New Issue Analysis: Speciality Restaurants

The IPO market, which usually intends to provide investors with champagne stock opportunities, has unfortunately turned out to be the foremost wealth guzzler, stripping unaware investors of their hard-earned money. While CY2011 saw a number of companies either pulling out their IPOs due to poor market conditions or getting involved in price-rigging scams, CY2012 so far has been plagued by concerns over the pricing logic applied by the promoters and their lead managers.

Out of the five IPOs that have hit the market so far in CY2012, barring MT Educare most others are trading well below their issue price. In fact MCX India, which was touted to be a massive wealth creator, is trading nearly 4 per cent below its issue price.

At such a time, fine dining restaurant chain operator Speciality Restaurants (SPL) has decided to test these troubled waters with its initial offering, which aims at amassing a total sum of Rs 170-182 crore through a public issue of 1.17 crore shares at a price band between Rs 146 to Rs 155 per share. The object of the issue is to mainly utilise funds towards the development of new restaurants, a new food plaza and repaying part of its term loan facilities.

SPL by virtue is one of India’s leading fine-dining restaurant operators. The company currently operates 69 restaurants of which 49 restaurants are owned and operated by the company and 20 are under the franchise-owned company-operated (FOCO) model. SPL also has 13 confectionaries in Mumbai.

The flagship restaurant of the group is ‘Mainland China’ (MC), which, with its 36 outlets spread all across India, reigned in around 61 per cent of the company’s total revenue as on December 31, 2011. As per our interaction with the management in a recently held road-show in Mumbai, we learnt that MC served around 1.5 to 1.6 million guests in FY11 with an average per day cover of 1.55 to 1.65x. The average billing per person is around Rs 600-655 which is more or less in line with its daily buffet rates. Going forward, MC would continue to dominate the company’s envisaged expansion plans as out of the planned 45 new restaurants to be developed between FY13-15, 32 restaurants would be for MC.

Besides MC, the company also operates a chain of other restaurants under various brands like Oh! Calcutta, Machaan, Sigree, Flame & Grill and Haka. In a nutshell, SPL has 82 restaurants and confectionaries under 11 brand names which are collectively located across 21 cities in India and two in Bangladesh.

The favourable demographic profile of India with its rise in younger population and working class individuals is expected to provide a great impetus to the restaurant business in the country. Also, increasing urbanisation, growing middle-class population and rising disposable income would lead to an increase in dining out as a lifestyle preference. All this is expected to provide a leading front-runner like SPL with ample growth opportunities to thrive forward and introduce new brand concepts of serving food in different formats with theme-based restaurants and gain popularity in the fine dining segment.

SPL’s business model is truly commendable as it clearly signifies the well-organised and efficient practices followed by the management to maintain the high industry standards. There are several steps undertaken by the company’s operational teams who regularly monitor and adjust the menus to suit the changing tastes and preferences of its guests’ by inviting chefs from aboard to visit its restaurants from time to time and train their chefs to introduce new items into the menus. The company also actively manages its service standards for all other staffs ranging from the waiters to the valets by putting strong emphasis on guest reviews, thus resulting in repeated guest visits across its restaurants.

A key initiative that the company has undertaken, as communicated to us during our interaction with the management, was to captively train its staff at its very own learning institutes and provide them with the required skills and techniques to better serve the guests. The company recruits its staff from deprived villages across India, trains them at its institutes and provides them with placements in their chain of restaurants. In this way SPL not only manages to provide ample employment opportunities but also limits the high attrition rate that the hospitality industry is majorly plagued with.

On the financial front, the company has performed well over the past five years as its topline and bottomline managed to register an impressive CAGR of 35 per cent and 47 per cent respectively. The company has done well on its return ratio front by reporting a ROE of 24 per cent and ROCE of 19.7 per cent in FY11. The EBITDA margins and PAT margins of the company have also shown improvement from 15 to 23 per cent and 6 to 10 per cent respectively between FY08 and FY11. For the period between April-December 2011, SPL has reported a net profit of Rs 15.02 crore on the back of sales amounting to Rs 149.72 crore.

It is worth noting that the company has historically maintained low debt-to-equity levels by funding all its prior expansion activities through its internal accruals, thus managing to curtail the overall financial risks. As on December 31, 2012, the company’s D/E ratio stood low at 0.3x its pre-issue equity capital and going forward we expect this to fall further as the company repays part of its loans. We expect the D/E ratio to stand at 0.15x after the debt repayment exercise. The strong operating cash flows generated by the company also help depict the strength of its brand name and enable the company to fund its future expansion plans without going in for too much of leverage.

However, despite the robust growth opportunities, our recommendation on SPL’s initial offering is constrained by its tad expensive valuations. At an annualised post-issue EPS of Rs 4.26, its PE multiple stands at 34-36x its offer band of Rs 146 to Rs 155 per share. Though there are no peer comparisons, one may go ahead and compare it with Jubilant Foodworks (JFL) that operates the Domino’s Pizza chain.

But even then the comparison may not yield comprehensive results as the business model of JFL is benefited by its low exposure to establishment cost as it mainly works on the home delivery system. Also, analysts on the street have pointed out that the sales growth for JFL has been more volume-driven rather than value-driven, indicating that people may have cut back on their spends. This could possibly be a dampener in the near term for SPL’s growth prospect, which may get impacted as consumers could defer their discretionary spends on fine dining.

Moreover the recent failure of Samvardhana Motherson’s IPO despite its leadership advantage in the automotive ancillary industry could also play a spoilsport to the market’s willingness to acknowledge such high valuations.

In conclusion, despite the favourable prospects of the food services’ industry in India, the strong foothold of SPL in the fine dining industry and the strong cash flows depicting the strength of its brand value, we feel that the aggressive pricing logic applied by the merchant bankers and promoters would fail to receive a fair response from the market. Hence we advise our readers and the investor community at large to stay away from this counter at the time of the IPO. Nonetheless, we shall review this counter in our post issue analysis, and update our readers about the same.