Company Reports

We lower our fair value estimate for no-moat Collins Foods by 6% to AUD 13.50 on a weak trading update. In the first 16 weeks of fiscal 2025, same-store sales in the core KFC Australia segment are essentially flat on the previous corresponding period, or PCP. Top-line growth of 3% for the segment was supported by the rollout of new stores.

We think the success of the Australian KFC network will prove crucial for Collins Foods. Despite KFC expansion into Europe and the nascent roll out of Taco Bell stores in Australia, we expect Collins' Australian KFC network will continue to drive the vast majority of operating earnings over the next decade. Collins is the largest KFC franchisee in Australia with over 280 restaurants out of a total of around 800 stores in the country. Its long-term earnings growth is mainly dependent on increasing sales, by increasing same store sales and adding to its store network. Collins grows its network through both new builds and acquisitions of existing restaurants from other franchisees. Similar drivers underpin growth of the smaller European business, although we forecast new builds to play a more important role.

The upcoming August 2024 reporting season will draw the line under a difficult year for Australian retailers in which they navigated soft demand and soaring labor costs. The combination results in a profit margin crunch and declining earnings for many retailers.

There are encouraging signs in no-moat Collins Foods’ fiscal-year 2024 result, but the KFC and Taco Bell franchisee is under cyclical pressure. The EBITDA margin for the core KFC Australia business, accounting for roughly 80% of operating earnings, lifted 60 basis points on fiscal 2023 to 15.6%. This was ahead of our forecast for flat margins, suggesting Collins is passing on some prior cost inflation through price rises. But group sales disappointed, rising 10% against our 13% forecast. The net effect was a 15% improvement in underlying EPS, to AUD 0.51, missing our AUD 0.55 estimate.

We think the success of the Australian KFC network will prove crucial for Collins Foods. Despite KFC expansion into Europe and the nascent roll out of Taco Bell stores in Australia, we expect Collins' Australian KFC network will continue to drive the vast majority of operating earnings over the next decade. Collins is the largest KFC franchisee in Australia with over 270 restaurants out of a total of around 730 stores in the country. Its long-term earnings growth is mainly dependent on increasing sales, by increasing same store sales and adding to its store network. Collins grows its network through both new builds and acquisitions of existing restaurants from other franchisees. Similar drivers underpin growth of the smaller European business, although we forecast new builds to play a more important role.

We initiate coverage on Guzman y Gomez, a Mexican-inspired quick-service restaurant operator and franchisor. Following a tremendous sales growth spurt, the QSR is ranked sixth in terms of market share in Australia. However, it is still relatively small in a highly fragmented industry. Major QSR brands like Guzman are consolidating the market, and we forecast that its store network will triple over the next decade.

We think the success of its Australian KFC network will prove crucial for Collins Foods. Despite KFC expansion into Europe and the nascent roll out of Taco Bell stores in Australia, we expect Collins' Australian KFC network will continue to drive the vast majority of operating earnings over the next decade. Collins is the largest KFC franchisee in Australia with over 270 restaurants out of a total of around 730 stores in the country. Its long-term earnings growth is mainly dependent on increasing sales, by increasing same store sales and adding to its store network. Collins grows its network through both new builds and acquisitions of existing restaurants from other franchisees. Similar drivers underpin growth of the smaller European business, although we forecast new builds to play a more important role.

Discretionary retail stocks had a strong finish to 2023 as the market ran ahead with visions of a consumer rebound on rate and tax cuts. But that narrative has been undermined by sticky inflation. Caught up in the pessimism weighing on consumer cyclicals, shares in no-moat Collins Foods have fallen 20% year-to-date. But we think the sell off is unwarranted. Collins looks significantly undervalued when set against our unchanged fair value estimate of AUD 14.40.

Talk of interest rate cuts and impending tax cuts is sparking a rally in consumer cyclicals. We agree these factors improve the near-term outlook for consumer spending, with cyclical retailers more exposed. We expect the combined impact of fiscal and monetary tailwinds to underpin mid-single-digit growth in total retailing sales in the medium term—compared with our estimate of only 2% growth in fiscal 2024. But underlying our near-term forecast is a significant divergence across categories, with sales in cyclicals virtually flat and defensives up 4%.

E-commerce platforms have been outperforming physical stores recently. Transaction data from National Australia Bank suggests online retail sales in October lifted 10% on last year, while total retail trade was up only 1%, as reported by the Australian Bureau of Statistics.

We think the success of its Australian KFC network will prove crucial for Collins Foods. Despite KFC expansion into Europe and the nascent roll out of Taco Bell stores in Australia, we expect Collins' Australian KFC network will continue to drive the vast majority of operating earnings over the next decade. Collins is the largest KFC franchisee in Australia with over 270 restaurants out of a total of around 730 stores in the country. Its long-term earnings growth is mainly dependent on increasing sales, by increasing same store sales and adding to its store network. Collins grows its network through both new builds and acquisitions of existing restaurants from other franchisees. Similar drivers underpin growth of the smaller European business, although we forecast new builds to play a more important role.

We raise our fair value estimate for shares in no-moat Collins Foods by 3% to AUD 14.40, with shares screening as significantly undervalued. Our upgrade is due to the time value of money and a marginally better sales outlook. The Australian store rollout is tracking ahead of expectations, and we now anticipate 12 stores will open in fiscal 2024, up from 10.

We expect only modest discretionary goods sales growth in fiscal 2024, while interest rates stay high and household incomes struggle to keep up with inflation. With demand soft, discounts and promotions abound in discretionary retail, and with wages rising as well, earnings are under pressure. But for some, cost pressures are easing. Steep declines in global food commodity prices bode well for fast-food restaurants. Quick service restaurant operator no-moat Collins Foods and master franchisee narrow-moat Domino’s Pizza screen as undervalued.

We initiate coverage of Collins Foods with a fair value estimate of AUD 14 per share and a no-moat rating. Collins Foods is Australia’s largest KFC franchisee. Despite ambitious development plans in the Netherlands, we expect its Australian KFC restaurant network to remain the key earnings contributor at over 80% of operational profits long-term. The rollout of Taco Bell stores has stalled and we expect Collins to ultimately exit the ailing business. On the back of rampant input cost inflation and wage increases, gross margins materially declined in fiscal 2023. However, we anticipate the wider quick-service restaurant industry, including KFC, to increase menu prices over the medium term to restore restaurant-level profit margins. E-commerce, including delivery, has been outperforming in-store sales. While delivery sales are lower-margin than in-store sales, they are profitable and we expect them to be largely incremental to carry-out, dine-in, and drive-thru. Collins lacks maintainable competitive advantages to support an economic moat. Although the global KFC brand is relevant, distinctive, and segment-leading, brand equity remains with its franchisor, Yum Brands.

We think the success of its Australian KFC network will prove crucial for Collins Foods. Despite KFC expansion into Europe and the nascent roll out of Taco Bell stores in Australia, we expect its Australian KFC network will continue to drive the vast majority of operating earnings over the next decade. Collins is the largest KFC franchisee in Australia with over 270 restaurants out of a total of around 730 stores in the country. Its long-term earnings growth is mainly dependent on increasing sales, by increasing same store sales and adding to its store network. Collins grows its network through both new builds and acquisitions of existing restaurants from other franchisees. Similar drivers underpin growth of the smaller European business, although we forecast new builds to play a more important role.