Jubilant Foodworks: Fresh from the oven; initiating with Buy:: Deutsche Bank

Jubilant Foodworks
Reuters: JUBI.BO Bloomberg: JUBI IN Exchange: BSE Ticker: JUBI
Fresh from the oven; initiating
with Buy


Generating free cashflow
A 65% market share in the under-penetrated Indian Quick Service Restaurant
sector, an exclusive franchisee of a globally successful brand and solid execution
(in terms of both new store openings and robust supply chain) drive a 42%
revenue CAGR (FY11-13E), 70% gross margin, negative working capital (~11% of
revenue) and FY11-13E 60% FCF CAGR. While the near-term valuation factors in
aggressive growth, our FY12E EPS is higher than consensus by 18%. We see
material upside potential: initiating coverage with a Buy.




Exclusive franchisee of a globally successful brand
Jubilant Foodworks (JFL) operates its pizza stores pursuant to a Master Franchise
Agreement with Domino‘s International, which provides it with the exclusive right
to develop and operate Domino‘s pizza delivery stores in India, Nepal, Bangladesh
and Sri Lanka. It is this association with Domino‘s that provides JFL with the
technical, marketing and operational expertise to compete successfully with other
restaurants in the QSR industry in India. JFL has a dominant 65% market share in
the organised pizza home delivery segment in India.

Robust supply chain; ranked top among Domino’s franchisees worldwide
The cornerstone of JFL’s operational success is based on its efficient supply chain
that drives negative working capital. Its operations rank among the top three
within Domino’s global operations. JFL has centralised the sourcing, warehousing
and distribution of its raw materials, as well as the production of dough at its
commissaries. This reduces the storage space required at its stores, thereby
enabling JFL to minimise its store operating costs, without incurring significant
additional expenses at the commissary level. The effects of its efficient supply
chain are reflected in its relatively high gross margins and negative working capital.

Initiate with a Buy and a target price of INR810
Our DCF-based target price of INR810 is based on a cost of equity of 13.6% and
4.5% terminal growth. Downside risks include increase in royalty charge to
Domino’s International and execution risk in the opening up of new stores.



Investment thesis
Outlook
A 65% market share in the under-penetrated Indian Quick Service Restaurant sector, an
exclusive franchisee of a globally successful brand and solid execution (in terms of both new
store openings and robust supply chain) drive a 42% revenue CAGR (FY11-13E), 70% gross
margin, negative working capital (~11% of revenues) and 60% FCF CAGR over FY11-13E.
While the near-term valuation factors in aggressive growth, our FY12E EPS (the basis of our
DCF-derived target price) is 18% higher than consensus.
JFL operates its pizza stores pursuant to a Master Franchise Agreement with Domino‘s
International, which provides it with the exclusive right to develop and operate Domino‘s
pizza delivery stores and the associated trademarks in the operation of pizza stores in India,
Nepal, Bangladesh and Sri Lanka. This has provided JFL with the ability to use Domino’s
globally recognised brand name, as well as operational support for pizza and food technology
(such as recipes), commissary and logistics management support, global marketing and
vendor development know-how. It is this association with Domino‘s that provides JFL with
the technical, marketing and operational expertise to compete successfully with other
restaurants in the QSR industry in India. JFL has a dominant 65% market share in the
organised pizza home delivery segment in India.


Valuation
Our DCF-derived target price of INR810 per share is based on the following assumptions:
�� Risk-free rate of 6.4% (Deutsche Bank estimate), market risk premium of 7.2%
(Deutsche Bank estimate) and Beta of 1, implying a cost of equity of 13.6%.
�� Growth in the stable phase of 4.5% (which is the long-term growth rate in the number of
households in India). Our valuation for Jubilant Foodworks works out at INR810 per
share.
At our target price of INR810 per share, the shares would trade at 30x FY13E earnings.


Risks
Significant dependence on the master franchise agreement with Domino’s
International
The master franchise agreement between JFL and Domino’s International was renewed in
September 2009 for another term of 15 years, which will continue until 31 December 2024
and is further extendable for a period of ten years (subject to certain conditions). Should JFL
default on the provisions of the agreement, then Domino’s International would have the right
to terminate the agreement.
Royalty to Domino’s may increase
JFL paid a royalty of 3% on its revenues in FY10. While the agreement with Domino’s is valid
until 2024, it is possible that after that date the royalty may increase. The company also pays
USD5,000 per new store opened.




Key investment positives
Exclusive franchisee of a globally successful brand
JFL operates its pizza stores pursuant to a Master Franchise Agreement with Domino‘s
International, which provides it with the exclusive right to develop and operate Domino‘s
pizza delivery stores and the associated trademarks in the operation of pizza stores in India,
Nepal, Bangladesh and Sri Lanka. Over its 49-year history, the Domino‘s business has grown
into a global network of over 9,000 pizza stores in more than 60 countries, involving more
than 2,000 franchisees. This has provided the JFL with the ability to use Domino’s
International’s globally recognised brand name, as well as operational support for pizza and
food technology (such as recipes), commissary and logistics management support, global
marketing and vendor development know-how. It is this association with Domino‘s that
provides JFL with the technical, marketing and operational expertise to compete successfully
with other restaurants in the QSR industry in India. JFL has a dominant 65% market share in
the organised pizza home delivery segment in India.


Robust supply chain; ranked top among Domino’s franchisees
worldwide
The cornerstone of JFL’s operational success is based on its efficient supply chain that drives
a negative working capital. Its operations rank among the top three within Domino’s global
operations. JFL operates four regional supply chain centres, or commissaries, located in
Noida (Delhi NCR), Mumbai, Bangalore and Kolkata. These commissaries primarily
manufacture dough (pizza bases) and act as warehouses for most of the other ingredients.
The primary raw materials used in the preparation of the pizzas, such as cheese, vegetables
and meat, are sourced and supplied to the stores by their commissaries, except for a few
stores which procure vegetables locally from vendors within their geographic area. This helps
JFL to ensure consistent quality and also ensure timely delivery of raw materials to its stores.
Furthermore, as the purchase function is centralised and the company purchases large
volumes of ingredients and packaging such as cheese, sauce and pizza boxes, it allows JFL
to maximise leverage and negotiate better prices with its suppliers.
For most of its key ingredients, JFL follows a multi-vendor policy to minimise reliance on any
single vendor and has entered into annual agreements with certain key vendors to ensure the
steady supply of ingredients. In addition, JFL has a dedicated fleet of hired trucks at its
disposal to ensure timely delivery of raw materials to its stores. These trucks are refrigerated
to ensure that the ingredients are supplied in a temperature-controlled environment, which is
monitored during transit to ensure quality and minimise wastage. The effects of its efficient
supply chain are reflected in its relatively high gross margins and negative working capital


Effective site selection and project management focusing on ROI
One of the major factors behind JFL’s continued growth has been its ability to open and then
operate most of its new stores profitably. A robust store selection process that takes into
consideration various factors such as location visibility, presence of competition, household
count as well as presence of corporate and other institutions that would enable it to operate
these pizza stores in a profitable manner is a key differentiator between JFL and its QSR
competitors.


As of 30 September 2010, JFL operated 339 stores in India across 79 cities located in 22
states and union territories, and, through a sub-franchisee, DP Lanka Private Limited, five
stores in Sri Lanka. These included entry into 22 new cities in FY10. Domino’s has mentioned
a store target of 700 stores for its India operations. At present, its competitors include Pizza
Hut (~150 stores pan-India), KFC (~50 stores pan-India) and McDonalds (~170 stores).
JFL also conducts a return-on-investment analysis based on projected sales and profitability
to determine the financial feasibility of the store. The company’s internal project management
system is designed to ensure that they purchase standardised equipment from selected
vendors, plan in detail the procurement of the standard equipments prior to lease signing as
well as designing standardised processes for all functions related to store openings. This has
enabled JFL to reduce its store opening time to between 35 and 45 days on average from
the date of possession of the premises for a new store location.


New product introductions and innovative marketing drive
revenues
JFL utilises three distinct marketing platforms, (a) national marketing campaigns on television,
print and radio, (b) local store marketing and (c) customer relationship management. Its
innovative marketing strategy that emphasised delivery within 30 minutes of an order’s being
taken or no charge would be made has become a marketing case study whereby delayed
public services are being compared unfavourably to efficient pizza delivery.
JFL’s local store marketing is aimed at increasing customer penetration by targeting new
customers and increasing the frequency of repeat orders from existing customers. The
strategy includes address mapping of an entire delivery area to precisely identify key demand
areas for a store as well as intensive coverage of households and corporates within a store‘s
sales area using store-specific door hangers and fliers. JFL also utilises details of customers‘
past transactions from its point of sales software system to provide customised
communication including mobile text messages and offers, relevant to each consumer
thereby maximising returns from individual customer relationships by increasing the
frequency of orders.
JFL’s product innovation and value promotions are another driver for footfall frequency. For
example, the company began offering a limited number of pasta dishes at the stores and
launched its own low-cost pizza – Pizza Mania. JFL, on a continuous basis, keeps evaluating
increasing dine-in space at selected existing pizza stores. This is quite apart from periodically
refurbishing its stores, and it intends to continuously upgrade its facilities and general pizza
store ambience.


Expansion using new distribution channels
Traditionally, JFL’s pizza stores have generally been located in neighbourhood markets in
urban areas. As it seeks new ways to grow its business operations, it has sub-franchised two
stores into India’s expanding infrastructure network of airports. In addition, metro stations
offer a distinct new channel for growth. As the company anticipates that its revenues from
these stores would be driven by commuters at these locations, the intention is to use a menu
of off-the-shelf pizzas.
JFL has integrated other distribution channels with its pizza stores‘ operations, such as web
and mobile technology, to expand its sales. In August 2009, it launched – on a pilot basis – an
online ordering facility for residents in Bangalore and it intends to gradually extend this
service to other locations. JFL also opened pizza stores on certain corporate campuses and in
certain food courts.


Cost consciousness driven by employee compensation structure
In line with its philosophy that the store manager is the CEO of the store, the compensation
for its store managers is driven by the sales and profitability of their respective stores. Also,
all costs attributable to a store are charged at the store-level and the store manager has
discretion to take action in order to increase sales or reduce costs. The policy of centralised
sourcing from an optimal number of vendors further facilitates cost efficiencies, enabling the
company to reduce manufacturing costs.


Leveraging its market position to launch new food services
brands in India
JFL has mentioned that it intends to leverage its current market position and experience in
the food services industry to launch new international food services brands in India. These
could include QSR such as Burger King and Starbucks although no formal announcements are
expected until at least the next two quarters.


Negative working capital driven by centralised sourcing
JFL has centralised the sourcing, warehousing and distribution of its raw materials, as well as
the production of dough at its commissaries, this reduces the storage space required at its
stores, thereby enabling JFL to minimise its store operating costs, without incurring
significant additional expenses at the commissary level. The effects of its efficient supply
chain are reflected in its relatively high gross margins and negative working capital.


Efficiency in capex is a driver of FCF
JFL opened 60 stores in fiscal 2009 of which 44 stores were opened in cities where JFL
already had stores and of the 70 stores opened in fiscal 2010, 31 stores were in cities where
JFL already had stores. To minimise additional capital expenditure and ensure quality control,
JFL plans to open new stores in cities and towns that would be located within less than one
day’s travel distance of its existing commissaries. For new stores where JFL cannot serve
efficiently from its commissaries, the company has developed a back-end production facility
model which should enable the company to service two to three stores in a city. These backend
production facilities procure vegetables and other perishables locally. JFL believes that
its future growth will be driven by its new stores in Tier 2 and Tier 3 towns and, therefore, its
back-end production facilities will play a key role in its success in these cities.

Namaste India - News Roundup:: Deutsche bank, 7 December 201

India Upstream: Incorporating Brent oil price forecast revisions [Harshad
Katkar]
Deutsche Bank has raised its oil price outlook for CY10-14 by 1.1-9.4% on a
stronger oil demand outlook but kept  the long-term forecast unchanged at
US$100/bbl. This leads to a 1-1.4% increase in the valuations of Indian upstream
oil companies ONGC, OIL and CAIL to  INR1540, INR1620 and INR365 per share,
respectively. We maintain Buy on ONGC and OIL and Hold on CAIL. ONGC
remains our top pick in the sector, as it looks well poised to benefit from diesel
deregulation and in our view, offers the best risk/ reward on reforms.



Sun Pharma: Finally proposes to delist US-listed Caraco [Abhay Shanbhag]
On Friday, Sun Pharma made a US filing proposing to take US listed Caraco private
by acquiring all its free float (~25.5%)  at a cash price of USD 4.75/share.
Consolidation phase commences: Post getting control of US listed Taro in end
Sept’10 with 69% of voting rights, Sun raised stake to threshold 76% of voting
rights in Nov’10. Sun now has 2 US-listed subsidiaries – Caraco (acquired in
1990’s) and Taro. We have always been surprised by Sun keeping Caraco listed,
despite its large underutilized war-chest.

India Economics Weekly: July-Sep GDP, fiscal update, PMI, core infra, WPI
[Taimur Baig, Kaushik Das]
India's real GDP rose by 8.9%yoy in the July-September quarter, similar to the
Apr-June outturn (revised up to 8.9% from 8.8% earlier). Data for the first two
quarters of the previous year were also revised up somewhat. The latest GDP data
indicate that the non-farm growth momentum (9.5% vs. 10.0% in the previous
quarter) is somewhat stronger than we had estimated. This is primarily due the
resilience of the services sector. Going forward, we expect non-farm growth
momentum to moderate in the second half of FY10/11, owing to negative base
effect led moderation in industrial sector activity, but agricultural sector growth
would remain supportive given a favorable monsoon outcome in 2010. This
assessment coupled with the strong 1HFY10/11 GDP growth outturn of 8.9%,
therefore leads us to revise up our annual growth forecast by ½ percentage point
to 8.5%.

Commodities Special Report: Thermal  Coal: Becoming Strategic [Daniel
Brebner]
On the back of our expectation of a market deficit in thermal coal of 28mt in 2011
and 30mt in 2012 we have upgraded our forecasts for these years to USD118/t
and USD140/t respectively (from USD110/t and USD120/t previously).

US Economics/Strategy Weekly: November employment clunker [Joseph
LaVorgna]
In October 2010 the Bureau of Labor Statistics announced that it planned to revise
down the level of March 2010 payrolls by 366k. This was based on more detailed
source data that showed less job creation through the first quarter of this year
than what was previously reported. However, new information since then
suggests that employment may in fact be understated. If so, this could partly
explain the grindingly slow pace of payroll gains thus far in the business cycle. The
November employment data were particularly weak. It will be interesting to see
how the disparity between what we learned in November and what we have seen
over the past few months in terms of improving tax receipts, jobless claims and
the various purchasing manager indices is ultimately resolved.


News Headlines
Sarkozy courts Indian business, clinches $20 billion deals (Reuters)
France's President Nicolas Sarkozy said  on Monday he had clinched deals worth
about $20 billion with India, becoming the latest among a string of world leaders
jostling for a share of Asia's third biggest economy
India should open up FDI in multi-brand retail – adviser (Reuters)
India should open its multi-brand retail sector to foreign investors and raise its
investment cap in the insurance sector to 49 percent from the current 26 percent,
Montek Singh Ahluwalia, the deputy chairman of the Planning Commission, said.
GST meet likely to be delayed, states want more time (BS)
Introduction of a Goods and Services Tax  (GST) could be delayed further with the
Centre and the states failing to reach  common ground at the meeting of the
Empowered Committee of state finance ministers on Monday.
Bill to allow options trading in goods, commodity derivatives introduced (BL)
The Government on Monday introduced in Lok Sabha a new Bill that would allow
trading in options in goods and new generation of commodity derivatives so as to
provide wider opportunities for risk management.
RBI plans open market purchase of G-Secs worth Rs 12,000 cr (BL)
In a bid to ease the tight liquidity situation in the market, the Reserve Bank of India,
on Monday, announced an open market purchase of government securities worth Rs
12,000 crore. The auction will be conducted on December 9
RBI asks banks to open resource centres for financial inclusion (BS)
The Reserve Bank of India (RBI) has urged commercial banks to open financial
inclusion resource centres throughout the  country. These would work as a storehouse of all relevant information pertaining to financial inclusion
Govt may consider diesel price hike - oil secretary (Reuters)
The government could consider raising diesel prices before planned share sales of
state-run companies IOC and ONGC, Oil Secretary S. Sundareshan said.
DGCA tells airlines to post fare details on websites (BS)
Passengers will soon learn more about the various fares available on any route,
thanks to the Directorate General of Civil Aviation. It has asked all airlines to post
various fare categories route-wise and date-wise on their websites by December 8.
MNP leads to minimal churn, show data from Haryana (BS)
Judging by the initial reaction, most cellphone users have no pressing desire to shift.
Mobile number portability was launched 11 days ago in Haryana. Since then, 30,000 -
35,000 customers have requested a change. Haryana has 17 million customers.
SBI to raise deposit rates from Dec 7 (Reuters)
State Bank of India, the country's top lender, said it will raise deposit rates by
between 50 and 150 basis points for various maturities, with effect from Dec. 7.
ONGC Videsh's agreement firmed for 25% stake in Kazakh oilfield (BS)
ONGC Videsh Ltd (OVL) will sign a formal agreement for taking a 25 per cent stake in
Kazakhstan’s Satpayev oilfield by the end of February 2011. It is to invest about $400
million (Rs 1,800 crore) in the 1,582 sq km North Caspian Sea oilfield.
Suzlon to asborb 2 fully owned units (Reuters)
Suzlon Energy said on Monday it would acquire the tower business division of fully
owned unit, Suzlon Towers & Structures, and the operations and maintenance
division of wholly owned Suzlon Infrastructure Services.
EU Ministers Rule Out Immediate Aid Boost (Bloomberg Finance LP)
European finance ministers ruled out immediate aid for Portugal and Spain or an
increase in the 750 billion-euro ($1 trillion) crisis fund, counting on European Central
Bank bond purchases to calm debt-spooked markets.
Bernanke Says More Fed Easing Is Possible (Bloomberg Finance LP)
Federal Reserve Chairman Ben S. Bernanke said the economy is barely expanding at
a sustainable pace and that it’s possible the Fed may expand bond purchases beyond
the $600 billion announced last month to spur growth.
China Outstrips Fed in Liquidity Surge Threatening Inflation Spike in 2011
(Bloomberg Finance LP)
China’s reluctance to allow a stronger exchange rate has hamstrung its efforts to rein
in inflation and endangered a campaign to shift economy toward domestic demand