Collins Foods Reveals KFC Has The Sizzle

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

-KFC the key to growth
-WA/NT acquisition to plan
-Valuation undemanding
 

By Eva Brocklehurst

KFC is sizzling but Sizzler is fizzling. That is the way UBS described the restaurant chain owner Collins Foods' ((CKF)) trading environment over FY14. The company's underlying profit in FY14 of $17.9m was up 9% and ahead of guidance. Excluding the contribution from the KFC franchisee acquisition, Competitive Foods, sales were flat on the prior year, with KFC growth offset by declines at Sizzler.

Moelis thought it was a solid outcome within a challenging quick service restaurant segment, and a reflection of the company's focus on efficiency and productivity. The integration of the Competitive Foods business has progressed to plan and Moelis retains the view that on FY15 estimates, a price/earnings ratio of nine times is undemanding in the context of the enhanced growth opportunities that are available to the enlarged group. The broker has a Buy rating and $2.40 target.

UBS agrees on the undemanding part but remains very concerned about the Sizzler chain. While the FY14 result beat the broker's forecasts by 3-4% because of better KFC margins, the Sizzler chain showed no sign of improvement. Management has signalled it expects KFC growth to continue but UBS has lowered FY15 profit forecasts by 8.0% and retains unchanged forecasts beyond that period. UBS strips out Sizzler and capitalises KFC's contribution, calculating that at the current share price, the KFC business is trading at a price/earnings ratio around 10.5 times FY15 estimates. The broker maintains there are risks to leverage involved, given the current valuation. Still, the stock offers significant leverage to an improvement in consumer sentiment and spending, relative to other consumer names in the small cap universe. Hence Sizzler is almost a free option, in the broker's view.

Other challenges include wage inflation which, when countered by operational efficiencies, is expected to keep margin growth flat. Traffic volumes are also challenging, particularly in the food court areas of shopping centres. UBS thinks this part of the business is likely to remain a drag on growth in the medium term, with no instant solution in sight. UBS retains a Buy rating and a target of $2.20, but recognises that the stock is subject to near-term volatility, particularly given the high operating leverage and uncertainty around Sizzler's future direction.

FY15 guidance was not provided but management did flag a positive outlook, supported by the positive trend for KFC, store openings and refurbishments, and the newly acquired KFC restaurants in Western Australia and Northern Territory. Management also expects Sizzler to return to growth and revenues to stabilise. The company reports same store sales growth of 1.5% for KFC in the first two months of FY15, reflecting a recovery from a soft fourth quarter. Collins Foods expects to build seven KFC stores, five in Queensland and two in WA, and remodel 11 stores in Queensland and five in WA.

The company's policy is to pay out 50% of profit from the old KFC Queensland and Sizzler businesses, with WA profits to be reinvested in WA. Management is also focused on lifting WA/NT operational margins. UBS estimates that portfolio is currently generating around 10.3% in earnings margins, compared to the Queensland stores on 15.2%.

There were few surprises in the results for Deutsche Bank, as the company appears relatively well positioned in its sector, even though vulnerable to a consumer downturn. The highlight was margin expansion, largely reflecting operating efficiencies. The broker expects solid medium-term earnings growth, underpinned by the KFC store roll-out and this has been augmented by the WA/NT acquisition. This broker also thinks valuation is undemanding and retains a Buy rating and $2.30 target.

Deutsche Bank does note some downside risks associated with any delays to store roll-out and refurbishment, which increases the likelihood of Yum! rolling out its own stores in Queensland, and the potential for Collins Foods to breach conditions of its franchise regarding KFC refurbishments. The overall risk of a termination in the franchise is low but Deutsche Bank observes Yum! has the balance of power as a franchisor and Collins Foods does not have exclusive territory rights to KFC in Queensland.
 

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