Kotak Institutional Equities reiterates 'buy' rating on Sapphire Foods, sees 19% upside; here's why

Domestic brokerage firm Kotak Institutional Equities has reiterated its 'buy' rating on Sapphire Foods (SF) and revised its target price to ₹1,700 apiece from 1,615 earlier. This new target price signals an upside of 18.63% for the stock from its previous closing price. 

Over the last 18–20 months, the stock has witnessed a muted performance, partly attributed to PE exits, causing a decline in PE shareholding from 70% to 42%. Kotak expects moderation in PE supply going forward.

Sapphire Foods is the second-fastest growing QSR in India, led by robust network expansion and resilient SSSG trends in KFC. It has delivered strong store growth, keeping pace with peer Devyani International (DIL), and superior execution (SSSG and margin improvement) in KFC, said Kotak. 

Over the period spanning FY2020–23, the company recorded a 19.8% revenue CAGR in India, the second highest among QSR companies in the country. This surge, as per the brokerage, was driven by a 20.2% expansion of its network, resulting in a total of 627 stores in India.

Furthermore, its per-store revenues from KFC and PH India outperformed most of its peers. Corporate EBITDA margins for SF experienced a year-on-year expansion of 120 basis points in FY2023, registering EBITDA growth of 46.4%, surpassing the majority of listed QSR peers, the brokerage noted.

The company has narrowed the margin gap versus Devyani over the past few quarters, driven by margin improvement (relative and/or absolute basis) in KFC and PH India. The company's operating margins in both KFC and PH have nearly converged with those of Devyani, signifying a substantial improvement from the past. This progress is attributed to SF's superior ADS delivery combined with better control over overheads. 

Sapphire Foods has outperformed DIL in three out of the past five quarters in terms of the SSSG of KFC and PH. Further, SF’s ADS trends in KFC have been marginally better than those of DIL in the recent past, despite a broadly similar pace of network expansion, the brokerage pointed out. 

The street has downgraded FY2024/25E revenue estimates of all QSRs (except Westlife) in view of demand weakness starting in November 2022. Sapphire’s pre-Ind AS 116 EBITDA forecast for FY2024E has been relatively resilient versus Devyani, Restaurant Brands Asia, and Jubilant Foodworks, according to Kotak estimates.

Despite this outperformance, the brokerage noted the correction in SF’s EV/EBITDA multiple by 20% since October 2022, higher than select peers. Thus, it said Sapphire Foods offers a robust 19% EBITDA CAGR (FY2023-26E) at a valuation (20X 2Y forward EV/EBITDA) that is inexpensive on an absolute and relative basis.

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