Collins Foods Looking For M&A Opportunities

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

FY24 results showed relative resilience, but also slowing sales momentum. With margin improvement unlikely in the short term, management at Collins Foods is focusing on M&A opportunities.

-FY24 results for Collins Foods marginally exceed expectations
-Analysts praise earnings resilience and are positive for the medium-term outlook
-For the short-term, slowing sales momentum is a concern

By Mark Woodruff

Despite a slightly better-than-expected FY24 result, analysts trim earnings forecasts for Collins Foods ((CKF)) on evidence of slowing momentum in the second half that has continued into early-FY25 trading. Management also cited challenging trading conditions in a later conference call with analysts.

FY24 was a tale of two halves, observes Morgans, with the second half slowdown due to a weaker consumer environment and a tougher comparison to the previous corresponding period.

After generating same store sales (SSS) growth of 6.6% in the first half, KFC Australia’s growth slowed materially (as expected by the broker) to 1% in the second half. Post week thirty-two, growth slowed further to 0.4%.

KFC Europe growth also slowed in the second half to 0.9% from 8.8% in the first half, and post week thirty-two sales growth declined again to 0.7%.

While revenue proved broadly in-line with consensus expectations, earnings grew by 15% and beat forecasts by Macquarie and consensus by 4% and 3%, respectively, driven by margin improvements across the KFC business segments.

Collins Foods operates Quick Service Restaurants (QSR) in Australia, Germany, and the Netherlands. In the latter country, the company is a corporate franchise partner, running KFC on behalf of US-listed fast-food company Yum! Brands.

The company operates 279 KFC restaurants (as the franchisee) throughout Australia, and a further 75 stores across the Netherlands and Germany. A further 27 Taco Bell franchises are in operation across Queensland, Victoria, and Western Australia.

Taco Bell appears to be turning a corner, according to Macquarie, with rising sales in FY24, and positive momentum continuing into early-FY25.

In coming months, as Taco Bell hits performance milestones, the company will review the restaurant rollout, after being on pause over the last year due to inferior performance.

Management cautioned the weaker consumer environment in both Australia and Europe will likely impact group performance over the year ahead, with weaker SSS’s and top line revenue placing pressure on margins in the near-term. Also, while most commodity prices are easing, costs of labour and energy remain elevated across all business units.

Swimming against the trend of brokers, UBS raises its 12-month target price and upgrades to Buy from Neutral on the basis Collins Foods is a trade-down beneficiary in the tough consumer environment. The company’s shares are considered an appropriate investment for investors seeking some retail exposure.

The company has both the scale and ability to drive share gains through market leading value offerings such as the KFC Australia $35 family of 4 “Feast” deal, notes this broker.

Macquarie disagrees, suggesting KFC’s strong value proposition is a potential risk to margins as management may need to reinvest in price to bring volume growth back into the business.

Energy and commodity costs are beginning to ease in Europe, explains Macquarie, following significant inflationary pressures over the last two years, which should allow for KFC Europe to mitigate some margin pressures that were anticipated for FY25.

Unlike in Europe, energy costs in Australia remain elevated and will create margin pressure over the coming year, explains the broker.

Management has walked away from its guidance for margin improvement in FY25, highlights Citi, due to both weak customer demand and labour headwinds.

Further positives

Collins Foods has exposure to the stronger Australian states of Western Australia and Queensland, notes UBS, and would also benefit from improved spending intentions by consumers over the next year at QSR’s, signalled by respondents to the broker’s latest consumer survey.

Further, UBS highlights twin positives of a potentially favourable protein cost outlook and ongoing organic store expansion, with a chance for M&A upside.

Wilsons has long admired the company’s strong cash conversion, and, because of de-leverage in recent years, Ord Minnett believes around $270m could potentially be allocated to M&A activities.

Partly due to this strong cash performance, the board declared a fully franked final dividend of 15.5cps taking the full year dividend to 28cps.

Potential M&A

A boost for growth could be on the cards, with management stating, “We’re exploring and evaluating M&A opportunities for KFC in existing markets and new geographies”.

Certainly, Macquarie sees significant scope for Colins Foods to increase its presence, particularly in Australia, while Ord Minnett highlights M&A would potentially speed up growth for the European business.

This broker explains management is primarily focused on KFC-branded opportunities, which could involve retiring franchisees in Australia or launching restaurants in new or existing markets in Europe, where operations are currently under-scaled.

These considerations include neighbouring countries to the Netherlands and Germany where management could buy a group of stores and rapidly expand the network, according to Bridge Street Capital Partners.

Apart from scale benefits, Macquarie points to potentially better control of marketing and pricing in operating markets, which would create an opportunity to further expand margins over the medium-to long-term.

Outlook

Jarden declares the medium-term outlook for Collins Foods is as strong as it has been in recent years, with a strong balance sheet, clean network, strong rollout pipeline, and a master franchisor focused on delivering value and gaining share.

While earnings growth in the half of FY25 is considered unlikely, Morgans anticipates decent growth will resume from the second half, noting QSR has proven to be a resilient category over time.

Morgan Stanley admires the resilience of the durable KFC brand, and its positioning as a value offering, and notes the company is trading at a slight discount to its long-run average 12-month forward price earnings multiple. It’s felt the company can sustain a multiple premium in an uncertain macro backdrop given its relatively defensive earnings.

The performance of KFC Australia should improve throughout FY25, Ord Minnett surmises, due to an easing of competition and the introduction of tax cuts, along with electricity rebates in Queensland.

The share price appears cheap, assuming margins recover as expected, but Barrenjoey thinks the risks remain balanced, while Canaccord Genuity prefers to await evidence of improved same store sales (on the proviso sales are driven by volume, not price) and stabilised margin dynamics.

Bridge Street has the gloomiest outlook with an Underweight rating and $8 target, while Morgan Stanley is Overweight with a $13 target.

The average target price of six covering brokers monitored daily in the FNArena Database is $11.27 suggesting around 24% upside to the current share price.

This average fell from $12.13 prior to the FY24 results on small decreases by most brokers and a move to $10.50 from $14.40 by Ord Minnett, after deciding to undertake its own research on Collins Foods rather than whitelabel Morningstar.

Four of these brokers have a Buy (or equivalent) rating, while Macquarie is Neutral and Citi is Sell- rated.

Outside of daily monitoring, Wilsons and Jarden have Overweight ratings, Barrenjoey and Canaccord Genuity are Hold (or equivalent). As mentioned, Bridge Street assigns an Underweight rating to Collins Foods.

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