KFC Europe Powers Collins Foods

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Brokers raise earnings forecasts in response to first half results for Collins Foods, as a strong outcome in the Netherlands supports outperformance for KFC Europe.

-Highest margins for KFC Europe in over three years for Collins Foods
-Store network growth is set to accelerate
-The opportunity for Taco Bell
-A comparison to another quick service restaurant peer

By Mark Woodruff

Better margins for KFC Europe and KFC Australia were behind a strong first half performance for Collins Foods ((CKF)).

In response, brokers raised earnings forecasts and lifted 12-month target prices, primarily driven by KFC Europe.

Collins Foods, an operator of quick service restaurants (QSR), is the largest KFC franchisee in Australia and is rolling out KFCs across Germany and the Netherlands. As at October 2021, the company operated 17 Taco Bell restaurants in Australia and was the franchisor of a number of Sizzler-branded restaurants in Japan and Thailand.

Along with first half results, management disclosed like-for-like sales for the first six weeks of the second half. KFC Australia rose 1.6% while Taco Bell fell by -8.9%. In overseas operations, KFC Netherlands jumped by 16.5% and KFC Germany climbed 7.1%, despite moderating growth from increased covid restrictions in the latter two weeks.

While management didn’t provide any FY22 guidance, store network growth is expected to accelerate via 17-24 new store openings during the period, and the acquisition of a further nine stores in the Netherlands is expected to close in early 2022.

Growth opportunities in KFC Australia are expected to flow from a combination of new store openings and leveraging digital and delivery innovations.

Europe explained

KFC Europe underpinned the first half beat versus brokers’ expectations, with 128.9% earnings (EBITDA) growth and a 620 basis point jump in margin to 14.7%. The result was underpinned by strong same-store sales growth of 14.6%, driven mainly by the 17.2% growth in the Netherlands, explains Macquarie.

As a whole, KFC Europe achieved earnings margins of 8.2%, the highest in over three years. However, industry-wide headwinds including rising food costs, labour shortages and wages pressures remain.

Wilsons believes that in the event of a sustained improvement in performance for KFC Europe a further re-rate of Collins Foods’ valuation will occur. Meanwhile, Canaccord Genuity certainly likes the way margins in Europe are heading as the company’s operations become more Netherlands-centric and trading conditions normalise.

The Taco Opportunity

Taco Bell posted a first half loss of -$1.1m, offset by lower corporate costs.

The company believes the potential for Taco Bell in the Australian market is considerable, as Australians are increasingly acquiring the taste for Mexican flavours. This conviction of management is cited as a risk by Morgans, as Collins Foods may be prepared to tolerate more losses in Taco Bell than the market can stomach.

Macquarie highlights Mexican QSR has grown at a 35% compound annual growth rate (CAGR) over the last decade, which has outperformed 3% growth for the broader QSR space. The broker expects Taco Bell to generate more than $10m of earnings from FY25 as the brand gains momentum.

Morgans points out Taco Bell is huge in the US, much bigger than KFC, and believes the company is right to persevere, provided it can avoid incurring ongoing material losses.

It should be noted the Taco Bell store rollout was adversely impacted by covid-related building restrictions in Victoria, with management now guiding to six to eight new stores in FY22 from nine to twelve previously.

Overall

Morgans increases its 12-month target price to $14.70 from $14.40 after increasing earnings estimates for both FY22 and FY23 by 5% and profit by 13% in each year, after allowing for higher earnings margin assumptions in both KFC businesses. However, investors should be mindful of the risk to earnings of a possible return to lockdowns in key markets such as the Netherlands.  

After increasing EPS estimates for FY22-24 and taking into account an improving outlook post-covid, Macquarie lifts its target price to $14.80 from $14.75. With QSR peer, Domino’s Pizza Enterprises ((DMP)), trading on double one of the broker’s valuation metrics, an Outperform rating is retained for Collins Foods.

While UBS raises its target price to $14.10 from $12.85, a Neutral rating is kept as the premium for quality is believed to be adequately reflected in the current multiple.

The broker pulls forward the European operations recovery in its forecasts and is confident in maintaining KFC Australia earnings margin estimates above 17% for FY22.

Cannacord Genuity, not one of the seven stockbrokers monitored daily on the FNArena database, raised its target price to $14.85 from $13.90 and retained its Buy rating. Meanwhile, Wilsons, also not one of the seven, raised its target price to $15.75 from $15.30 and retained its Overweight rating.

The database has a consensus target price of $14.53, suggesting 2.9% upside to the last share price.

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