Collins Foods Delivers KFC Feast

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

-Tourist areas strongest
-Healthy balance sheet
-Cash flow conversion low
 

By Eva Brocklehurst

Collins Foods ((CKF)) maintains its reputation as a strong KFC franchisee, with a positive contribution emanating from both existing and new and remodelled stores in the first half. Core KFC businesses, largely in Queensland, delivered the strongest contribution, supported by inbound tourism to coastal regions in that state.

Canaccord Genuity observed a number of product launches in the half year as well as brand marketing achieved growth in foot traffic over product prices. This is a signal to the broker the fast food chain is robust and can obtain price rises in the future.

Like-for-like sales growth was 5.2% for KFC, with 170 basis points of margin expansion as a result of operating leverage and cost reductions in the recently acquired Western Australian/Northern Territory business. Revenue was up 5.0% and the first half dividend increased 20% to 6c.

Earnings of $35.3m exceeded Canaccord Genuity's forecasts and the broker increases estimates for FY16 and FY17 by 9%. The broker has a Buy rating and believes the stock is trading at fair value, elevating its target to $5.44 from $5.22.

With an acquisition mandate and comfortable balance sheet, brokers are confident Collins Foods should be able to accrue further accretive KFC restaurants in the future, having stated it was keen to extend the KFC footprint nationally.

UBS also suspects Collins Foods may pursue a master franchise licence for KFC Australia, although this is unlikely in the near term. Cash generation improved but remains relatively low, with the broker calculating a gap of 33 percentage points between operating cash flow conversion and free cash flow conversion. UBS believes this gap needs to be monitored but expects it will close from FY18 onwards as major refurbishments are completed.

Still, the return on invested capital in KFC is now above the weighted average cost of capital for the first time since listing in 2011 and the broker expects new store openings should contribute meaningfully from the second half.

The Sizzler chain closed three stores and no growth capital was allocated to the business in the half year. This business is expected to remain profitable in FY16 but brokers ascribe it little or no value. Sizzler is non-core and brokers expect the chain will disappear in a few years. There are around 2.5 years in average lease life remaining on the Australian network of 23 restaurants.

To UBS, the company has fulfilled expectations inherent in its share price thus despite the strong near-term outlook, the broker downgrades its rating to Neutral from Buy. Sales and margin forecasts are upgraded with the long-run earnings margin for KFC increased to 17% from 15.5%. The target is raised to $4.65 from $3.50.

In contrast, Deutsche Bank believes there is more upside yet and the valuation is undemanding, sticking with a Buy rating and upgrading its target to $4.85 from $3.10. The broker increases FY16 forecasts by 22% and FY17 by 23%, largely from earnings upgrades and lower depreciation and net interest assumptions.

While the company did not provide FY16 earnings guidance, growth is still expected and management has indicated that trading over the first six weeks of the second half has been running at the same rate as in the first half, albeit with a little softness in areas dependent on the mining industry – western Queensland and Western Australia – as opposed to tourism.

Poultry costs, the largest input cost for KFC, are covered until January 2017. The company remains committed to a further 4-5 new KFC openings in the second half and seven remodels. Collins Foods also envisages scope for a further 7-8 new KFC outlets per annum over the next 3-4 years.

See also, Healthy Cash Feed Flows From Collins Foods on November 24 2015.
 

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