Business – Pricey Pizza;Domino’s India

Sarath Chelluri

As the frequency of eating out or preference for fast food increases, players in the take-away or home-delivery space should benefit. Amongst the leading players is Jubilant FoodWorks (JFL), which operates pizza chain Domino’s in the domestic market. JFL has a master franchise agreement with global pizza giant Domino’s which extends till 2024. The company is currently operating 286 stores across 60 cities and enjoys around 65 per cent market share of the organised segment. JFL proposes to raise Rs 306 crore at the lower end of IPO price band, which will make it the first quick-service restaurant (QSR) chain in the country to be traded publicly. However, a large part of the public offer is to provide an exit route to private equity firms. The IPO will fetch JFL around Rs 58 crore, part of which will be used for repayment of loans.

The Domino model
Domino’s current business model is mainly focused on home-delivery and take-away, wherein customers get the convenience of eating in the comfort of their own homes and workspaces.

Domino’s Pizza has the first-mover advantage and competes with the likes of Pizza Hut and Papa John’s in the pizza space. Going ahead, the company plans to add revenues from dine-in (not a major source for JFL currently) as it is making provisions for the same in the new stores—customers will be able to consume Domino’s offerings at the outlet itself. In the dine-in model, it has to contend with the likes of McDonald’s and KFC.

As competitive landscape heats up, advertisement and promotion expenditure is likely to increase. While national campaigns of “Hungry Kya?” and “Khusiyon Ki Home Delivery” ensures higher brand recall, the “30 minute or Free” proposition implicates better delivery time (average order delivery time is 22.5 minutes for the company) and also adds to its sales. Overall, JFL’s sales grew at an average 42 per cent annually in the last four years, while the QSR segment managed a 20 per cent growth in the same period.
ROBUST GROWTH
in Rs crore FY08 FY09 HI FY10
Net Sales 211.2 280.6 182.7
EBITDA 26.2 34.6 29.5
EBITDA (%) 12.4 12.3 16.1
Net profit 7.8 6.7 12.1
NPM (%) 3.7 2.4 6.6
EPS (Rs)* 1.3 1.1 3.8
P/E (x)@ Rs 135* – 119.9 35.5
P/E (x)@ Rs 145* – 128.8 38.2
*FY10 is based on annualised net profit of H1
Source: Company

For a greater pie
The company has the first-mover advantage among organised players in most cities, and it aims to sustain that in the future as well. It plans to expand its presence by entering new cities and towns and simultaneously increase its penetration through new stores in existing cities. However, JFL’s plans to drive future growth from new stores in Tier 2 and Tier 3 towns will require it to spruce up the back-end production facilities to match the demand and sustain service levels.

From around 120 stores in 2006-07, the company has expanded its store count to 286 as of November 30, 2009—another 40 are planned in the remaining four months of 2009-10. In the same period, its same-store sales (SSS) growth grew at an average 16 per cent. The higher historical growth rates in SSS, to some extent, are an indication of a growing appeal of Domino’s brand in India. However, the impact of economic slowdown was visible in 2008-09 as SSS dropped to 6 per cent before recovering to 16 per cent in the last six months as consumers started to spend more.

Investment rationale
Typically, it takes 3-4 years for JFL to achieve positive cash flow for every new store it opens. Since it was in the early stages of growth, JFL incurred net losses up to 2004-05; accumulated losses totalled Rs 62 crore as on September 2009. Positively, this has helped the company reduce its tax-outgo in recent years.

Notably, despite the significant growth in operational size, the emphasis on operational efficiency and the ability to pass on the rise in raw material prices to end-customers, have helped the company to maintain its operating margin at around 12 per cent historically (last four years); these were up at 16 per cent in the recent six months.

Interest costs, however, have been a bane for the company. In 2008-09, net profits took a hit of 13 per cent to Rs 6.7 crore in 2008-09 as interest costs jumped. In the first six months, too, interest costs have come higher at Rs 6.6 crore (up 35 per cent on an annualised basis). Out of the IPO proceeds of Rs 58 crore, the company intends to repay term loans worth Rs 35 crore that would help profitability, going ahead.

In terms of valuations, even at the lower price-band of Rs 135, the stock trades at a P/E of 35.8 times its annualised 2009-10 earnings. While there are no comparable listed companies in India, globally, Domino’s UK, Domino’s USA and Papa Jones are trading in the range of 13-21 times their CY2010 earnings. Hence, the offer looks stiffly priced in the near-term, even after considering JFL’s dominance in the business. Investors with a two-three year perspective may invest.