Healthy Cash Feed Flows From Collins Foods

This story features COLLINS FOODS LIMITED. For more info SHARE ANALYSIS: CKF

-Continues to target KFC acquisitions
-Progressive dividend policy likely maintained
-Sizzler Australia gradual closure on the cards
 

By Eva Brocklehurst

Collins Foods ((CKF)) has a track record for generating cash and, in uncertain times, investors tend to target these sorts of stocks. Such is the basis on which Canaccord Genuity initiates coverage.

Same store sales growth across the company's KFC stores has averaged 4.8% since FY02, which the broker believes highlights the defensive nature of its revenue. The company's business is underpinned by the KFC chain and it is the largest KFC franchisee in Australia.

While Collins Foods has diluted its earnings margin profile by acquiring 44 KFC franchises in Western Australia, the broker envisages upside to forecasts as the company leverages its shared services structure and negotiates better terms with suppliers. Also, while growth capex requirements are high going forward, such spending is expected to deliver returns that exceed the cost of capital.

Canaccord Genuity has a Buy rating and $5.22 target. The company operates 171 KFC franchises, primarily in Queensland and Western Australia. Collins Foods owns 26 Sizzler restaurants, predominantly in Queensland, and receives royalties as a franchisor of 60 Sizzler restaurants across Asia. The company also owns six Snag Stands.

Cash flow is the key, with the broker noting a compound growth rate in cash flow of 11% or more since FY12. This provides significant reinvestment potential in the business. The company maintains an acquisition mandate, recycling capital into opportunities.

UBS is also confident the company's business will be underpinned by the robust trade in takeaway food and has a Buy rating and $3.50 target. The broker expects the company to continue to increase its share of the KFC footprint in Australia and, at this stage, is not convinced Snag Stands will be anything other than a niche offering.

Canaccord Genuity expects the company to acquire KFC stores that have scale and provide a relevant geographic footprint and notes that management has flagged potential acquisitions in a new retail vertical and the possibility of a domestic roll out.

A progressive dividend policy is also likely to be maintained, given the low pay-out ratio. Management has guided to a 50% pay-out ratio in FY16 which Canaccord Genuity estimates will translate to a 12.2c dividend, a 6.1% increase on FY15.

The broker considers the stock fundamentally cheap and trading at a significant discount to its international peers. The closest listed peer is New Zealand's Restaurant Brands, given a similar business model and earnings drivers.

Restaurant Brands owns 91 KFC franchises in New Zealand, along with 46 Pizza Huts, and recently reported a strong first half performance which should augur well for Collins Foods, in Canaccord Genuity's view.

The KFC brand is owned globally by Yum!, and is one of the world's largest chains with 14,316 outlets. Yum! also owns Taco Bell and Pizza Hut. Collins Foods is required to make annual fee payments to Yum! of 6.0% of annual sales and pay at least 6.0% of annual sales in advertising and marketing.

Collins Foods has access to the Yum! supply chain but retains an option to select its own suppliers such as Inghams, Steggles and Turi Foods. Canaccord Genuity expects the continued reduction in interest rates coupled with record low fuel prices will aid the KFC brand in the short to medium term.

What about the company's other restaurant chain, the Sizzler brand? This business has been less than stellar for Collins Foods, with Canaccord Genuity noting a very poor FY15 result. This business is now considered a non-core enterprise, a decision announced at the time of the FY15 results that was welcomed by brokers.

The book value of Sizzler Australia has been revised to zero, effectively signalling the progressive closure of the network, but Canaccord Genuity understands no disclosure has been made on the quantum of its lease liabilities.
 

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