Jubilant has been one of the top 10 performing IPOs of this year. However, in its latest report to institutional investors, Kotak says that it is not comfortable with its valuations. Incidentally, JFL shares hit an all-time high yesterday

In a report dated 8 November 2010, Kotak told its institutional investors that although it likes the Jubilant Foodworks business model, has strong conviction in the management, and sees huge growth opportunities for the company driven by changing demographic and socio-economic factors, it finds it difficult to justify the current valuation of the company.

Kotak points out that the stock is trading at 42 times its expected FY12 EPS of Rs13 (Kotak's estimates) - one of the highest among the stocks it covers. This implies that the market has limited concerns about the sustainability of the company's margins over the next few years, says the brokerage. "This looks like a classic case of the market ascribing peak multiples to peak margins, leaving no room for execution risk," the report concludes.

Top performing issues of 2010

Clearly, Kotak's main discomfort (besides high valuations) is about margins. "During 1HFY11, the company reported average EBITDA margin of 18.4% (18.5% in 1QFY11 and 18.2% in 2QFY11). This is likely one of the highest, since it began operations, in our view," it says in its report. JFL's operating margin was only 13% between FY07 and FY09 but improved to 16% in FY10 because of cost controls. However, strangely, despite its concerns about margins, Kotak expects margins to expand to 19% in FY12 and 20% in FY 13 (see estimates below).

Jubilant operates the Domino's Pizza chain in India through an exclusive franchise agreement with Domino's International, which was renewed early this year for another 15 years. It operates 339 outlets across 79 cities and as per its agreement with Domino's International, it has to open at least 25 stores a year. The pizzas that it sells are definitely not on the affordable side but the brand recall for Domino's Pizza is pretty high in India.

Commenting on its 2Q results, Kotak says that high sales growth of 67% was probably due to a weak base, high same-store growth (44%) and price increase of around 5%. Same-store sales are sales from stores of a retail chain that have been open for a year or more. In JFL's case, same-store growth of 44% in this quarter and 37% in 1QFY11 is significantly higher than the average of 20% in the last six years, points out Kotak.

The company has more than 50% single-store cities. In 2QFY11 it entered new cities such as Jalgaon, Jamnagar and Trichy. Kotak says while these regions present huge opportunity for penetration-led growth, success of the product in these cities would be a key factor to watch out for in FY11E and FY12. Currently around 65% of JFL's sales come from top seven cities and around 50% of its stores are in Maharashtra, New Delhi, and Karnataka.

JFL's EBITDA margins have risen considerably as a result of flat material cost as a percentage of sales was flat (scale benefits) and a decline in rent as a percentage of sales. In the quarter the company introduced two new products - 'Pasta Italiano' and 'Mexican Wrap'. Kotak says it is worth watching if these new launches cannibalise pizza sales.

Kotak estimates

In August, JFL had said that it plans to hire about 2,000 people this year (slightly more than it hired last year). It currently employs 9,700 people. It has aggressive expansion plans - its target is to open 375 outlets by the end of March 2011 (versus 339 at the end of September) at a cost of Rs600 million-Rs700 million.

Jubilant Foodworks promoters (the Bhartia family) hold 61% stake in the company, FIIs hold 21%, and DIIs hold a little more than 7%. Large holders (more than 1%) include HDFC MF, T Rowe Price, Arisaig Partners, Amundi Funds India, and Quantum World Fund Inc. The shares hit an all-time high of Rs634 yesterday.

(This article is based on secondary research. The report is for information only. None of the stock information, data and company information presented herein constitutes a recommendation or solicitation of any offer to buy or sell any securities. Investors must do their own research and due diligence before acting on any security. Some of the opinions expressed in this article are the author's own and may not necessarily represent those of Moneylife).