Collins Foods Expansion Strategy On Track

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Despite a soft result in FY18, brokers remain confident in the longer-term ambitions of Collins Foods as the expansion strategy is rolled out.

-Stock considered attractive in view of long-term growth options
-Share price likely to remain muted until strategies unfold further
-Successful delivery function important given competitive disruptions
 

By Eva Brocklehurst

Collins Foods ((CKF)) has re-ignited confidence in its multi-pronged expansion strategy after a weak FY18 result initially disappointed expectations. The company has reported better trading conditions for the first seven weeks of FY19, with KFC Australia same store sales growth up 3%.

KFC Australia was affected by persistent weakness in Western Australia in FY18 because of increased promotional activity while KFC Europe reported lower earnings because of elevated costs and a slower roll out.

Morgans reduces FY19-21 forecasts to reflect lower assumed margins in KFC Australia, despite management expecting improvement in FY19. The broker takes a conservative approach but acknowledges that same-store sales growth of over 2% would provide upside risk to its assumptions.

Regardless, strong top line growth is still expected because of the annualising of recent acquisitions, organic roll out and better margins in Europe off a subdued base. The broker considers the stock attractively priced in the context of the long-term growth options.UBS, too, continues to envisage strong growth opportunities from the company's expansion strategy. Europe is expected to have operating leverage from both an increase in store numbers, on predominantly fixed costs, amid improved operations in Germany.

Deutsche Bank upgrades to Buy from Hold, although found the FY18 result underwhelming as margins were disappointing and comparables soft. The margin weakness in Europe reflected the cost of establishing a presence in Germany and the Netherlands, yet the broker believes the outlook for Europe is favourable in the long-term.

Canaccord Genuity, not one of the eight stockbrokers monitored daily on the FNArena database, has a Buy rating and $6.50 target. The broker points out a number of growth levers will add to earnings over the medium term and the company's initiatives appear to be implemented in a conservative manner.

Still, the share price is expected to remain muted until these strategies unfold further. Strategies involve the delivery network in Australia, rolling out of Taco Bell and the network expansion of KFC in Europe and Australia. Canaccord Genuity suspects European expansion may be slower and more challenging given a larger population and lower brand awareness.

Given the ultra-low cost of capital in Europe and ability to leverage the equity investment, the broker suggests the terminal value of the business is highly sensitive to a number of factors, such as same-store sales growth and bond yields.

Collins Foods reported revenue of $770.9m, up 21.7% in FY18. The company's European business continues to deliver in line with expectations although earnings were affected by the costs involved in opening new restaurants.

No FY19 guidance was provided. Brokers expect top line growth to be supported by continued promotional investment in WA at some expense to the margin. The company intends to roll out eight KFC stores in Australia in FY19 and 6-8 in Europe.

KFC Australia same-store growth was 1.0% in FY18 and the 15.9% EBITDA margin compared with 16.4% in the prior year. The margin included a partial contribution from the recent Yum! Australia acquisition.

Same-store sales growth was 0.8% in Europe comprising 2.8% in Germany and 0.4% in the Netherlands. A net four stores were added and the divisional margin was 7.2%.

Sizzler reported a -22% decline in revenue with two stores being closed. Earnings in Sizzler Asia offset the decline in Sizzler Australia. The company opened five restaurants in Thailand and one in China, which will be offset by the closure of one store in FY19. Sizzler Australia has 13 stores and the operations are being wound down over time.

Taco Bell

Two Taco Bell stores are expected by the end of 2018 and the company reports the initial store at Annerley in Queensland continues to trade strongly. Canaccord Genuity considers Taco Bell a growth option but does not include the division in modelling, believing it will take a number of years before Taco Bell becomes positive in terms of cash flow.

Collins Foods does not have exclusivity in Australia and is not likely to be supported by Yum! to build brand awareness. The broker estimates the cost to open a new Taco Bell restaurant is below a KFC restaurant, at around $1.2m versus $1.7m. Restaurant Brands has also shown interest in entering the domestic market with Taco Bell.

Delivery

Management is continuing trials to expand its delivery service and also intends to add stores to the Foodora/Deliveroo platforms in the first quarter of FY19. Canaccord Genuity believes a successful internal delivery function is important, given the potential disruption and increased competitive threats of new delivery platforms that provide choice, flexibility and convenience.

The broker acknowledges the rolling out of the company's delivery function has been slower than initially expected. Digital innovation is expected to drive same-store sales growth in the domestic restaurants.

FNArena's databases shows three Buy ratings for Collins Foods. The consensus target is $6.19, suggesting 6.7% upside to the last share price.

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