Collins foods: Navigating challenges and seeking growth opportunities in the fast-food market
Brisbane-based Collins Foods Limited (ASX:CKF) operates, manages, and administratively supports fast-food restaurants and food service outlets. The company’s portfolio of owned and franchised KFC outlets makes it one of the largest KFC franchisees in the world. While known primarily for those outlets, Collins Foods also operated 71 Sizzler stores in Japan and Thailand, which have now been sold to MFG International Holding (Singapore) Pte. Ltd (Minor), a subsidiary of Minor International Pcl (a company listed on the Thai stock exchange), and has reintroduced Taco Bell to the Australian market, opening 26 stores in Queensland, Victoria and Western Australia.
At the conclusion of its 2023 financial year, ending 30 April, the company operated 363 KFC and Taco Bell restaurants in Australia, Germany, and the Netherlands.
Share price performance and recent decline
In the twelve years since listing in 2011, the Collins Foods share price has risen 379 per cent, excluding any dividends reinvested. It reflects a couple of powerful forces that Collins Foods benefits from. The first is leveraging the KFC brand, which has been building since ‘Colonel’ Harland Sanders opened the first Kentucky Fried Chicken franchise in Salt Lake City, Utah, in 1952, challenging the dominance of the hamburger. While Collins Foods pays a single-digit royalty to Yum! the amount is materially less than it would otherwise have to pay for the R&D required to build a successful fast-food offering. The other force Collins Foods benefits from is the long-term compounding of same-store sales growth and store numbers.
One should know, however, the 21 per cent per annum compounded share price return since the IPO, masks the fact the share price has declined 26 per cent in the last year and a half since its peak at $13.37 on a weekly closing basis. And the primary reason for that is the view by many professional investors that fast food is discretionary and performs poorly when a slowing economy is accompanied by high rates of inflation.
While the bulk of the company’s revenues are derived from the 272 KFC restaurants in Australia ($1.05 billion compared to $249 million from Europe), Australian revenue grew by 10 per cent in FY23 versus 31 per cent in Europe. And the runway for growth in Europe is significant. KFC’s footprint in Germany and the Netherlands is a fraction of that already established by McDonalds, Burger King and Dominos, and that is a function of the fact the brand is possibly still finding its niche.
In Australia for example, marketing is targeted at tradies and families where the brand has found and established its audience. In Europe, whether store numbers follow brand establishment remains to be seen.
Revenue breakdown: Australia vs. Europe
In FY23, KFC Australia’s revenue surpassed $1 billion for the first time, driven by same-store sales (SSS) growth of almost six per cent. The result was attributed to higher ticket sizes (read prices), significant e-commerce growth, and a collaboration with Uber Eats. Delivery, web and app represented almost a quarter of all sales in the second half of FY23, up from 16.9 per cent in FY22, thanks to investments in new software to enhance customer adoption of KFC’s app, digital ordering and personalised offers.
It should be noted professional investors are nervous about the contribution Uber Eats made to growth because a weakening economic environment may reveal consumers no longer wish to pay for Uber Eats. Growth in Australia was also helped by winning market share again burger vendors who were forced to raise prices even more than KFC amid surging beef inflation.
Quoting from the company’s FY23 Investor Presentation, “Same Stores Sales growth of +5.8 per cent reflects increased ticket and significant growth in e-commerce. Transactions were broadly flat on PCP.” In other words, volumes were flat, and the revenue growth on a same store sales basis came from rising prices. Obviously, as a business owner, there’s merit in being able to raise prices without a detrimental impact on unit sales volumes. Still, investors with a shorter-term horizon see this as lower quality growth, especially given the company’s year-end is April and the worst of the expected consumer downturn is yet to come.
Despite ongoing labour and supply chain inflationary pressures, underlying EBITDA was only slightly down by 2.5 per cent to $201.6 million with a consistent EBITDA margin.
KFC Australia added eleven new restaurants to its network in FY23, exceeding its target of seven. Collins Foods’ business performance was attributed to prioritising long-term brand health over short-term margin pressures, keeping menu prices competitive, and engaging customers with exclusive app-only promotions. The company said it also plans to continue exploring new opportunities to grow its customer base and improve customer and aggregator partner experiences through innovations in restaurant design and technology.
KFC Europe revenue growth of 31 per cent was supported by double-digit same-store sales (SSS) growth of almost 14 per cent (13.9 per cent), which in turn can partly be attributed to the assumption of operational control under the Netherlands Corporate Franchise Agreement. Double-digit SSS growth in Netherlands and Germany resulted from a “balanced” increase in transaction volumes and price.
The company noted record inflation levels and significant margin pressure in Europe across labour, utilities, and commodity prices, but the underlying EBITDA margin (post AASB16) remained at 13.2per cent, in line with previous forecasts. The impact was offset by sales growth (both volume and ticket size), the mentioned operational control in the Netherlands, and ‘value’ marketing and pricing strategies there that resulted in a greater number of consumers agreeing with the statement “I can feed an entire family affordably” than they do for McDonald’s and Burger King.
Europe as an investment option for Collins Foods
The company has grown its European business by over 50 per cent in the last two years through new establishments and selective acquisitions. We believe Europe should continue to grow following Collins Foods Group’s redeployment of the proceeds of the sale of Sizzler and also from being names Franchisee of The Year by Yum! Brands. One can reasonably conclude Yum! brands’ lacks a significant KFC presence in Europe and that is probably due to inconsistent franchisee quality. Collins Foods Group may just become Yum! Brands’ preferred expansion partner, potentially conveying preferred financial and site location arrangements between the two companies.
Europe represents an ‘option’ for investors, given the FY25 P/E ratio of 15 times. Understandably, Collins Foods aims to make Europe a key growth driver and plans to continue expanding its portfolio to scale the KFC brand in the region. As mentioned, Yum! has recognised Collins Foods Group as ‘Franchisee of the Year’ in Western Europe, which CKF believes is a positive confirmation of their future growth plans.
Since the end of the company’s financial year, trading has been outstanding, surpassing consensus expectations. For the first seven weeks of FY24 same store sales growth of nine per cent in the Netherlands, and 12.4 per cent in Germany, as well as close to nine per cent in Australia, has been recorded, which is well ahead of consensus of four per cent for FY24. I suspect the reason for the less enthusiastic PE ratio (less than 18 times FY24 and less than 15 times FY25) is fear of a recession in Australia and its effect on discretionary consumer behaviour. However, investors should keep in mind the extraordinary growth in Europe despite the fact that Europe has been in a deeper slowdown than Australia for some time.
While investors are nervous the worst of the downturn in consumer behaviour is yet to impact volumes for KFC, and increases in wages and electricity have yet to be felt, some point to a belief that the worst of commodity inflation is behind them. The optimists also note management is bullish about acquisitions and the broader store rollout plan in Europe, as well as expectations EBITDA margins in Europe have room to expand from current levels.
And there is also the company’s conviction high inflation and slowing economic growth will lead to a migration of customers from Fast Casual restaurant offerings to its Quick Service Restaurants (QSR), leading to market share growth.
CKF is a typical stock to own in tough times. On this occasion, the rising cost of labour, raw ingredients and energy costs makes it marginally less compelling. Having said that, at the right price, the long-term option over Europe becomes captivating, so investors should maintain a watchful eye on the performance of the shares in the next twelve months.