

[Unknown Analyst]

Yes. Now, is it okay?

[Operator]

Sir, could you please switch to your handset, sir. Your voice is sounding muffled.

[Unknown Analyst]

Now, it is okay?

[Operator]

Yes, it's better. Please go [Technical Difficulty].

[Unknown Analyst]

I'm asking can I ask question in Hindi?

[Manish Dawar, executive]

Sorry, [ Maroof ], can you please repeat? We are not able to get you.

[Unknown Analyst]

Can I ask question in Hindi? Hindi? [Foreign Language]

[Manish Dawar, executive]

Sure. Absolutely. Feel free. [Foreign Language]

[Unknown Analyst]

[Foreign Language]

[Manish Dawar, executive]

[Foreign Language] We want to experiment. We want to see. [Foreign Language]. So the whole idea is to experiment, test what is successful, what is not successful, what is that the consumer demand is? [Foreign Language]

[Operator]

Thank you, sir. The next question is from the line of Saurabh Kundan from Goldman Sachs.

[Saurabh Kundan, analyst]

Yes, just a couple of questions on Pizza Hut. So, is there a very large divergence between your Pizza Hut SSSG in the states that you're present in? Are some states really very bad versus others? Or is it across the states -- similar across the states?

[Manish Dawar, executive]

It's similar across the states, across metros, non-metros. I mean, obviously there are some pockets which are always an exception, but largely the trends are very similar, Saurabh.

[Saurabh Kundan, analyst]

Okay. And another question, if I remember correctly, in the previous quarter call, I think the management had mentioned that Pizza Hut will return to mid-teens margins in a couple of quarters. If I understood your comments today correctly, now you're saying that it might take a little bit longer for that to happen. Is it?

[Manish Dawar, executive]

Yes, because we've seen continuing weakness. And as I said, I mean, it's a matter of what ADS levels can we get to? And as you start to see the ADS improving because we've managed to arrest the decline through our initiatives on marketing, on promotions, on menu introductions and so on and so forth. So, as you see the ADS coming back and ADS improving, we will see the margins also kind of moving in tandem.

[Operator]

Thank you, sir. The next question is from the line of Ashish Kanodia from Citi.

[Ashish Kanodia, analyst]

Manish, so on Pizza Hut, you know, as you recalibrate your store expansion for maybe, you know, next 2 year, 3 years given, you know, maybe macro slowdown plus competitive intensity. I mean, you know, when you maybe, you know, interact with the brand owner, maybe with Yum! Brands, you know, is there a discussion or thought process that maybe, you know, instead of kind of, you know, reducing the store expansion, you know, maybe Yum! Brands can kind of support in terms of lower royalty, et cetera?Because, I mean, at the end of the day, it boils down to, you know, ROCs and cash flows and, you know, opening more number of stores as -- I mean, opening less number of stores makes sense because demand is weak, but whenever demand kind of picks up, you know, having kind of deeper density of stores, of course, helps, right. So had there been any discussion or do you think this is a feasible model to work on?

[Manish Dawar, executive]

Ashish, see, we and Yum! are continuously engaged as far as any of their brands and the businesses are concerned, right. So therefore, let's say, if you look at the introduction of value layer, if you look at, let's say, premiumization of the pizzas, if you look at the new menu introductions, all of that is in collaboration with Yum! and they are also equally concerned as to what is happening to the brand and the brand performance. So similarly, for example, we've also seen that, I mean, while we've spent additional money on marketing, Yum! has also kind of pitched in with the additional marketing money from their side. So, 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.

[Ashish Kanodia, analyst]

Got it. But, I mean, what I'm just trying to understand is, you know, for example, they kind of have, you know, some benefits in terms of accelerated store expansion, right? And at a time when sentiments are weak, I mean, you know, this is a time when brands normally invest to come out much stronger, right? So, I mean -- and one way, you know, in which Yum! can, you know, help and it's, you know, ultimately everyone's decision there, but to have lower royalty rates and, you know, kind of leave more in the pocket of maybe the franchisee partner to drive that, you know, aggression. So, just wanted to -- I mean, I understand that it's -- you know, both are discussing, but do you see this as a feasible model if that has to happen?

[Manish Dawar, executive]

So, Ashish, we are engaged with Yum!, but obviously so far there is no output as far as royalty discussion is concerned. But again, I mean, your point is absolutely valid. Because see what happens, let's say, when the ADS is down and the brand is the same, I mean, obviously their income levels also come down through the royalty because it is a percentage revenue, it's not a fixed royalty. But your point is absolutely valid. We are engaged with Yum! on that. So, let's see how that goes.

[Operator]

Thank you, sir. The next question is from the line of Jay Doshi from Kotak.

[Jaykumar Doshi, analyst]

Hi, thanks for the opportunity. And my apologies I've joined the queue -- you know, call late. So, in case if this question was already answered, I'll go back. Now my question is Manish, when I sort of -- you know, when you look at your store portfolio, let's say, in 2 years, you've gone up from 300 stores to 540 stores in KFC 2Q FY '22 versus 2Q FY '24. And 2 years back, brand EBITDA margin was 22.4%. Right now, it's down 300 basis points. Gross margin is almost comparable.So for the original 250-300 stores that you had, the portfolio of stores you had 2 years back, has store level profitability or EBITDA improved, it has remained at a similar level? I just want to understand, you know, the numbers that we are looking at on profitability front, is that largely the drag of new stores or is it also slightly lower profitability in other stores versus what you used to do 2 years back [ in core ]?

[Manish Dawar, executive]

Sure. Jai, see there are multiple things at play when you look at either of the brand performance. So, for example, when you look at -- obviously, we've doubled the store count. The new stores take time to mature. They take time to reach the overall brand averages in terms of the top line and the bottom line. And that impacts the overall mix. The old stores are stable. They are performing well.But at the same time, we are also seeing the external or the macro factors in terms of the inflation, in terms of so on and so forth, which kind of impacts the overall portfolio. And we've seen the inflation is not just on the food side, it is all across, which has impacted the consumer sentiment, which has impacted the consumer wallets.And therefore that kind of impacts the old and the new stores. Similarly, for example, if, let's say, we take new initiatives in terms of value layer, that new initiative will be kind of taken at all the stores. So overall, therefore, I mean, the portfolio is doing well, it is getting stronger. And if we all believe in the QSR opportunity in this country, I think we are in a good place.

[Jaykumar Doshi, analyst]

Understood. Sorry, I have couple of follow-up questions -- connected question. So, when I -- you know, when you look at -- when you think about the next 2 or 3 years now, you know, inflationary pressure at least for KFC is almost entirely East. Your gross margins are tracking at a fairly decent levels. So do you see, you know, EBITDA -- brand EBITDA margin remain at these levels as you continue to add 100, 125 stores a year? Or will it move up directionally a little up or will it sort of -- can it go down further?

[Manish Dawar, executive]

Yes, as the new stores mature and as the macros kind of improve a little bit, we are confident the ADS will improve. And as the ADS improves, the deleverage that we are seeing currently will kind of go off and that's the reason -- so I kind of addressed this question earlier on also that as the ADS improves, if you see in the past, we've seen KFC brand contribution coming in at 21%, 22% level. And as the ADS improves -- macros improve, we think we will be able to kind of hit those numbers back again.

[Jaykumar Doshi, analyst]

So SSSG recovery will translate into margin expansion, there is...

[Manish Dawar, executive]

Yes, SSSG recovery, because again remember that as the base is expanding, the new store as a percentage to the base and in terms of dilution also keeps coming down. So, therefore, that is also going to be helping the brand on an overall basis.

[Jaykumar Doshi, analyst]

And final one, on KFC portfolio, you know, now that you are at 540 stores and you're going to be adding another 120, 130 per year. So are you seeing any impact of cannibalization at all on some of your existing stores? Or it's still, you know, there are enough white spaces, you know, that you see that will ensure that you don't -- your core -- existing network does not get cannibalized by the new stores?

[Manish Dawar, executive]

Jay, it's a combination of both because, for example, it really depends as to where are you opening the store. So, for example, as we go deeper into the metros because metros are big consumption hubs, we do see some kind of cannibalization in the neighboring stores. But overall as a metro, it kind of does not. If you go to a new town, if you go to smaller city, there is no impact at all. So, it's a combination of various kind of factors.On an overall basis, we think India has a huge potential as far as KFC is concerned because of the macro in terms of the non-vegetarian population, the chicken consumption amongst the non-vegetarian population and so on and so forth. So therefore, if you're going to consider that, we are very, very highly underpenetrated as far as the current KFC penetration is concerned, but there is this small impact which is kind of there depending on where you're opening the store.

[Operator]

Thank you. Ladies and gentlemen, as there are no further questions, I would now like to hand the conference over to the management for closing comments.

[Unknown Executive]

Thank you so much for your participation in our quarterly results presentation call. We do hope that we have been able to manage all your questions to answer satisfactory. And should you need any further clarifications or would you like to know more about our company, please feel free to contact our Investor Relations team. Thanks again to all investors, analysts for your time to join in our growth story. Thanks.

[Operator]

Thank you. On behalf of Devyani International that concludes this conference. Thank you for joining us and you may now disconnect your lines.

[Varun Ravi Jaipuria, executive]

Thank you so much.