Collins Foods: Initiating on QSR Operator With Medium-Term Profit Margin Recovery on the Cards

We initiate coverage of Collins Foods CKF 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.

Collins’ capital allocation is Standard. The balance sheet is sound and distributions to shareholder are appropriate, but Collins’ investment efficacy is diminished by a recent tendency to overpay for acquisitions. The decision to reintroduce Taco Bell into Australia has led to value destruction to date, albeit to a limited extent. Our Morningstar Uncertainty Rating of High reflects Collins’ leverage to the economic cycle. When disposable income is squeezed, consumers can always choose cheaper options, including eating at home.

At current prices, shares screen as undervalued. We think the market is overly cautious on the outlook on both gross profit margins and sales growth consumer tightening their belts.