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Was this float a Turkey?

Consumer discretionary | Comments (34)

Was this float a Turkey?

The float of Collins Foods earlier in the year at a price of $2.50 did not interest your author.  The lack of interest however was not shared by others and the company listed on the ASX with a ‘Top 20 Shareholders’ list that included many if not most of the major nominee companies (Nominee companies have long been established as the mechanism by which asset managers and custodians can process transactions on behalf of their clients).

I wrote a column for Alan Kohler in which I explained why investors might want to reconsider any enthusiasm and you can find the full column here http://rogermontgomery.com/invest-in-kfc-or-just-eat-it/

Much of the commentary around the time of the float referred to the “defensive” nature of fast food restaurants but as we have always suggested here, the only truly defensive stock market investment is an extraordinary business at a large discount to a conservative estimate of its intrinsic value.

One of the issues I had with the float was articulated thus:

“To begin with it is important to note that Pacific Equity Partners (PEP) – the private equity firm behind REDgroup, the parent company of Angus & Robertson and Borders now under administration – will be exiting its stake completely.

“Perhaps more interestingly, the existing management team is cashing in, too. Managing director Kevin Perkins will reduce his holding from over 20 per cent to about 8% and the rest of management will reduce their holding, too.

“When Pacific Equity Partners paid $US210 million in September 2005 (the $US6.92 a share was a 42% premium to the then traded price of $US4.92) for Worldwide Retail Concepts, the US publicly listed company that is now Collins Foods, management then co-invested with a 48% stake. According to all reports, management will now retain just 10%. In other words, management is selling 80% of its holdings into this float.”

Shares fall 50%

The prospectus (which didn’t include the above photo of a genetically modified chook) noted Collins Foods strengths included: “Attractive market dynamics”, “Leading market position” and “strong financial track record”. But just two months after the float, Collins Foods has warned that it will miss prospectus forecasts.  The shares are down 50% at the time of writing after the company stated that it would miss forecasted by almost a third (up to 27% to be precise).  Collins Food said that the downgrade is due to “fragile consumer confidence and a highly competitive restaurant industry”.

Indeed.  My contacts tell me that, according to analysis of credit card usage, the only place doing really well in Australia’s retail sector is…wait for it…restaurants.  Meanwhile at yesterday Dominos Pizza AGM, that company confirmed that on a like-for-like basis, sales had grown by double digits.

You cannot help but wonder, what was motivating management to sell so much of their stake into the float?

If you had your hands on the prospectus for Collins Foods and followed the steps in Chapter 11 of Value.able to value the float of Collins Foods, you might have used a forecast profit of $16 million, equity of $161 million, 93 millions shares on issue (giving an equity per share of $1.73), earnings per share of 17.3 cents and dividends per share of 11.8 cents (giving a payout ratio of 68%).

Return on equity of 10% is low and this is with the benefit of leverage (total borrowings $105 million).  Immediately you know that if you are using an Investor Required Return of more than the ROE of 10%, the intrinsic value will necessarily be less than the equity per share of $1.73.

Shares fall to Intrinsic Value Estimate

Using Tables 11.1 and 11.2 and an Investor Required Return of 13% Table 11.1 produces an income valuation of $1.33 and Table 11.2 produces a growth valuation of $1.08.  Multiplying $1.33 by the payout ratio of 68% results in 90 cents and Multiplying $1.08 by one minus the payout ratio of 68% results in 34 cents.  Adding 34 cents and 90 cents gives a valuation of $1.24.  (You can see just how bullish you or I would have to be to produce, at the time of the float, a valuation of $2.50!)

You might like to download the prospectus yourself from the ASX website here and try using Value.able’s Table 11.1 and 11.2 to arrive at the same valuation.  If you don’t have a copy of Value.able, you can order your copy here

I’d love to know how you go. If you have valued any ‘Turkey’s’ yourself, go right ahead and upload your thoughts about the company and your valuation, along with a comparison to its current price.

Posted by Roger Montgomery, Value.able author and Fund Manager, 03 November 2011.

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Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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34 Comments

  1. Ben
    :

    There is money to be made…

    I bought in during the race to the bottum panic….sitting on pretty 13% gain :-)

    we have family own KFC franchise, there is nothing like inside knowledge it’s not as bad as CFK paints

    Seem like the copulos family think the same line…they own 50 KFC in NSW
    and bought in a 5% stake…they hell sure know more about KFC
    than any analyst on this planet :-)

    BUY the FEAR…

  2. Ben
    :

    There is money to be made…

    I bought in during the race the bottum panic….sitting on pretty 13% gain :-)

    we have family own KFC franchise, there is nothing like inside knowledge it’s not as bad as CFK paints

    Seem like the copulos family think the same line…they own 50 KFC in NSW
    and bought in a 5% stake…they hell sure know more about KFC
    than any analyst on this planet :-)

    BUY the FEAR…

  3. Rici Rici
    :

    look at the latest substantial shareholders notice.

    Who was it?????

    Is this group a fellow franchise.

    Without giving any advice I think there is money to be made here.

  4. Andrew
    :

    Had a quick look at this company and to me it seems its about as healthy as an investment as one of their huge family meals at KFC.

    Some quick thoughts that came to mind when i looked over some of it.

    It appears to me to have all the hallmarks of a mature company, revenue has been pretty flat since 2009 and so has profits. The same store sales growth is well below the average based on the period of 2002 onwards and is tending to be flat. This gives me the impression is that the only way to dramatically improve revenue is to roll out new stores and thet requires the area around it to grow enough to be able to warrant and sustain these new stores.

    Compound annual growth in the after float period is a good 2% lower than the compound annual growth before the float which just makes me think that they see it as a good opportunity to flog off a mature asset onto other investors so they can cash out and find better ones. This leads me to believe that the rear view mirror might be a very helpful and perhaps accurate guide to what lay ahead.

    I have 75% of the assets made up out of intangibles, which i will let yourselves make up your mind. KFC is a huge brand so probably not surprising and i never got stuck into the details of what those intagibles actually are.

    They have a negative current ratio which, isn’t necessarily a deal breaker as they get cash at point of sale so they could probably meet their obligations by just working their receiveables etc a bit harder. The fact that they will be starting from a low cash base is a bit of a concern.

    Net debt to equity is pretty high at 63%, yes it is non-current so they have a break for at least 12 months before it becomes due but still, it has to be paid at some point.

    They are spending up big on CAPEX over the next year so thats an extra drain on cash and they forecast free-cash flow to fall dramatically which is not something i look for in a value investment. I want to see free cash growing so it can be used to fund other adventures that will benefit the shareholder (dividends, buy back etc)

    i get a value of $1.17 which offers me a small margin of safety however i would really label it a “no need to value”.

    These are just my thoughts but i think its best days are behind it, hence the reason private equity are selling off. I agree with some of the thoughts here that if Private Equity are the seller than run.

    I think turkey might be a decent description, definitley not a compay i am interested in but a very interesting exercise.

    • Rici Rici
      :

      Firstly is your ‘value’ of $1.17 based on proforma or statutory net profits.

      Secondly yes they are spending on CAPEX, what what is the marginal return on renovating (i think this point is only appreciated by those that opperate in the hospitality business)

      Thirdly, yes quite agree with you in regards to business maturity, therefore this becomes an issue of creating that margin of safety whereby its essential that one doesnt over pay for a business. Intrinsic value will only rise slowly over time. But at current prices i have a huge margin of safety, if the future share price appreciates back to intrinsic value, i will offload a good portion since future intrinsic value will provide substandard returns. But the difference between share price and intrinsic value provides me with sufficient upside that the approximation of share price to intrinsic value will reap a very very attractive return.

      Forthyly, yes i agree at the IPO price of $2.50 (with a desired IPO price fo $2.9+), the private equity players got out at a good price. But we are not talking about $2.50 anymore, current market price is significantly lower. I am not interested in historics, i am very much interested in current price vs future return.

  5. Rici Rici
    :

    Spent some more time going through this company on the weekend.

    Some interesting highlights:
    CKF owns 117 KFC stores: 89 FSDT styles and 30 Food court styles. Replacement cost value is around $86million (rough figures being $800k for FSDT and $500k for foodcourt)

    CKF owns 26 sizzler outlets (+franchise rights internationally). Replacement costs of the sizzler outlets: between $26 and $52million.

    Total replacement cost of ‘shop fronts’ is between $112million and $138million.

    Section 3.7.2 – 3.7.4 of the prospectus: Proforma Income Statements:
    FY 2009 EBIT: $39.3
    FY 2010 EBIT: $36.1
    FY 2010 EBIT: $40.8

    Other interesting information:
    EBITDA For Sizzler:
    2009: $10.6, 2010: 11.9, 2011: $12.8
    Sizzler EBITDA to total group EBITDA: around 20%

    Page 30: Company Overview: SSSG FY 2002- FY 2012:
    Shows long term same store sales growth. (notice the negative period in 2010 around the time of the GFC, a nice bounce into 2011, and now an updated profit warning of below estimated sales, correlating with the tough times that Queensland is experiencing at the moment).

    The more i delve into this company the happier i feel, that the underlying company is fine. That it is relatively stable. However the price paid for it will be the major determinant of whether one receives an adequate return on their investment.

    • Peter
      :

      Rici,

      “the negative period in 2010 around the time of the GFC” ??? Did someone change the dates of the GFC and forget to tell us ?

      Not one of those figures you have quoted make this investment grade, by the way. I think any “investment” in this company will end in tears.

      Peter

  6. Parag
    :

    Here is a recent IPO ‘turkey’

    Onthehouse.com.au IPO start of this year. $1 per share would buy you the shares in a company which had a forecast of $2m profit for FY12 with the company having a market cap of $81m at the $1 IPO price – that’s a 40x forward PE!

    OTH is now at $0.37.

  7. Martin R
    :

    On 9th Sept a notice was given regarding NAB basically doubling it’s holding in Collins Foods at prices between $2.00-$2.10, more than 6.2 million shares. Three weeks later, the price fell of the cliff after the forecast downgrade.

    Is this simply another case of the company misleading investors in much the same way that MCE did with regard to it’s orders, by not disclosing, or creatively disclosing all the facts? It seems to be an issue far to often.

    So either I am wrong, or the persons responsible for authorising that purchase must be feeling a little like that less than attractive bird pictured at the top of the page. Any further price declines could make it something worth considering now that it is priced at it’s estimated worth.

  8. Shannon
    :

    There are so many other wonderful business to buy? Why bother with a company that is in the business of “animal cruelty” and unhealthy products. Sure, on surface their chicken wings are cheap but that’s because the true costs have been externalised to the society. Obesity, environmental issue related to factory farming, you name it.
    Perhaps in the future most fast food company will be grouped in the same column as tobacco company.

      • David Sinclair
        :

        No, cross breeding is not a form of genetic modification. Nice attempted recovery, Roger, but in this case you were simply wrong. Cross breeding is selective mating of individuals to promote a specific trait or set of traits. It utilises the existing gene pool of the organisms involved. Genetic modification refers to the insertion of new DNA sequences directly into the genes of an organism at the molecular level. A simple analogy would be to say that cross breeding is stirring a bag of scrabble tiles in the hope of pulling out an interesting word, while genetic modification is adding new letters to the bag.

        David S.

  10. Rici Rici
    :

    The key in my opinion is to differentiate the underlying company from the fact that it is ex-private equity.

    Yes only a donkey would have bought at the IPO price.

    But there is a price that represents intelligent buying for everything. Their KFC outlets are based in Queensland, and we know that the Queensland economy has been very hard hit in recent times.
    Unemployment has been high, the high AU$ has had a significant effect on their tourism market, residential property has been hit hard (wealth effect).

    I am sorry but i am not prepared to write off the underlying company, only the IPO price.

    I have been patiently waiting on the sidelines, and now i am striking. I am starting off with a relatively small position in the portfolio (2%) so i have plenty of wiggle room to adjust depending on BOTH future performance and share price.

    I will also be watching director transactions. With the price reduction, what will the directors be doing?

  11. Craig
    :

    Has consumer confidence become fragile, and the restaurant industry highly competitive, only in recent times?

  12. Tim S
    :

    Smells like foul play to me. Management may have over promised in the prospectus and under delivered in reality! (which I guess resembles many other IPO’s). Did they know this full well when selling into the float so they could get out before it all hit the fan and leave ‘investors’ high and dry? Based on the integral actions of management, I don’t think I would entertain investing in this company at all. Great management with its best interests toward share holders is key to an extraordinary company.

    Thanks again Roger for your insights.

  13. David
    :

    In my opinion, it will be a cold day in hell before the ACCC or ASIC ever do anything about this sort of behaviour.

    David

  14. Scott T
    :

    Another great article Roger, many thanks.

    Ever since reading your book one of my main interests has been to Calculate IV’s from prospectus’.

    For Collins Foods I got $1.31, and as of this afternoon it is now well below even your most conservative (pessimistic) valuations.

    I have however noticed a very clear trend, when a business is floated by founders, who built the business, such as Maca or Matrix for example there is often value left for investors.

    However when a business is floated by private equity operators, such as Myer, Collins Foods, Kathmandu, there is very rarely any upside for float subscribers, and often nasty surprises down the track.

    All the best

    Scott T

  15. Andrew
    :

    Here is an example of a company that would be more value.able on the kitchen table than on the farm.

    BEL (Bentley Capital) which is a funds management company.

    It paid out more than it earned in dividends so i am simply using the (ROE/RR)*EQPS to come up with a crude valuation that would be roughly in line with the value.able figure which came to $0.06 with a RR of 13%.

    However the reason i found it is i was doing a bit of a crude analysis regarding the old cigar but approach to see what came up. I used the Net Current Assets-all liabilities/shares which came up with a figure of $0.396 against a market price of $0.175.

    Perhaps there is a final puff there, it isn’t my style but i am open minded to investing and i am re-reading the snowball which makes a lot of mentions of the old buffet approach.

  16. Rici Rici
    :

    To quote the above
    “you might have used a forecast profit of $16 million”

    this includes IPO charges that are paid by the subscribers, ie the buyer not the seller (a warning sign).

    Using proforma the intial estimate was $24 odd million.
    Latest management estimate is $18-$20 million.

    I am using lower estimate of $18million in my figures.

    • Rici Rici
      :

      Using your ‘simple IV calculation’, $18million profit on equity of $161million provides a ROE of 11%, hence a rough intrinsic value estimate of $1.90 using 10% RROR. (However will need until the 2012/13 financial year to see the full ‘benefits’ of profits accrue to shareholders (because of the difference between proforma and statutory net profits because of cost of IPO).

      At the current price of around $1.20 i believe there is sufficient margin of safety to start acquiring (at a discount of 52% to the IPO price)

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