Speciality Restaurants: Hold

Dining out is gradually becoming more frequent among Indian consumers with higher incomes, curiosity about different cuisines and willingness to spend on food.

Fine-dining, at the premium end of the dining spectrum, caters to those with a palate — and a wallet — for quality ambience, materials and service.

This format is turning increasingly popular, and holds good promise, offering better operating margins and a measure of pricing power.

In this fray is Speciality Restaurants, which owns, among others, nationally-established Mainland China.

The chain has built up a good reputation and enjoys strong consumer following. At Rs 168, the stock trades at 29 times estimated earnings for 2013-14.

While valuations are high, the stock benefits from a lack of listed peers — Jubilant FoodWorks, which operates the Indian Dominos Pizza chain, is the only other competitor in the listed space, trading at 68 times trailing earnings.

However, Speciality Restaurants is far smaller, and has posted sedate growth in the half-year ending September 2012. Prices of inputs such as vegetables are on the rise.

Persistent high inflation has eaten into customer wallets and premium formats are likely to bear the brunt of the large middle-income segment turning cautious, tamping growth in the near-term. Investors can thus hold the stock, but avoid fresh exposure. The stock is up 13 per cent from its issue price in May. Speciality straddles a multitude of cuisines from Chinese to Indian to British, which allows it to address a large customer base. It also has both quick-service and fine-dining chains, again allowing a wide market access, though it is more focused on fine-dining.

Varied chains

Mainland China is its strongest chain, which holds the highest brand recognition across the country. The format spans 46 outlets as of November.

Contribution of this chain to revenues hovers around 60 per cent. Next format in line is Oh! Calcutta which has eight outlets and accounts for 12-13 per cent of revenues.

This is followed, in order of revenue share, by Sigree, Flame & Grill, Machaan and Haka. It has other chains as well, but these are negligible in size and contribution.

Steady expansion

Past expansion has been kept up at a steady pace, with time enough for restaurants to break-even. This has helped it keep costs, debt and quality under control. Even where it uses franchisees to expand, the company undertakes operations, which prevent a slip-up in quality that could dent its reputation.

But while it has a large restaurant portfolio, focus remains on the flagship Mainland China. Expansion has been quick here, with nine stores opened in the current fiscal and 23 more to come up by FY-15.

The company plans to open the lesser-known chains such as Flame & Grill jointly with Mainland China outlets. This piggy-backing could serve it well in building up new brands while keeping promotion and advertising costs under check.

Apart from Mainland China, efforts to increase outlet-count are focused on Sigree. The company also plans to stick to metro and Tier I cities, where propensity to spend on fine-dining is higher and more frequent.

Setting up multiple restaurants in the same city is rather unlikely to lead to cannibalisation — it could, in fact, lead to higher footfalls, by drawing those customers reluctant to drive far enough to reach existing outlets.

Bankrolling expansion is not a worry, with a chunk of its May public offer proceeds earmarked for expansion and negligible debt. New outlets usually break even quickly, within six months.

It also plans to step up focus on the lucrative take-away market. But it faces both intense competition and higher costs in this venture.

Margins falter

Sales have grown by an annual 19 per cent over the past three years to Rs 196 crore, while net profits have grown 31 per cent to Rs 17 crore.

But for the six months ending September 2012, revenues and profits grew 11 per cent over the year-ago period, as consumer spending waned.

The company undertakes regular price hikes and enters into year-long fixed supply contracts. Even so, on higher staff costs, operating margins dipped 3 percentage points to 20 per cent in FY-12.

In the half-year to September 2012, input costs spiked alongside staff costs, bringing operating margins down to 17 per cent.

Promotional spending is also beginning to inch up, which could add to pressure on margins.

Debt had already been low prior to the public offer. Even so, most debt was paid off through the issue proceeds. But the resultant savings in interest cost was offset by higher depreciation, with the result that net profit margins have remained at 10 per cent. With at least 30 new outlets coming up, depreciation charges are likely to remain high.

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