Australia | Nov 29 2018
The KFC Australia business of Collins Foods continues to perform well amid new menu and delivery initiatives while KFC Europe is promising but requires further work.
-Increased use of delivery aggregators, remodelling continues
-Operating leverage should become evident in Europe as network expands
-Modest expectations for Taco Bell maintained for the near term
By Eva Brocklehurst
Stronger margins for KFC Australia offset a softer performance in Europe for Collins Foods ((CKF)) in the first half. Same-store sales growth has slowed slightly in the second half to date while Europe remains negative.
First half results were driven by acquisitions and KFC Australia continues to perform well. Although KFC Europe offers significant potential, the region retains its difficulties and requires further work. Meanwhile, early signs for Taco Bell in Australia are quite positive and the rolling out of stores is expected to be driver of growth.
For Deutsche Bank the result highlights a strong rebound in Australia, driven by a recovery in Western Australia and continued traction on menu and delivery initiatives. The company has ramped up its Australian delivery footprint which should bode well for same-store sales growth. Use of delivery aggregators, such as Deliveroo, will increase and domestic restaurants are being remodelled to support dual-lane drive-through.
Canaccord Genuity also expects the expansion of deliveries at KFC Australia will be a primary driver of earnings. There are 44 restaurants currently operating with a delivery option and this will rise to 70 in the near term.
While the company provided no specific guidance, KFC Australia started the second half with same-store sales growth just below 2%. Wilsons expects positive momentum in Western Australia to continue amid incremental sales from the expansion of the delivery network. Margins are modelled to contract in FY20 and FY21 on assumptions for higher raw material costs.
Wilsons, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Buy rating and $7.46 target. Canaccord Genuity, also not one of the eight, has a Buy rating and $7.70 target. The broker also expects management's initiatives will keep comparable store sales healthy, with the options for Taco Bell underpinning the investment thesis.
First half revenue was up 27.6% and underlying earnings (EBITDA) up 31.7%. Morgans remains attracted to the growth prospects in the base KFC Australia business but, following the recent share price rally, believes the stock is trading on a significant premium to the long-term average.
The only blemish UBS found on an otherwise solid result was in Europe. Still, this was offset by earnings for KFC Australia and Western Australia in particular that were well above estimates. The company expects six new KFC Australia restaurants in the second half and another four for KFC Europe.
Margin weakness in Europe is reflecting the company's investment strategy, amid a significant roll-out. Negative aspects in Europe are expected to continue through the second half before modest growth returns.
Management has been forthcoming about the difficulties in both the Netherlands and Germany and Canaccord suspects retraining, rebranding and promotional campaigns will take time to produce results. Deutsche Bank also expects operating leverage to become evident as a network expands and believes the European opportunity remains highly attractive.
The focus in Europe is on a variety of value/snack initiatives in Germany as well as a breakfast menu at German train stations. Loyalty and mobile offerings are hyped in the Netherlands and 24/7 trading is being introduced in selected Dutch restaurants. Nevertheless, Morgans remains cautious about the European expansion in the short term.
Two additional restaurants in 2018 for Taco Bell will be added and another 10 are proposed for 2019. Canaccord Genuity observes it will take six months for these stores to mature and maintains modest expectations in the near term. The model relies heavily on customer engagement.
The company has guided to aggregate operating earnings losses at Taco Bell of -$2m over FY19 and FY20. Canaccord Genuity believes it will be important to build the right culture in the stores to drive customer acceptance and ensure the success experienced in early Queensland stores can be replicated across the broader network.
UBS is confident the company can achieve free cash flow ex-expenditure on new stores. Nevertheless, another acquisition that will materially contribute to earnings in FY19 is considered unlikely. The three businesses the company has acquired over the past 14 months are expected to contribute around 18% of operating earnings and management is expected to focus on integrating these in the near term.
The database shows two Buy ratings and one Hold (Morgans). The consensus target is $7.40, signalling 2.6% upside to the last share price. This compares with $6.51 ahead of the results.
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