Sapphire Foods India Ltd
NSE:SAPPHIRE
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Sapphire Foods India Ltd
Earnings Call Analysis
Q3-2024 Analysis
Sapphire Foods India Ltd
The company showed a notable rise in gross margins to 75.7%, marking a 130 basis points improvement. Sri Lanka's steady performance, with a Same-Store Sales Growth (SSSG) of 1% year-to-date and a revenue increase of 7% in local currency, reflects resilience despite economic challenges. The brand remains the top Quick Service Restaurant (QSR) in the country, showing promise for growth with expected improvements starting from the next financial year. This expectation is bolstered by an upswing in macroeconomic conditions and political stability, along with an improvement in gross margins by 450 basis points in the region, suggesting effective cost management measures.
The company is facing heightened competitive pressures, especially evident in the performance deceleration of Pizza Hut over the last six quarters. Given that brand association remains strong with consumers, the focus will be on revitalizing consumer interest through strategic marketing and solid operational delivery. Previous successful product launches, like the Momo Pizza and Flavour Fun, underscore the value of sustained innovation and marketing. Learning from past experiences, the company aims to extend support for new initiatives beyond short-term campaigns to generate lasting engagement.
While KFC has been a stronger performer, the company is cognizant of the ever-evolving competitive landscape, particularly from cloud kitchen models that present a disruptive challenge to traditional QSR formats. To counteract potential threats and maintain consumer interest, the company is committed to innovating and bolstering its brands continuously, addressing the ease and lower costs associated with setting up cloud kitchens versus traditional restaurants.
Even with a slight decline in Same-Store Sales Growth (SSSG) for KFC, the company has maintained a robust margin of 20%. This has been achieved through a continuous 'pace setter' program that benchmarks store cohorts against each other for cost efficiencies in labor hours, utility consumption, and wastage. Consequently, customer metrics have reached all-time highs, indicating that these efficiencies have not come at the cost of customer satisfaction. While the margins can be sustained given the current Average Daily Sales (ADS), they could be pressured by further declines in SSSG.
Stores require approximately three years to attain maturity in terms of profitability and revenue matching the brand average. With a policy to sustain margins around 20%, the company is prepared to adjust expansion plans based on profitability metrics. If profitability exceeds the 20% mark, further investment in aggressive store openings may occur. Conversely, should margins dip substantially below this threshold, the expansion strategy would be reassessed. These dynamics symbolize the company's commitment to balanced growth and financial health.
A reported 65% Same-Store Sales Growth (SSSG) in the current quarter has been noted; however, the company cautions that this number may not be directly comparable to past performance due to cycling effects from prior periods, which could distort the like-for-like comparison.
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Ladies and gentlemen, good day, and welcome to the Sapphire Foods India Limited Q3 and 9 Months FY '24 Earnings Conference Call organized by Orient Capital. [Operator Instructions] Please note, this conference is being recorded.
I now hand the conference over to Mr. Bhavya Shah from Orient Capital. Thank you, and over to you, sir.
Good evening, everyone. Welcome to the Q3 and 9 months FY '24 Earnings Con Call for Sapphire Foods India Limited. From the management, we have with us Mr. Sanjay Purohit, Group CEO; and Whole Time Director; Mr. Vijay Jain, CFO; and Mr. Rahul Kapoor, Head, Investor Relations.
I hope everyone had a chance to go through the results and investor presentation, which was uploaded on the exchange earlier today. Before we proceed, a reminder that this call may contain forward-looking statements, which do not guarantee future performance and involve unforeseen risks. Our detailed disclaimer has also been published in the presentation.
I would now like to hand over the call to Mr. Sanjay. Over to you, sir.
Good afternoon, everybody. Thank you for joining our investor call. Let me start off -- our quarter 3 FY '24 consolidated restaurant sales was INR 664 crores and this grew by 12% Y-o-Y, and EBITDA at INR 123 crores grew by 5%. Now if you -- these numbers seem to suggest that the quarter continues to be tough from a demand perspective. Indeed, when you look at most consumer product categories, we can see that demand conditions are tough.
And then when you look at the rest of the QSR industry, again, you will see demand condition stuff growth generally being muted, but in the light of competitive highlights that have been given out, this performance still is relatively a strong performance driven by KFC, which is doing quite well. Sri Lanka being stable and Pizza Hut continuing to be a challenging quarter.
In the quarter, we added 36 restaurants, 25 KFC, 8 Pizza Hut in India and 3 Pizza Hut in Sri Lanka, taking a total restaurant count to 850. Our consolidated restaurant EBITDA margin -- EBITDA was flat Y-o-Y and margin was down 16% -- down to 16%, 210 basis points lower than last year. Our consolidated EBITDA post IND-AS was INR 123 crores or 18.4%, and this grew year-on-year by 5% though down by 120 basis points. Our adjusted EBITDA was INR 72 crores or 10.9% and this declined Y-o-Y by 2% or by 155 basis points.
I'm now going to jump to the KFC slide, which is Slide #18 and talk about what we are trying to drive on the KFC brand. Like I said, in general, we are seeing growth being challenging in the QSR space. However, on KFC, our biggest priority is to be able to continue -- is to be able to grow the fried chicken relevance. And we have taken 2 occasions of lunch and snacking, and we are starting to blow this up.
This is both through product menu innovation and then advertising both digital as well as mass media television advertising to back these initiatives. Both of these -- so you would have seen snacking as a continuing theme from last couple of quarters. And lunch is occasion that we have started backing from this quarter onwards.
Like I said, both of them come with a variety of options at attractive price points, and we are advertising to create demand. From an operational perspective, our customer scores and our operating scores continue to improve. For example, our Google ratings, Swiggy ratings, the Zomato ratings on the basis of which consumers make a choice between brands have never been higher than what they are today.
That's on account of the rigor in operational initiatives that we drive at the front end. So that's doing really well. We have overall implemented digital kiosks. This is Slide #20 and about 130 restaurants, and that's going well.
From an accessibility perspective, we used to call out that in overall -- on an overall basis, we should be able to double our restaurant count in 3 to 4 years. On KFC, at least, we think that it is -- we should be able to call out that we will double this restaurant count in 3 years' time.
Quickly, let me hand it over to Vijay to talk -- to take us through the numbers part.
Thank you, Sanjay. Just to clarify on the previous side, doubling the count, we meant December '21 as the base. We are on track to double it by the end of calendar year '24.
Slide #22. Dine in mix was 43%, delivery came at 38%, 200 basis points higher than last year. In terms of SSSG, we were at minus 2% with overall revenue growth of 15%. ADS of 125,000 includes 25% new store additions. So we added 81 stores over last calendar year. So that impact is there in the ADS of 125,000. Overall gross margin grew by 190 basis points and sequentially also, it improved by 50 basis points. This, combined with the cost efficiencies meant that we were able to deliver a very strong EBITDA of 20.1%.
And even if you look at our 9-month performance, 19% revenue growth with a 20% restaurant EBITDA, this is the highest ever restaurant EBITDA for Sapphire KFC for a 9-month period.
Moving to Slide 25. It gives you a 4-year trend and 5-quarter trend. Now that we have the benefit of looking at results of all other QSR players, we can safely say that the last 9 months' performance of KFC and especially the Sapphire KFC, I would like to underline this Sapphire KFC is by far the best in the industry, considering the scale, growth and the margins which we are able to deliver.
While KFC has been a shining star in our overall portfolio, Pizza Hut continues to face a challenging situation on the back of quite severe competitive pressures. Last time, we have tried to distill out everything that we are doing into really 3 simple buckets. And we have called out specific actions that we are taking under each of these initiatives. And here, we are giving you a summary update.
Now given the nature of the decline that we have had on the brand, I must say this is -- there are no silver bullets to rejuvenating the brand. This is going to be a medium-term task and to be able to change perceptions on the brand.
So the first action that we have called is how do we revive customer interest in the brand by building the brand and both product innovation and enhanced marketing investments are the specific actions. You should be able to see innovation starting to roll out in the next 2 quarters. And we will be putting in higher level of marketing moneys to back this innovation.
Then we said we got through operational initiatives, how do we grow both dine-in and home service? We have now implemented the Dragontail kitchen planning tool in 100% of our restaurants. And most importantly, because this is a delivery forward kitchen planning tool to -- for it to be effective, we needed to integrate with the aggregator platforms. That is also complete.
So now our simple premise is that if we are able to deliver pizza within 20 minutes to a customer as soon as it comes out of the oven, then it is hot and fresh. And we are now seeing month-on-month improvement in these metrics of the number of orders that we are able to serve within these 20 minutes. That resulted in our higher ratings on Google, on Swiggy and on Zomato. So across the platform, we are close to 4 rating on Zomato, and this has seen a substantial improvement and above 4 on Swiggy.
Further building occasions like KFC is an important initiative, both lunch as well as late-night deliveries are the 2 areas that we are focusing on. The lunch day part activation has been rolled out, and over 90% of our stores now are open for late night deliveries. So this also, we think, will give us an upside.
And finally, we've talked about our philosophy on capital allocation and given that the brand right now has had a challenging couple of quarters on profitability. We've said that we will do 3% to 5% portfolio corrections in the next 2 quarters. We will slow down on our rate of expansion, but we will continue to invest in refurbishments so that customer experience is really maintained.
So like I want to underline here, brand revival will take a few quarters, but the actions we believe we are taking are fundamental in nature, and it's just persistence that will definitely drive and deliver results.
Moving to Slide 32. Dining in mix came at 35% and delivery is at 49% largely stable quarter-on-quarter and even for last 9 months in a similar range. Overall, SSSG for the brand was minus 19%. And even the overall revenue decreased by 4%, ADS came at 45% -- 45,000 ADS. Again, in terms of last 1-year additions, we roughly added 15% of stores in last calendar year.
Moving to the gross margins, 75.7% up by 130 basis points and this -- all the gross margins improved, the operating deleverage on account of negative SSSG meant that our restaurant EBITDA came down at 4.6%.
Slide 35, which gives you the 4-year trend in 5-quarter trend clearly shows that the brand is facing challenging times. However, Pizza Hut continues to be important second leg for Sapphire, and the confidence that it will emerge stronger in the medium term.
Very quickly on the Sri Lanka business performance. Sri Lanka has been quite steady. On a YTD basis, we are seeing 1% SSSG. The operating conditions are quite steady. I think this is a period where with cost stabilizing with the country's economic and political scenarios stabilizing, we should look at an improvement in the growth outlook towards the latter part of the year.
We still believe strongly that there is good growth potential in this market. And as -- and for the brand, Pizza Hut, there is still a long runway for expansion and growth here and we will continue to be careful. We opened 7 stores last year. We will continue to be in that vicinity till we see an uptick in the overall macros and then we should be able to accelerate. The brand continues to be the #1 QSR brand in the country.
We have 1 more slide that we would like to -- I will cover from the financials of Sri Lanka. Slide 40, the Dine in mix came in at 27%, delivery was at 37%, again largely in line with the last year. SSSG was 1% in LKR. In terms of overall revenue growth, 7% in LKR, 22% in Indian rupees. And while gross margins improved by 450 bps, cost inflations on other lines meant that restaurant EBITDA came at 14.2%, again, largely in line with the last few quarters.
Also, our absolute restaurant EBITDA grew by 4% in LKR terms. So that's another heartening part that now we're able to grow our restaurant EBITDA. So over the last 1 year, over the past few quarters, we lost out on our restaurant EBITDA on absolute basis. We are again seeing the growth happening on absolute EBITDA basis. So 4% for the quarter, 2% for -- on a YTD basis in LKR terms and 19% for the quarter in INR terms and 19% on YTD basis as well.
Slide 44 gives out the 4-year trend and 5-quarter trend. As you can see, last few quarters have been quite steady in terms of our performance in terms of profitability and as macroeconomic recovery continues, as mentioned by Sanjay, we expect improvement in this starting from next financial year.
Moving on to Slide 45, very pleased to inform that Sapphire Foods is now rated by S&P on ESG parameters. Our DJSI ratings -- we were rated as 42 in terms of scores, which is -- we are highest or first amongst the QSR brands in India. 95th percentile amongst the global QSR companies. The key areas of impact have been human capital development, business ethics and the customer relationship management.
With this, we hand it over back Anuja to you, we can open the forum for questions.
[Operator Instructions] The first question is from the line of Nihal Mahesh Jham from Nuvama Wealth Management Limited. Please go ahead.
Sir, 2 questions from my side. Starting off with Pizza Hut. Over the last 6 quarters, there has been a significant deceleration in the performance, which you also highlighted. So is this totally related to the competitive intensity? Or maybe from a brand perspective, also some choices or some aspects have not worked out right? Because if you look at the history, there was a [Technical Difficulty] with the brand, but it is surprising in terms of the kind of deceleration, the specific brand has taken versus some of the other pizza players.
Yes. So I think part of the issue is the competitor intensity and perhaps that's affected Pizza Hut a little more than other brands. So that's what the numbers point out towards, Nihal. Having said that, I think we recognize that in a highly competitive space at this moment, we've got to start upping the ante. The brand still means a lot to consumers. All our consumer research still shows that the brand retains a top of mind awareness consideration. And yet, in the face of, like I said, competitive pressures, we have lost out on growth despite our higher expansion.
So the answer really lies in how do you revive consumer interest behind the brand and it's -- and so to do that, it's a combination of how much marketing that you put behind the brand and through both innovation as well as value attract consumers and back set up with very strong operations to deliver a great experience to consumers when they either come to the store or when they order in their homes.
Sir, a related question was that we've been very aggressive with product launches in Pizza Hut over the last 2 years. When you are incrementally looking at launching further products, what is going to be different versus launching those 10 units of pizzas, which I think just happened 6 months back?
So if I just look at our last, say, perhaps 2 or 3 years, what really worked on the brand was when we launched first -- about 2 years ago, when we launched the Momo Pizza that seemed to work on the brand. When we launched Flavour Fun for a period of 6 to 9 months, we saw a significant upside on the brand, brand ADS started to move up.
The core pizza Refresh, which was the 10 new pizzas and branded as What's your mood pizza perhaps did not have as much of impact as it should have because you're changing around toppings and not offering the consumer anything significantly new. So that's a lesson that we are perhaps taking out.
So -- whereas when I look at the first 2 innovations that I talked about, both Momo as well as on Flavour Fun, I think 1 recognition is that we should have been able to support these innovations for a longer period of time through heightened marketing.
Given the size of the brand and cost of media today, we thought that if you are able -- if we support these initiatives for 1 quarter basis or so that will be enough. I don't think that's enough. And -- I think those are the -- those are our learnings out of what we have launched in the past. And I think we should take that into our future launches.
Just if I may, 1 last question. In case of KFC, it has obviously been a much better performer, as you said. Is there a possibility in that category also, say, online competition would come up and become an issue in the future. There are 1, 2 brands who obviously launched specific chicken offerings. So just your view on that?
So I guess the overall competitive pressure in food has increased. And if I even just break up this competitive pressure, we are not seeing so much of pressure coming from -- so brick-and-mortar and our omni restaurants. So people who are putting up stores as well as being online. So the competitive intensity there is, I would say, normal but not heightened where it seems to be coming out is in the form of cloud kitchens.
Now each one of them, whether they are making money or not is a secondary question, but at least in the initial stages, it's quite easy to -- there are lower costs of set up, continuing cost of being able to make money is a different question. But -- therefore, you'll see a burgeoning of what I think are cloud kitchen brands and in this space also, pizza is a little easier than perhaps KFC. So could it happen on KFC, yes, it could happen on KFC. It could happen on any brand really and hence, again, how do you continuously build consumer interest on the brand is really the answer only to counter such competition.
The next question is from the line of Jay Doshi from Kotak Institutional Equities.
I have just 1 question. With such a strong store growth over the last couple of years and SSSG decline in KFC, you're still able to hold on to a margin of 20%. So what are the steps you've taken over the past couple of years to improve efficiency at store level? And do you think this is a sustainable margin assuming that the demand environment remains weak.
So again, Jay, at minus 2% SSSG, this was possible because we also got a benefit of gross margin. Having said that, a lot of work has gone on the cost efficiency side as well. If I give you a few examples, and I've called out it on previous forums, the pace setter exercise, which we follow internally, where you bucket the similar revenue stores in the cohorts of 15 and 20 and then you try and compare one cost versus other and challenge the better -- the less performing stores to deliver the cost parameters as well as greater performing stores or better performing stores is a continuous exercise.
So that exercise actually cuts across whether it is labor hours, whether it is electricity unit consumption, whether it is gas cylinder consumption, whether it is wastage across the stores. So this is a continuous program, which we have developed in-house and over the last 3 years have been giving us quite a bit of joy.
Having said that, if the pressure on SSSG continues, I don't think the gross margin, there is a further scope of improvement. If we're able to hold on to this ADS levels, I think, yes, it's possible to hold on to margin in this particular range. But if the ADS level goes down and if the SSSG goes even further down, then it becomes difficult to hold on to this level of margin.
Having said that, while we have taken various measures on the cost front, just to clarify, not at the cost of the customer, so our customer metrics are at all-time high in terms of whether it is Swiggy ratings, Zomato ratings, or Google ratings are just experience scores. The ratings which we measure internally on operating and brand standards, so we are at all-time high. So these efficiencies are driven not at the cost of experience.
A follow-up there. You had about 250 KFC stores 2 years back December 2021 quarter. So you have 150 plus stores that are less than 2 years old. What would be the profitability gap between, let's say, stores that are 2 years and above maturity wise and the stores that are less than 2 years. What would be the differential in this margin because...
No Jay, we typically don't give out vintage-wise profitability. However, I can tell you is that typically, it takes 3 years for the store to mature in terms of revenue levels and in terms of coming to the profitability near the brand average. So if it is 2 years, yes, it's short of the brand average in terms of both revenue and profitability. It takes closer to 3 years to reach the brand level of -- brand level in terms of the ADS and the profitability.
But is it a big drag on overall profitability or not so much? I mean, stores less than 2 years.
I would not look at those as being dragged. This is like you're building it for the future growth. It's a natural course, which it is to traverse over 3 years. It's profitable in year 1, we breakeven almost in quarter 1. In year 1, the profitability will be in double digits. In year 3, it will move towards the brand average.
So while it will be shorter of the brand average, after 3 years, it becomes a rolling cycle, right? The stores which have opened 3 years ago, now are adding to the profitability. I will again add new stores. So it's a continuous cycle. And that's why we said that we are very happy to target ourselves to deliver a margin, which is in the range of in and around 20%.
We don't want to really have a scenario where this goes beyond 20%, and if it goes beyond 20%, we will invest even more aggressively on the brand by opening even more aggressively. So that's the approach. If it goes down considerably below 20%, we'll have to relook at our expansion plan. So that's the simple approach we applied.
You are seeing that already on Pizza Hut that moment of profitability was impacted. We have called out first in the industry to go slow on our expansion plan. And if you look at the last 2 quarter numbers on Pizza Hut, we have slowed down in single-digit store expansion.
KFC profitability is very resilient and impressive in context of what we are seeing across the space. One last thing. You talked about Pizza Hut turnaround, but -- you have steps and you have a slide there. But my question is that, look, there are 3 stakeholders here, yourself, the other franchisee and Pizza Hut India.
If interest of all 3 are not aligned, then is it possible for any one stakeholder to [Technical Difficulty] around the brand and do something. And in this case, is there an equal level of commitment you see from the other franchisee as well as the Pizza Hut to actually fix this issue.
So while it can be difficult, but not an impossible one. As long as the interest and the objectives are aligned, which they are and over the years, we have seen that all the 3 partners have come together on the platform, and we have been able to arrive at a way forward, which is aligned across all the 3 parties.
That's what happened when April '19, if I may recall, we did the complete -- reread of the menu card, brought in the everyday low pricing. That's what happened when we did the meal options. That's what happened when we did Flavour Fun and even the going-forward plan, when we're calling out that we are going to heighten the level of marketing investment and product innovations.
Heighten the level of marketing investment is not just by Sapphire, other partner franchisee as well and not just other partner franchisee, even Yum themselves will put additional money towards that. So yes, our interests are aligned.
As I said, as long as the objectives are aligned, we are able to figure out the way. Three partners on the table can also mean the 3 thinking people. So the idea can come from any one of the three. As long as it's good for the brand, there is no harm in accepting that idea and move forward.
Yes. So I'll add my 2 bits also here, Jay. So unequivocally, yes. So we are aligned between Devyani, between us and between Yum.
No. I never had doubt about alignment, it's about commitment, the level of investment that each one of you would be willing to put in, right? That can...
So alignment without commitment is useless. So I would say, in my book, so it is alignment with commitment. And at this moment, you just have to take me for -- at face value perhaps. But hopefully, this will play out in the next couple of months.
The next question is from the line of Tejash Shah from Avendus Spark.
My question is an extension of what Jay asked on resilience on KFC margins. So interestingly, we were at 65% SSSG 1Q last year and we delivered 20.3% margin, and we are at minus 2% this quarter and still we are at 20.1%. So understandably, as you explained that in that period, you would have kind of reinvested it into the brand and hence, we did not kind of overrun from the -- on the operating leverage part that period.
But I'm just wondering if those investments were done at that point and immediately, it is followed by such a weak period of demand in SSSG. How should we think about that operating leverage not allowing to come through in the margins and investing? And how do you calculate or how do you track ROI of such investments. When the tailwind is in your favor, you don't -- let's say, you don't allow margins to go up and then headwinds are not under our control. So I just wanted to understand the mindset of philosophy over here.
Tejash, you were referring to which quarter? if you can just come again, which quarter you are referring to?
1Q FY '23 when we had a low base, our restaurant EBITDA in KFC was 20.3% with SSSG of 65% and even 3Q last year on 3%, we are 20.2%. So we have been very resilient on this point -- on EBITDA margin. I was just wondering that, let's say, if the things have to improve...
Got it. Got it. So I was just wanting to understand which quarter you were referring to. When you're looking at a 65% SSSG growth, Tejash that's not really comparable or normalized SSSG, isn't it? Because Q1 FY '23 is getting compared with Q2 FY '22, which is the second wave -- or the peak of second wave of COVID, right? So it comes across from a really low base.
What you need to look at is what were the ADS levels at those points in time. And our ADS levels have been in the range of I would say anywhere between 120 to 140, those are the kind of ADS levels range we have been hovering around. So those ADS levels would determine what kind of restaurant EBITDA I'm able to hold on.
Having said that, my new stores also comes at a lower ADS and when we say we'll invest back in the business, we never meant invest back in the business through increasing the level of promotions of marketing. Those are at a standard level of 5% as per the agreement with the Yum.
What we meant by invest back in the business is by opening or pacing or -- increasing the pace of our expansion. So if you are able to go faster and take the market by adding more stores, that's the preferred route or the strategic route, which we are choosing.
Growth with profitability rather than just trying to pocket the profitability and then have a lower growth. That's what we meant. So it's not that when the tailwinds are there, we are not wanting to pocket the profitability.
Second, Sanjay in his opening remarks called out that pace of expansion will be relooked and perhaps in more in Pizza Hut and we will also go down on some store corrections. So if you can assign some number to this comment of yours on -- for both the brands, you have a target of doubling on CY'21, but you are almost at the fag end of that for KFC as well. So if you can give some color on how should we think about, let's say, next 3 years for both the brands.
When we gave out the CY '21 numbers, so CY '21 if I put all the 3 verticals together, we had 550 restaurants, and we said we could double it to 1,100 restaurants in 3 to 4 years' time. We again gave a range of 3 to 4 years because we know in India [indiscernible] can happen, it's happening for us right now in one of our brands. So that's the reason we gave out a range of 3 to 4 years.
Within that, while we can largely double. Yes, one brand can be 2.1x, other brand can be 1.8x, 1.9x. We never wanted to get into a year-by-year or quarter-by-quarter targets. What it meant was that we could be in the range of 130 to 160 restaurants opening all verticals put together. For the last 2 years, we have been on track on that.
What we called out today specifically was that while we gave a range of 3 to 4 years, increasingly, it looks like for KFC, we would be able to meet that target of doubling in 3 years' time. So probably within the range of 3 to 4, lower end of the range. In case of Pizza Hut, we called out that probably in the range of 3 to 4, we would go on the higher end of the range, which was 4.
As of today, if the brand is delivering minus 19%, I would not want to get into a conversation on how many stores. I think the immediate priority for the next 6 months is let's see whether we can get some growth back on the brand, and then we can try and do discussion on what the numbers look like. It will continue to be slow. Right now, the numbers are single digit. We are opening 8 stores. For the next 2 quarters, probably we will even see lower number as well.
But the annual numbers, the target for the next 2 years, I think I can -- I called out, it looks like more towards 4 years rather than 3 years, but I think it would be prudent to park the conversation for the next 6 months at least, and let's focus on getting the growth back.
Sure. And whatever this 3 or 4 years, whenever you are comfortable giving, you are referring to net addition and not gross?
Net additions and on the base of December '21.
The next question is from the line of Arnab Mitra from Goldman Sachs.
Great to see the resilience on the KFC business from Sapphire. My first question was actually on the store expansion in KFC, where you seem to be obviously doing -- you're bringing down your target to 3-year doubling. So the macro environment is still bad for food, where KFC is of course, being more resilient. So just wanted to understand what's giving you the confidence that you could actually accelerate KFC addition.
And is there a risk that we overdo KFC addition in our environment, which is really bad and that like puts us in a trouble spot? And if you could put some light on like the last 3, 4 quarters, the new store openings. How have those new stores done, qualitatively versus there, let's say, you normally expect it to be, have they been significantly worse or more or less in line. So broadly, the [indiscernible] on this acceleration in this weak environment.
So while we call it acceleration, I think we are trying to say that we're largely maintaining the pace, right? We opened 80 stores in this calendar year -- in this calendar year as well. So it's not going to go dramatically higher than that. And still we will be able to closely hit that doubling the count in 3 years.
So first of all, we are not seeing we will go extremely further aggressive from the current pace of expansion. The current pace of expansion actually leads us to -- results into the 3-year doubling count on KFC.
Secondly, the approach we've always called out Sapphire's approach on capital allocation, we would not get swayed by saying that if we can double in 3 years, 4 years, 5 years. It's based on a simple approach that if you're opening the stores and those stores which you have opened are able to hit the strike rates or hurdle rates, which gives us the required or desired payback of 3 years or so, it gives us a desired level of profitability. It means whatever you're doing, it's working.
And if it's working, you can continue with your pace of expansion. If it's not working, you have to reduce the pace of expansion. That's what exactly we are doing on KFC, whatever we are opening right now. If you can see overall margins in the range of 20%, which means the new stores are not a big drag on our profitability.
Those are working. They are able to follow the cycle, largely the cycle of getting us the payback of 3 years or so. Over 3 years, they are able to mature and hit the profitability, which is of brand level leverage. So as long as we are able to hit that profitability mark, it gives us an indication that we can continue the pace of expansion.
Moment we fall on the SSSG even further or the moment we fall on the benchmark even further on the profitability, it gives us an indication immediately, and this is the time to relook at your numbers. We relooked at Pizza Hut numbers, nothing will stop us from relooking or revisiting the KFC numbers as well because capital allocation will be of prime importance.
Having said that, on Pizza Hut, we did not revisit the numbers on the first -- very first quarter when the numbers went outwards. We always said these are conversations or decisions, which cannot be taken on quarter's data. We waited for 3 quarters for Pizza Hut before calling out, yes, 3 quarters, 9 months is long enough, and this warrants a store expansion approach, which is more cautious. So if anything of that sort happens in KFC, yes you will have to wait for 6 months, 9 months to come up with what the new approach of the management would be.
My second question was on Pizza Hut. See at this SSSG level and the margin level are somewhere at its exceptional circumstances right now. So is there not a strong place to completely pause expansion temporarily till your initiatives that you highlighted come in and before economics improve.
And if such a measure has to be taken, does Yum have to be in agreement with a pause in store expansion or that's something you can take on your own based on the circumstances. And is there like a red line of margins that you take a call that this is just too bad, we need to stop and get our economics back in the existing stores.
So while I answer the question specifically, first, just an overall strategy on Pizza Hut for us, it's a very important second leg for Sapphire. And while we are right now in challenging times, even in this challenging times, our second leg, which is Pizza Hut is way ahead than any other competitor's second leg. Few of our competitors doesn't even have a second leg. So that's an important point to remember that it's a very important part of our portfolio in the medium term, in the long term.
Yes, currently, we are facing challenging times. We have already tapered on our expansion if you can see 8, 8 stores vis-a-vis what used to -- our run rate used to be 15, 20 stores almost per quarter prior to that. The stores which you put are again an independent decision.
So while the current SSSG may not be great, there could be few opportunities, a few pockets, few trade areas, which could be completely, let's say, not served by the existing stores or existing channels, which means there could be opportunity, there could be a good real estate available, there could be a great rental deal.
So you don't want to completely go into a situation where you are not able to capture those things. Also there would be few stores which we have already signed in terms of the pipeline. If those are at great commercial, you may want to open that.
So completely pausing may not be an approach, but if it comes to that situation, yes, you are right. This requires a conversation with Yum. Having said that, thrice we had a conversation with Yum over the last 7 years or so on the Pizza Hut store expansion and thrice we have been successful to renegotiate our development agreements in terms of store expansion.
So if this warrants any conversation, yes, we can have those conversations. And as long as those conversations are with common sense and business sense, we have been able to confidently pull that off as well.
So I'll just add here, Arnab. Finally, we are all taking business decisions from a single lens and I can't see any reason why Yum should not back us. And in fact, they should be the first people who will tell us that go slow on expansion. Let's get the brand right, because -- let's get profitability right.
Because they know that a profitable franchisee anywhere in the world is more than willing to put in further capital. But if you are not being able to get your returns, then what is the point in expanding for the takeoff expansion. So I think the conversations are fairly logical and fairly business forward.
The next question is from the line of Devanshu Bansal from Emkay Group.
My question is specific to dine-in or on-premise channel for KFC. The numbers suggest that performance has been sort of relatively much better versus peers in this quarter. We have reported a 6% to 7% sequential decline -- sorry, sequential growth in our dine-in channel versus flattish to negative trends for other formats. So what is working well for us here? Is it new launches, the KFC lunch, Wednesday offer or the store modernization that we have done. So if you could just throw some light on this?
So yes, so a lot of our current offers are focused on actually encouraging dine-in consumers to come in, dine-in and takeaway. So our lunch offer is one of such examples, which is focused dine-in consumers. There's another offers which is currently going on crispy, which is again dine-in and takeaway focus. So yes, the efforts are there, which actually try and get the consumer on the premise vis-a-vis just having it on the delivery platform. That's one.
Secondly, if you look at the mix and the quarterly mix also plays a role. Typically, if you look at quarter 3 being a festival quarter, dining is definitely better in this quarter compared to the other quarters. So entirely looking at sequential performance may not be right way. When you compare it last year quarter with this year, the mix for dine-in has likely gone down as well.
So Vijay, I was comparing it across players. So those things play out for other players also. From a gross margin point of view, Vijay, you indicated that for KFC at least, there is not much room to improve there. But the other franchisee is still at 100, 150 bps higher. So is it just because of channel difference? Or can you throw some light there? Because, yes.
So first of all, on the gross margin, I said there's not much of a room there. What I meant was, again, from an inflation point of view, we had a stable -- steady state over last couple of quarters. So whatever upside we had and whatever the gross margin we lost a year or so back because of high inflation, we've been able to largely pull back.
[indiscernible] not much headroom available over there, and they're quite steady, both for KFC as well as Pizza Hut. When you try and compare with the gross margins of Devyani, unfortunately, we will not have a breakup or details of the labor. And this number over the period, over the last couple of years have gone up and down. So frankly, I would not have a specific answer.
Having said that look at restaurant margins here.
Having said that, there are 2 or 3 reasons which can lead to a different gross margins across both the franchisees. The first -- buying mix. So while we negotiate to one system Yum level on key raw materials and vendors, the buying pattern could be very different. I would buy from a vendor who is nearer to me vis-a-vis the vendor who is far away from me but cheaper, because the transportation cost would make it quite expensive. So buying mix could be quite different.
The sales mix could be quite different. So those are the mix which can be at play. Having said that, if you look at the overall P&L profitability on restaurant EBITDA and even if you look at 9 months profitability, because sometimes quarterly numbers, there could be skewness and it will not do justice. On a 9-month basis, KFC Sapphire is now at 20% restaurant EBITDA, highest in the industry. And Devyani, if I remember the number correctly, at 19.8%. So we are 20 bps higher than them.
Traditionally, I used to answer questions where that why are you -- why are 2% lower than Devyani on KFC. And we have called out that some of the territories, which they operate in North, Northeast. They have a cost advantage in terms of lower rentals, lower utility costs, lower cost of even wages. So right now, we have been able to breach and overtake. I think it's a fantastic performance by Sapphire.
No doubt about that Vijay, a very good performance on the margin front. Just last 2 bookkeeping questions from my end. This depreciation expense has seen an increase in Q3. So can you -- is this expected to normalize? Or what is the reason for this?
So 2 parts to it. First of all, our capacity additions, if you see if our brand is not growing or overall revenue growth is not higher than the store addition, it will impact PBT, right? So we have been adding stores in the range of 20%, 25% in case of KFC and we're adding stores in the range of 15% in case of Pizza Hut.
And the brand growth -- because of the negative SSSG is not able to -- it's not gone beyond 20%. So as a result, there is a deleverage impact. So depreciation as a percentage would increase as well. So that's first part. Capacity addition and revenue not increasing in line with the capacity addition. And especially for new stores, revenue comes at 70% to 80% of the brand average. So that's one thing, but SSSG actually helps us to set up some of those things in terms of percentage to sales or percentage to revenue for depreciation.
Second part, we have also taken a conservative approach, and we have accelerated depreciation for some of our Pizza Hut stores, which we believe is under watchout list and we called out that there could be a 3% to 5% portfolio correction. So this is an accounting practice, which is more conservative, where even before closing the stores, we felt that if that's on a watchout list and if they're going to close in the near future, let's take a accelerated depreciation.
The impact of this could be anywhere between 0.7% to 0.9% or 0.7% to 1% of our overall revenue. Whether this would come down, I think, for the next 2 quarters or so, we believe we would accelerate some of the stores which are not working out for Pizza Hut. So you may not see this coming down for the next 2 quarters also.
Got it. And the tax rate for coming quarters as well, if you could elaborate?
So right now, again, to clarify on tax, we don't have a tax payout. So the tax expense, which you see is deferred tax impact, which you have taken in the P&L. Because if you remember last year, quarter 4, we created a deferred tax asset on all our past losses. We don't have any tax outflow. The rate is that same 25%, what you see largely would remain in the P&L, but without the corresponding cash outflow. This gets knocked off against the deferred tax assets, which we carry in our books.
The next question is from the line of Shirish Pardeshi from Centrum Broking.
I just have 1 fundamental question. Sanjay, in your experience, you have been a marketing guru. And the reason why I'm asking this question is that candidly, the Pizza Buy is getting shrunk. So I've got 3 observations. One is that either the entire category is creating shrunk and people are moving away from pizza consumption. Or it could be a situation that you have been saying that the competition has become aggressive and they are taking share from the organized top 2, 3 players.
Or there could be a reason that the traffic is there, but the platforms are taking away your traffic and giving it to somebody else. So what is the realistic thing? And is it a structural decline story? Or do you think the consumption is still resilient, but I think this time will sell and then people will come back and start eating dine-in.
I mean, if it is a long-term structural issue on a country like India, I think it will be very, very surprising. So I have said this in the past also. Typically, you see sinusoidal growth curves in India. There are periods when growth is fantastic and then there are troughs also. But in general, those sinusoidal curves are pointing upwards. So it is still growing in the -- it is still growing over a medium to long-term perspective.
Having said that, on pizza, I mean, if you speak to the platforms also, they say pizza is growing. When we look at -- so I can't see any reason why pizza is not growing, other categories are growing. So in many of the year-end reports, pizza continues to be the #1 and #2 category. So I don't think there are any issues with the category itself.
Clearly, when -- coming out of COVID, when you had a strong momentum on eating out, you will find many people coming in. And then whether they are sustainable or not is a different question and that sustainability is really a factor of can they deliver the required sales and profitability. So that we will see occurring over the next 1 or 2 years.
But everyone or anyone can set up a cloud kitchen today at a much lower level of investment than an omnichannel store of ours. It delivers also significantly lower sales. It is far more difficult to differentiate the brand on aggregator platform. A pure cloud kitchen brand, I would believe will struggle significantly to establish what the brand is about and what its promise is about.
But in the short run, a consumer who is willing to experiment will look at the name, will look at what they have to offer. And it's quite likely that people will buy once or twice and then go back to brands that they trust. So I think this is what we are seeing on pizza, which really leads us to believe that surely our 310 or 315 stores that we have got and overall say 700, 800 stores in the country that we have got on Pizza Hut, actually is a big advantage.
Both from a physical presence, we can get consumers in to dine-in and plus deliver and therefore, if we change the narrative on the brand, build interest, I can't see any reason why we can't come back just as powerfully. There are many similar examples that you might -- you would have seen in other countries. For example, in the U.S., where there is enormous amount of competitive pressure on coffee, how the leading brand came back. So I think it's been done before.
We are quite confident that through persistence and fundamentally perhaps change a couple of things that we have done in the past, learn from what we have done in the past, and I talked about what we have learned on innovation plus on marketing and continue the operational excellence, I think we should be able to bounce back.
As there are no further questions, I would now like to hand the conference over to the management for closing comments.
So thank you very much, everybody, for joining this call. It's been a tough quarter, but relatively when I look at the performance of other players in the industry, we have much to feel proud of. We continue to drive operational efficiencies and customer experience metrics at our end. We believe in the power of the Pizza Hut brand. And while in the immediate term, we'll be a little more cautious from an expansion perspective, we are investing both in innovation, in marketing and in customer experience improvement to really revive this brand. So thank you so much.
On behalf of Sapphire Foods India Limited, that concludes this conference. Thank you for joining us, and you may now disconnect your lines. Thank you.