HINDUSTAN UNILEVER LTD : SMALL ACTIONS, BIG DIFFERENCE !!!

Scrip Code: 500696 / HINDUNILVR

CMP:  Rs. 863.75; Market Cap: Rs. 1,86,898.93 Cr; 52 Week High/Low: Rs. 981.00 / Rs. 553.35 

Total Shares: 216,38,08,180 shares; Promoters : 145,44,12,858 shares –67.23 %; Total Public holding : 70,93,95,322 shares – 32.78 %; Book Value: Rs. 15.15; Face Value: Rs. 1.00; EPS: Rs. 19.94; Div: 1300.00 % ; P/E: 43.31 times; Ind. P/E: 58.10; EV/EBITDA: 31.97.

Total Debt: ZERO Cr; Enterprise Value: Rs. 1,86,278.32 Cr.

HINDUSTAN UNILEVER LTD: The Company was founded in 1931 and is based in Mumbai, India. The company was formerly known as Hindustan Lever Limited and changed its name to Hindustan Unilever Limited in 2007. Unilever Ltd on November 17, 1956, offered 5,57,000 shares of Rs. 10 each to the public at par. In February 1980, in order to reduce the Non- Resident holding in the company to 51 %, Unilever Ltd offered for sale of 42,39,523 equity shares of Rs. 10 each at a premium of Rs. 9.50 per share, this was out of its shareholding in the company. Hindustan Unilever Ltd have given lucrative bonuses in the past. Company first gave bonus in the year 1979 in the ration of 1 new share for every 3 held; then in 1983 in the ratio of 3 new for 5 held; then in 1987 in the ratio of 1 new for 1 held and lastly in the year 1991 in the ratio of 1 new for every 2 held. The company had last split the face value of its shares from Rs. 10 to Re. 1 in the year 2000. Hindustan Unilever Limited, is a Fast Moving Consumer Goods (FMCG) company providing home and personal care products; foods and beverages in India and internationally. The company operates in 7 business segments. The company offers soaps and detergents, including soaps, detergent bars, detergent powders, detergent liquids, and scourers; and personal products - such as oral care, skin care, hair care, deodorant, talcum powder, and color cosmetic products, as well as Ayush services. It also provides beverages - including tea and coffee; foods, such as atta (flour), salt, and bread; culinary products comprising tomato and fruit based products, and soups; and ice creams, such as ice creams and frozen desserts. In addition, the company offers chemicals, such as glycerin and fine chemicals; agri commodities; and water purifiers, as well as exports marine and leather products. HUL has over 35 brands spanning 20 distinct categories. Its portfolio of brands includes the brand names like - 3 Roses, Annapurna, Brooke Bond, Taaza, Bru, Kissan, Knorr, Kwality Wall’s, Lipton, Modern, Red Label, and Taj Mahal brand names; personal products under the Aviance, Axe, Breeze, Clear, Clinic Plus, Closeup, Dove, Fair & Lovely, Hamam, LEVER Ayush Therapy, Lakme, Lifebuoy, Liril 2000, Lux, Pears, Pepsodent, Pond's, Rexona Soap, Sunsilk, and Vaseline brand names; and home care products under the Active Wheel, Cif, Comfort, Domex, Rin, Sunlight, Surf Excel, and Vim brand names and water purifiers under the brand name Pureit. As on March 31, 2013, Company had over 35 brands spanning 20 distinct categories. From April 01, 2013, Aquagel Chemicals Pvt Ltd becomes a subsidiary of Hindustan Unilever Ltd. On July 04, 2013, the parent company Unilever Plc raised its stake in HUL from 52.48 % to 67.28 %, by acquiring 31,95,63,398 shares representing 14.784 % in HUL via open offer priced at Rs. 600 per share. The company is locally compared with ITC, Godrej Consumer, Dabur India, Colgate, Marico, Emami, Godrej Ind, P&G, Gillette India, Bajaj Corp, Jyothy Labs, Amar Remedies, JHS Svendgaard, GKB Ophthalmics and Globally compared with Associated British Foods Plc of London, Colgate-Palmolive Co of New York, Kimberly-Clark Corp of USA, Procter & Gamble Co of USA, Nestle S.A of Europe, Pepsico Inc of USA, Coca- Cola Co of USA, Mondelez International Inc of USA (earlier known as Kraft Foods Inc which acquired Cadbury’s), Heineken Nv of Amsterdam, Starbucks Corp of USA, McDonald’s Corp of USA, Yum! Brands Inc of USA, Danone of Paris, Asahi Group Hld Ltd of Japan, and Kerry Group of Dublin.

Investment Rationale: 

HINDUSTAN UNILEVER LTD is a play on consumption growth in India. Hindustan Unilever Limited (HUL) is India's largest Fast Moving Consumer Goods Company with a heritage of over 75 years in India and touches the lives of two out of three Indians. HUL has over 35 brands spanning 20 distinct categories such as soaps, detergents, shampoos, skin care, toothpastes, deodorants, cosmetics, tea, coffee, packaged foods, ice cream, and water purifiers, the Company is a part of the everyday life of millions of consumers across India. Its portfolio includes leading household brands such as Lux, Lifebuoy, Surf Excel, Rin, Wheel, Fair & Lovely, Pond’s, Vaseline, Lakmé, Dove, Clinic Plus, Sunsilk, Pepsodent, Closeup, Axe, Brooke Bond, Bru, Knorr, Kissan, Kwality Wall’s and Pureit. HUL is a subsidiary of Unilever, one of the world’s leading suppliers of fast moving consumer goods with strong local roots in more than 100 countries across the globe with annual sales of about €49.8 billion in 2013. Unilever has about 67.23 % shareholding in HUL. The Company has over 16,000 employees and has an annual turnover of around Rs. 28,019.13 Cr (financial year 2013 – 2014). 

                             The Indian Fast Moving Consumer Goods (FMCG) sector is the fourth largest in the Indian economy and has a market size of $1,310 Cr. This industry primarily includes the production, distribution and marketing of consumer packaged goods, that is those categories of products which are consumed at regular intervals. The FMCG market is set to treble $3,340 Cr in 2016. Penetration level as well as per capita consumption in most product categories like jams, toothpaste, skin care, hair wash etc in India is low indicating the untapped market potential. The Indian FMCG industry represents nearly 2.5 % of the country’s GDP. The industry has tripled in size in past 10 years and has grown at 17 % CAGR in the last 5 years driven by rising income levels, increasing urbanization, strong rural demand and favourable demographic trends. Food products and personal care together make up two-third of the sector’s revenues. Rural India accounts for more than 70 Cr consumers or 70 % of the Indian population and accounts for 50 % of the total FMCG market. With changing lifestyle and increasing consumer demand, the Indian FMCG market is expected to cross $8,000 Cr by 2026 in towns with population of up to 10 lakh.  With significant distribution scale, a portfolio of iconic brands and leading market share in many categories, we give India’s largest consumer products firm a narrow economic moat rating. Hindustan Unilever’s (HUL) products reach about 70 lakh outlets across India, the largest distribution network among peers. 19 of its brands generate annual turnover of over Rs. 500 Cr, or $ 8 Cr, each; while a good 95 % of products hold the two leading spots in their respective categories in terms of market share. To ensure that its dominance remains intact, the company is constantly investing in product innovation and supporting brands via the media. As the company innovates to bring new-to-India products to market and gains further scale benefits it is anticipate that HUL’s operating margins will expand over the coming decade, keeping returns above its cost of capital. HUL’s ability to innovate ahead of competition is truly remarkable. HUL has impressive ability to expand margins despite mounting competition in soap and detergents, which contributes 47 % to sales. This has been possible by launching new products such as fabric softeners, liquid detergents ahead of competitors. At the same time, its rural strategy of converting local villagers to salesmen has allowed them to access the interior regions of India, and sell them one rupee sachets of its products, keeping volumes buoyant. Personal products, contributes 28 % to sales & is a big opportunity for HUL to drastically improve its margins. The under-penetration characteristics of this category will allow HUL to leverage the breadth of its brands across price points, to lead adoption across affluent as well as poor households in India. Its recent launches of TRESemme and Tony & Guy brands, is a step in that direction to explore how far up the price band can be expanded in this luxury category. 

                                      Hindustan Unilever's (HUL) narrow economic moat stems from its portfolio of iconic brands--which allows the company to continue holding the top two spots in terms of market share across 95 % of its product categories, despite new entrants. In fact, eleven of the company's brands each drive over Rs. 1,000 Cr in annual sales, while another eight generate annual revenue in excess of Rs. 500 Cr each. Furthermore, HUL’s large retail distribution network which directly touches 32 lakhs outlets of India's estimated 85 lakhs retail outlets, and this is the largest coverage of universe in all of consumer India. Not only this, the secondary distribution of HUL’s products reaches over 80 % of all retail outlets in the country, making its products easily available across the country. HUL’s products play across the price points caters to the premium-mid-and-low end of the markets, and its premium brands are enjoying pricing power compared to its local brands of Marico in the body lotion category, and Godrej in soaps. Also when we give a snap shot look at HUL's 15 year financials, it turns out that it has been consistant in its returns. HUL's 15 years average of ROCE comes at 99.85 % & 15 year average of ROE comes at 89.67 %, its returns on invested capital (ROICs) which comes to an average 53 % over the next five years, well over its 10.9 % estimated cost of capital, supporting HUL's narrow economic moat. Here is HUL's 15 years financial snap shot - 

YEARS	EPS(Rs.)	P/E(x)	BV(Rs.)	Div/Sh(Rs.)	ROCE(%)	ROE(%)
1999	4.86	46.29	9.55	2.90	65.00	51.00
2000	5.95	34.68	11.30	3.50	66.70	52.67
2001	7.46	29.97	13.82	5.00	61.50	50.64
2002	8.04	22.60	16.62	5.16	58.05	48.38
2003	8.05	25.42	09.71	5.50	59.13	82.87
2004	5.44	26.37	09.50	5.00	45.08	57.23
2005	6.40	30.82	10.47	5.00	67.66	61.09
2006	8.41	25.74	12.34	6.00	65.89	68.14
2007	8.73	24.50	06.61	9.00	138.72	122.97
2008	11.46	20.72	09.45	7.50	135.55	120.30
2009	11.47	21.86	09.45	7.50	118.59	121.34
2010	10.10	23.63	11.84	6.50	106.78	85.25
2011	10.58	26.89	12.19	6.50	102.66	86.70
2012	12.46	32.89	16.25	7.50	95.40	76.61
2013	17.56	30.21	12.37	18.50	163.59	141.98
2014	17.88	32.01	15.15	13.00	147.56	118.01

Looking forward, it can be expected that HUL's free cash flow will roughly equals its annual earnings in the future, as it has done in the past. And, it can be expected that its ROIC's to remain above the Cost of Capital (COC) for at least the next decade, given its strong brands with pricing power, negative working capital cycle, and low acquisition strategy in India. HUL had already given two Buybacks till now, one was in October 2007 where HUL bought back 3,02,35,772 equity shares of Re. 1 each at an average price of Rs. 207.13, spending Rs. 626.27 Cr (approved not more than Rs. 230). The second buyback came in June 2010 where HUL bought back 2,28,83,204 equity shares of Re. 1 each at an average price of Rs. 273.25 spending Rs. 625.29 Cr (approved not more than Rs. 280). So, looking at its strong cash flows and with the Free Reserves of at Rs. 3,507.76 Cr (as on 31 March 2015), another buyback can be expected at around Rs. 700 per share, and company may utilize around Rs. 930 Cr for this buyback. A buyback improves many financial metrics like ROE & EPS. Both of these metrics have number of shares as denominator & buybacks reduces number of shares, thus increasing ROE & EPS. Goods and Service Tax (GST) will replace the multiple indirect taxes levied on FMCG sector with a uniform, simplified and single-pint taxation system and this is likely to be implemented soon & the benefits are likely to come in by the end of FY’16. The rate of GST on services is likely to be 16 % and on goods is proposed to be 20 %. A swift move to the proposed GST may reduce prices, bolstering consumption for FMCG products. While the rural market certainly offers a big attraction to marketers, it would be naïve to think that any company can enter the market without facing any problems and walk away with a sizable share. Distribution is the most important variable in the marketing plans of most consumer goods manufacturers, because managing such a massive sales and distribution network is in itself a huge task. This sector will continue to see growth as it depends on an ever-increasing internal market for consumption, and demand for these goods remains more or less constant, irrespective of recession or inflation. Hence this sector will grow, though it may not be a smooth growth path, due to the present world-wide economic slowdown, rising inflation and fall of the rupee. This sector will see good growth in the long run and hiring will continue to remain robust.

Outlook and Valuation:

HUL is the largest company in the FMCG industry, with market leadership in soaps, detergents and personal care categories. The company is a subsidiary of Anglo Dutch FMCG giant Unilever. It has over 35 brand spanning 20 distinct categories; the company is a part of the everyday life of millions of consumers across India. It has strong brands, with market leadership in most of the categories it operates in. It has a large distribution network with direct reach of over 1m retail outlets. The FMCG Industry is characterized by a well-established distribution network, low penetration levels, low operating cost, lower per capita consumption and intense competition between the organized and unorganized segments. In the last decade the FMCG sector has grown at an average of 11 % a year; in the last five years, annual growth accelerated to 17 % and last year it grew 5 %. Within this, urban growth was 4 % and rural growth was 8 % as per Ac Nielson MAT numbers. The rural India accounts for 70 % of India’s population with 56 % of National Income and commands 64 % of total expenditure and one third of the total savings. The Indian FMCG sector is the fourth largest sector in the Indian economy. Indian rural markets contribute around 45 % in HUL sales. 

                                                HUL did its first-of-its-kind deal with the music channel MTV- a part of Viacom 18 media group for five of its best-selling brands. The deal will help HUL to showcase its brands in six 60-minute movies, one aired every month on Viacom 18's youth and music platform. Each movie is directed by a Bollywood’s young directors like Anurag Basu for Sunsilk; Nikhil Advani for Ponds; Rohan Sippy for Tresemme; Abhinay Deo for Lakme; Anurag Kashyap & Shoojit Sircar for Close up. The agreement would include not just the movies themselves but interviews with directors, on-ground and on-air promotions of the films, airtime for ads etc. The Elements of these movies such as songs and trailers of the movies are likely to give a boost to HUL. The deal size is being pegged by industry insiders around Rs. 20-25 crore, all inclusive. With the launch of MTV Movies, HUL will redefine the way in which brands tell their stories to consumers. These will focus on communicating the brand purpose and build brand love. 

                                                  On Financial side HUL’s Performance was quite satisfactory. During Q4FY15, HUL’s Revenues jumped 8.2 % YoY to Rs. 7,680 Cr. Domestic consumer business grew by 8.9 % led by 6 % volume growth and 3 % jump in price realization. The Operating profit increased 22.3 % YoY to Rs. 1,320 Cr. The operating margins grew 2.00 % YoY to 17.2 % led by 2.70 % drop in Raw Material costs and 0.50 % decrease in other expenses and 0.30 % decline in employee cost. However, this decrease was partially offset by 1.50 % increases in Advt & Promotional spends. Net profit increased by 23.4 % YoY to Rs. 1,020 Cr. Excluding exceptional gains of Rs. 180 Cr related to property sale, the Adj. PAT increased 3.0 % YoY to Rs. 900 Cr. Other segments reported satisfactory performance during the quarter – Beverages segment reported 12.3 % YoY growth in revenues to Rs. 980 Cr and 11.4 % YoY jump in EBIT to Rs. 180 Cr and Processed Food recorded 13.6 % YoY increase in revenues to Rs. 480 Cr and 10.6 % growth in EBIT to Rs. 25.4 Cr. HUL’s all three detergent brands – Surf, Rin and Wheel have crossed Rs. 2,000 Cr mark. Lifebuoy and FAL also crossed Rs. 2,000 Cr mark. Magnum Ice-cream extended to Delhi and Kolkata & now has presence in 7 cities. One of the HUL's newest products Pureit achieved its break even. The company is witnessing the momentum coming back in Close Up. The business environment for HUL continues to be challenging with slowing growth being witnessed on both the value front and volume fronts. The overall competitive intensity has stepped up in various categories while the up-trending has come to a pause. The discretionary category which was outpacing the other category over a longer term has come to a pause, but the company believes it to be a short-term phenomenon. HUL has a robust product pipeline, and has a strong and lucrative personal products portfolio, and expanding distribution network. HUL is also a good play because it has a revenue growth from a medium to long term perspective, however due to increase in royalty, steep hike in tax rate and slowdown in discretionary segments remains an overhang on this stock. Depreciation in rupee impacts price of imported raw materials. The price war in HUL’s popular segments with new entrants entering the fray could hit the company hard. HUL pay’s rich dividends and one can hold this stock from a three five year perspective and focus on new product launches and market share gains in existing categories. Also there could be another buyback at around Rs. 700 per share. At current price of Rs. 863.75 the stock is trading at P/E of 41.92x FY16E on EPS of Rs. 20.60 and 34.96x FY17E on the EPS of Rs. 24.70. It is expected that the company’s surplus scenario is likely to continue for the next three years keeping its growth story in the coming quarters also.  

KEY FINANCIALS	FY14	FY15	FY16E	FY17E
SALES (₹ Crs)	28,019.10	30,734.10	34,442.60	39,602.50
NET PROFIT (₹ Cr)	3,555.30	3,837.20	4,456.80	5,342.90
EPS (₹)	16.40	17.70	20.60	24.70
PE (x)	54.50	50.50	43.40	36.20
P/BV (x)	59.10	52.00	47.90	38.10
EV/EBITDA (x)	42.20	37.40	30.70	25.80
ROE (%)	119.50	109.60	114.70	117.00
ROCE (%)	88.20	94.40	98.10	92.30

 As I always say, I am a long term believer in markets & I do respect the markets and will keep a strict stop loss of 8 % on every purchase. (Why Strict stop loss of 8 % ?) - Click Here

*As the author of this blog I disclose that I do hold Hindustan Unilever Ltd in my investment portfolio.

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RETURN ON CAPITAL

SPECIALITY RESTAURANT LTD: SPECIALITY PREFERRED !!!

Scrip Code: 534425 / SPECIALITY

CMP:  Rs. 163.65; Market Cap: Rs. 768.46 Cr; 52 Week High/Low: Rs. 218.60 / Rs. 127.20.

Total Shares: 4,69,57,657 shares; Promoters : 2,84,99,962 shares –60.69 %; Total Public holding : 1,84,57,695 shares –39.30 %; Book Value: Rs. 64.72; Face Value: Rs. 10.00; EPS: Rs. 2.33; Dividend: 10.00 %; P/E: 70.23 times; Ind. P/E: 45.23; EV/EBITDA: 20.56.

Total Debt: 0.62 Cr; Enterprise Value: Rs. 756.11 Cr.

SPECIALITY RESTAURANTS LIMITED: The Company was founded in 1992 and is based in Mumbai, India. The company was formerly known as Speciality Restaurants Private Ltd and changed its named to Mainland Restaurants Pvt Ltd on May 7, 2003. The company again changed its name to Speciality Restaurants Pvt Ltd in Jan 2004, and on conversion to a public limited company, the name was again changed to Speciality Restaurants Limited on Feb 10, 2011. Speciality Restaurants Limited came out with an IPO on May 2012 offering 1,17,39,415 equity shares of Rs. 10 each for Rs. 155 per share raising Rs. 181.96 Cr. The object of offer for sale was to repay a term loan, development of new corporate restaurants, development of food plaza. Speciality Restaurants Ltd is a fine dining operator in India with 107 restaurants and 14 confectionaries. They focus on providing their guests an affordable fine dining experience with quality food and service in a modern ambience. Speciality Restaurants has established several famous brands across the nation, including Mainland China, Oh! Calcutta, Café Mezzuna, Sigree, Haka, Machaan, Mostly Kababs, Just Biryani and Sweet Bengal, Flame & Grill, Kix, Shack, and Kibbeh brands; and confectionaries under the Sweet Bengal brand. It also operates Mobifeast, an outdoor catering arm for parties. It runs 62 Food & Beverage outlets in various important cities of India. Mainland China alone serves more than 2 lakhs Chinese meals per month, which is a record of its sorts in the country. Their restaurants consist of different restaurant concepts and are located across India, with the majority concentrated in the western region. The four factors that contribute to the quality of the food that they offer are quality fresh ingredients, modern food preparation and storage equipment, standardised recipes prepared by trained chefs and effective quality monitoring. Speciality Restaurants Limited owns and operates restaurants and confectionaries in India, Middle East, Africa, UK, and Bangladesh. Speciality Restaurants Limited is locally compared with Jubilant Foodworks Ltd, Westlife Development Ltd, Galaxy Entertainment, Indage Restaurant, Viceroy Hotels Ltd, Kamat Hotels India Ltd, H.S. India ltd, Byke Hospitality Ltd, Country Club India Ltd, Srs Ltd and globally compared with BJ’s Resturants Inc of USA, China Bistro, Cheesecake Factory, Darden Restaurants, Buffalo Wild Wings, Neo Group Ltd of Singapore, Borneo Oil Berhad of Malaysia, Berjaya Food Bhd of Malaysia, Abu Dhabi National Hotels of UAE, New Palace International Co. Ltd of Taiwan, Misonoza Theatrical Corporation of Japan, JB Eleven Co Ltd of Japan, Burger King Worldwide Inc of USA, Dunkin’ Brands Group Inc of USA, Red Robin Gourmet Burgers Inc of USA, BJ’s Restaurants Inc of USA, DineEquity Inc of USA, Domino’s Pizza Inc of UK, Hilton Worldwide Holdings Inc of USA, Hyatt Hotels Corp of USA, IFA Hotels and Resorts of USA, New Mauritius Hotels Ltd of Mauritius, Kuwait Food Company of UAE, Naiade Resort Ltd of UAE, Carrianna Group Holdings Co of Hong Kong, Bloomberry Resorts Corp of Philippines, Millennium & Copthorne Hotel Plc of UK, InterContinental Hotel Group Plc of UK, Kouni Reisen Holding AG of Switzerland, Restaurants Group Plc of UK, Sodexo S.A. of France, Spirit Pub Company of UK.

Investment Rationale:

Speciality Restaurants, promoted by the Anjan Chatterjee and family who owns and operates chains of fine dine and multi cuisines restaurants in India and abroad. The very first restaurant was started in 1992 named Only Fish. This group has two flagship brands Oh! Calcutta and Mainland China. Speciality Restaurants Ltd is a leading restaurant chain having presence with 107 restaurants (2 restaurants are opened in 4QFY15) across India, primarily catering to fine dining. Mainland China is its prime brand and contributes around 60 % in its revenue and also this enjoys strong brand equity and throughout India has virtually become synonymous to Chinese food. Moreover, the company’s experiment with Mainland China Asia Kitchen and Sigree Global Grill formats have borne rich dividends, with Global Grill in particular being a resounding success. Global Grill has aided customer churn for Sigree franchise from 1.4 times to 1.7 times and is commanding a higher Average Per Customer realisation of Rs. 650 to Rs. 680 vis-à-vis Sigree’s APC of Rs. 550 to Rs. 600. Going forward, Sigree & Sigree Global Grill will contribute around 20 % to 22 % to the net revenue for Speciality Restaurant Ltd from current 18 % contribution. The company has so far refrained from taking any menu prices increase, since customer footfalls are under pressure. However, discretionary spending is expected to get better with improvement in macro environment, and there could have a build-in 1 % to 2 % increase in the APC in FY17E for Speciality Restaurants Ltd.’s top- 3 brands. Owing to relative inelastic menu prices of a fine dining restaurant (visà- vis inflation), the margin of Speciality Restaurants is expected to improve going forward. The company continues to get better footfalls on weekends and has now focused on improving the weekday footfalls especially for large corporate clients. If the cover turnaround ratio improves by 5 % to 6 % and raw material prices further reduces from the current level, then there could be an improvement in operating margins and company’s margins would get back to double digits. Also the company is banking on initiatives, such as reducing dependence on imported raw materials and better space management at the restaurant level and this will add-on to the profitability of the company in the long run. With an increase in disposable income levels and the culture of dining out fast catching up with the middle class, the restaurant industry in India is expected to grow at 17 % annually. Fine dining is an upcoming format in urban India which is gaining good acceptance for serving the highest quality of food and services in a soothing atmosphere. The size of this market is estimated at Rs. 1,045 crore. The average bill size in the fine dining space ranges between Rs. 650 to Rs. 3,000 per person. The industry has an OPM of close to 40 %, which is higher in comparison to the 15-25 % OPM in the QSR industry. The growth of the Indian food service industry is broadly driven by consumers and food service operators. The food market in India is estimated at Rs. 75,000 Cr last year and would reach Rs. 1.37 Lakh Cr in 2015 according to data. The industry is highly fragmented with 1.5 million eating outlets of which little more than 3,000 outlets form the organised segments. However, the organised segment is rapidly growing at an annual rate of 16 %. The India’s Quick Service segment is the clear winner in the eating out market with a growth rate of 21 %. Organized segment is expected to reach Rs. 22,000 Cr by 2017 driven by rising disposable income, nuclear family structure, increasing working population, rapid urbanization and consumerism, increased private equity interest. The market size of Indian Quick Service Restaurants is of Rs. 4,675 Cr and is expected to grow at 21.5 %, the market size of Casual Dining is of Rs. 2,365 Cr and is expected to grow 11.9 %; the Indian Café’s Market size is of Rs. 1,265 Cr and is expected to grow 12.3 %; the market size of India Fine Dining is of Rs. 1,045 Cr, and is expected to grow at 12 %, the market size of Pubs , bars, clubs and Lounges is of Rs. 963 Cr and is expected to grow at 11.00 % . Indian on an average eats out lesser than 2 times a month as compared to 40 times in Singapore. Even a small increase in this number provides a huge market opportunity for restaurants in India. Speciality Restaurants Ltd is focusing on increasing weekday footfalls in their restaurants. For their flagship brand Mainland China, and company has undertaken various incentives and promotional offers ranging from providing discounted rates for Women Kitty group every Wednesday to 2 times reward points accretion for the members if they dine during weekdays. Further to increase churn rate, various dining formats have been experimented with in recent years; with Asia Kitchen, Global Grill and Hoppipola brands giving rich dividends. Speciality Restaurants Ltd is test marketing its QSR brand Zoodles by opening one restaurant at Andheri (W), Mumbai. Though the potential for Zoodles to grow is huge given the brand pedigree, the QSR format is currently crowded and the management is undertaking a market study for Zoodles before entailing a focused brand capex for the same. Speciality has an asset-light business model as all its properties are leased and this aids optimal utilisation of capital for efficiently managing the restaurants at various locations. Most of the lease agreements are for 10 years, however, the company is striving to re-negotiate the lease agreements for 15 years period. The Company has its own roll-out process after finalising a particular location; the company normally enters into a lease agreement and applies for regulatory permits. On securing the same the company starts the interiors. Typically the time between entering into a lease agreement and rolling out a restaurant is around 120 days. The breakeven period for any particular restaurant at the EBITDA level ranges from six months to eight months. Location is a critical component for the success of any outlet. The company is focusing on introducing more and more combos and multi-brand formats which will reduce the operational cost (centralised kitchen) and employee cost. Also, the need for a larger space would allow the company to negotiate the lease rentals. Moreover, for new properties, the lease agreement is a minimum guarantee deed, wherein Speciality Restaurants Ltd pays the owner either 12 % of the revenue garnered in the restaurant’s first year of operations or the minimum guarantee, whichever is lower. For the second and third years, the revenue share increases to 13 % and 14 % respectively. Case in point is the new property in the upcoming DLF Mall in Noida. Lease arrangements for 25-30 restaurants out of 77 owned restaurants of Speciality Restaurants Ltd (19 restaurants are franchise managed) have already been reworked. This kind of business entails services for cash and thus the business has excellent operating cash flows. With more and more of its restaurants attaining maturity, it can be expected that Speciality’s free cash generation ability to improve substantially in the coming years. This will not only take care of the future expansion plans, but also help in rewarding the investors with good dividend pay-outs. Speciality Restaurants is professionally managed and have experienced management team which helps company to cater to aspiration needs of the customer through the largest pan India chain of multi-cuisine fine dining restaurants. Company also maintains a strict check on the quality of service through in-house staff training for all its restaurants, it also conducts regular auditing as well as quality control audit of the ingredients behind the signature dishes through a central hub for non-perishable raw material sourcing.

Outlook and Valuation:

Speciality Restaurant is a reputed player with leading and established brands. With a portfolio of well established brands including core brands Mainland China, Sigree and Oh! Calcutta, Speciality Restaurants Ltd (Speciality) is a leading player in the fine dining space with value-for-money proposition to offer five-star quality food, ambience and services at affordable rates this has enabled it to successfully expand its chain of restaurants to over 107 restaurants spread across 22 cities in India. Management mentioned that the payback time for Mainland China is 3 years, while, the breakeven for the blended portfolio on an average has increased to greater than 6 months which was 3 months to 6 months pre-2011. Out of the total annual capex of Rs. 45 Cr that Speciality has entailed, 75 % of it is will be utilized for its top-3 brands. Specialty served 104 guests per restaurant. Since the operational costs per restaurant largely remains constant, lower consumer footfall per restaurant increases the payback period per restaurant and this is hurting Speciality Restaurants Ltd the most. Hence in the wake of expected discretionary spending revival, on a low base, consumer footfalls can increase at 20 % CAGR over FY15-17E. There is a marked increase in the competitive intensity in the chain restaurants’ space with Impresario Entertainment & Hospitality Pvt Ltd. who owns & operates Smoke House Deli, Salt Water Grill, Mocha Café; the Mirah Hospitality who owns & operates Rajdhani, Manchester United Café, Café Mangii, Falafel; the JSM Group who owns & operates Shiro, Hard Rock Café, California Pizza Kitchen; the Indian Cookery Pvt. Ltd. who owns & operates Sanjeev Kapoor’s Yellow Chillies, Signature by Sanjeev Kapoor, Sura Vie, Pin Yin Café; the Sayaji Hotels who owns & operates Barbeque Nation etc. all vying for a share in this Rs. 2.5 lakh Cr food services industry. Moreover, Impresario Entertainment & Hospitality Pvt Ltd. and Mirah Hospitality have also partnered to negotiate lease rentals with various mall owners in pan India basis. This can be business threat for an established chain of Restaurants Company like Speciality Restaurant Ltd, since location is the key to the success of fine-casual dining restaurants. A key location for a restaurant is defined as that location which attracts high number of discretionary spenders; for e.g. a mall like Palladium at Phoenix Mills, Mumbai or Great India place at Noida and Speciality is located in most of the prime areas and in premium malls & remains confident of maintaining its growth momentum of opening 10-15 new restaurants each year despite the above mentioned emerging trend. Speciality Restaurant is adopting innovative marketing like Fixed price, unlimited food model are being followed at Sigree and Sigree Global Grills. Member are being granted rewards for Mainland China patrons, attractive corporate offers on weekdays and discount coupons for LSD on popular websites like Freecharge are some other initiatives taken by the company to increase occupancy. Going forward, Speciality may extend its online visibility for confectionary brand, Sweet Bengal. Speciality Restaurant Ltd is confident of maintaining brand equity of its flagship restaurant and growing its portfolio by opening 10-15 restaurants each year, having entailed an annual capex of Rs. 45 Cr to Rs. 50 Cr for the same. 

Speciality Restaurants Ltd enjoys more than 85 % of its revenue from just 3 brands, notably Mainland China which contributes 60 %, Oh! Calcutta contributes 10 % and Sigree & Sigree Global Grill contributes 18 %. The company has experimented with numerous formats in the past to reduce its dependence on Mainland China and has tasted success with Sigree Global Grill which is the merged version of Sigree, Machaan and Flame & Grill. The Management indicated that in the next 2-3 years, the revenue ratio from Mainland China and its hive off brand Asia Kitchen and other brands may see a shift from current 60:40 to 55:45, with contribution to the net revenue from Sigree Global Grill increasing from current 18 % to 25 % to 30 %. The raw material prices have corrected from its high, but the company is yet to get full benefit of same. The large benefits of lower raw material prices can be seen in the coming quarters. The company has maintained its focus on reducing the operating cost and has undertaken several initiatives in the past including setting up of commissaries in key markets. In its one of the recent initiatives, the company is trying to reduce the kitchen space in its key restaurants from 1500 square feet to around 700- 800 square feet for better space management and improving margins over the period of time. In view of enhancing its footprints in the quick-service restaurant (QSR) space, the company has opened Zoodles restaurant in Mumbai (more of a takeaway and delivery format). It is a 600 square feet outlet, smaller than the other restaurants, which the company has under its portfolio. The average takeaway bill size stands at around Rs. 1000 per order. The takeaway is gaining good acceptance in the recent times especially in the urban markets and Speciality Restaurants Ltd wants to explore opportunities in this space. In H1FY2015, the company opened six restaurants including two Mainland China and two Sigree Global Grill. The company is planning to add another six to eight restaurants in the second half. The Mainland China Asia Kitchen is operating as per the expectation and some of the existing Mainland China restaurants will be converted into Mainland China Asia Kitchen in the coming quarters. Also the company is working on converting some of its brands such as Sigree, Flame & Grill and Machaan under one Indian food brand – Sigree Global Grill. Speciality Restaurants Ltd bought 51 % stake in Love Sugar Dough for an estimated Rs. 75 Lakhs. Love Sugar Dough (LSD) is a Mumbai based company set up in 2011 by Nauzad Munshi and Tarannum Merchant. The chain currently has eight bakery stores spread across Mumbai, Pune and Surat Management is upbeat on LSD’s youth proposition and sees strong synergies with Speciality Restaurants Ltd. Being a low capex business, Speciality plans to sale the its entire stake of 5,100 equity shares held in Love Sugar & dough Pvt ltd and would be getting not more than Rs. 0.57 cr. The company bought stake in May 2014 for Rs. 75 lakhs. There can be a revival in footfalls for Speciality Restaurants in 6-9months. Further, an indirect 4 % price hike through service charge could impact customer churn in the near term. While softening food cost is a structural positive, but it would still be difficult to achieve FY12 levels in gross margins as Indian cuisine is a low margin business and its share is increasing with focus on Sigree Global Grill. Company posted 17.3 % YoY growth in revenues on the back of healthy 20.7 % YoY growth from owned restaurants but faced 20 % decline in revenues from franchisees. Operating profit was down 18 % at Rs. 7 Cr on the back of 4.05 % decline in operating margins at mere 9.3 % as RM cost increased by 29 % YoY while admin and other expenses increased by 21.3 % YoY. PAT was down by 40.8 % at Rs.2.4 Cr due to lower operating profit. Apart from this, the company indirectly raised customer billing by 4 % in November by introducing service charge of 10 % across restaurants where it was not present previously which could hurt footfalls. Company witnessed 1.20 % sequential improvement in gross margins as food cost inflation continued to reduce on MoM basis and is near April 2014 levels. Measures to reduce cost by lowering menu items, smaller restaurant size, centralized kitchen & storing and price hikes will help margin expansion. Formats such as Happipola and Mainland China Asia Kitchen have higher margins. Along with an exponential growth in the quick service restaurants (QSR; eg KFC, Domino’s and McDonald’s) within the organised segment, the fine dining (full service restaurants) are also expected register a healthy high double-digit growth rate for several years. It is expected that the operating margins for the company to expand to 17 % by FY16 on the back of strong operating leverage as more than 80 % of the cost is fixed in the business. Speciality Restaurant is confident on long term growth due to its focus on increasing same store sales growth, foray into international markets and home delivery business. The key downside risks for Speciality are longer break even time for new restaurants along with non-acceptability of new restaurant formats. Speciality Restaurant trades at lowest PE as compared to its peers namely Jubliant Food trades at PE of 51 times, Brinker International Inc trades at 22 times, Café de Coral trades at 25 times, Darden Restaurant Inc trades at 15 times and Speciality Restaurant trades at 22 times. At the CMP, the stock is trading at of Rs. 163.65, the stock is trading at its all-time high P/E of 77.92 x FY15E, 36.36x FY16E and 20.98 x FY17E. The company can post EPS of Rs. 2.10 for FY15E and Rs. 4.50 for FY16E. It is expected that the company’s surplus scenario is likely to continue for the next three years keeping its growth story in the coming quarters also.  

KEY FINANCIALS	FY14	FY15E	FY16E	FY17E
SALES (₹ Crs)	263.80	300.30	397.20	493.60
NET PROFIT (₹ Cr)	19.00	9.90	21.20	36.60
EPS (₹)	4.00	2.10	4.50	7.80
PE (x)	46.40	89.10	41.50	24.00
P/BV (x)	2.90	2.90	2.70	2.50
EV/EBITDA (x)	22.20	27.00	16.90	11.30
ROE (%)	6.40	3.20	6.70	10.90
ROCE (%)	5.00	1.50	5.60	10.70

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*As the author of this blog I disclose that I do not hold Speciality Resturants Ltd in my any of the portfolios.

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