Thursday, October 11th, 2018
This week KFC restaurants operator, Collins Foods (CKF), held in the ASX Model Portfolio, hosted its annual investor day in Brisbane, which we were fortunate to attend. The surprise coinciding with the day was CKF’s just-inked agreement with Taco Bell (a Yum-Brands subsidiary) to roll out 50 new Taco Bell restaurants by 31 December 2021. This follows a successful pilot in Brisbane and is in addition to the three Taco Bell stores planned for the remainder of calendar year 2018.
Although it was known the Taco Bell trial store in Brisbane was trading above expectations for its first year, the magnitude and short time-frame of the initial roll-out perhaps caught the market by surprise. CKF shares rose almost 6% to $6.45 on the news, building on a strong rally since August which has seen shares rise 26% in total.
Our investment thesis is centred around global expansion opportunity available to CKF due to the inherent strength of KFC’s global brand, and CKF’s management proficiency which has it positioned as one of Yum Brands preferred Australian franchisees.
As a franchisee, CKF owns and operates stores and pays Yum Brands a fee in the order of 6% of sales for the right to trade under the KFC brand. CKF creates value by expanding its restaurant network, either via new builds or acquisitions, growing same-store sales, and extracting efficiencies to increase margins. On this front, we believe management has executed well, as shown in the following chart. Over the last 5 years, revenue growth has matched store growth (despite a revenue lag associated with new stores), while EBITDA and NPAT growth has been stronger on increasing margins.
Although CKF listed a short time ago in 2011, the business has been refining practices for many decades. In fact, this year marks the 50th anniversary of the company’s first KFC franchise in 1968. Building out nationally from its home in Queensland, CKF’s ongoing greenfield store roll-out and acquisition program has seen the Australian store network grow to 227 stores, representing 35% market share. We expect CKF’s share to grow due to its plans to add 8 to 9 stores per annum over the next 5 years, accounting for almost half of forecast total market growth.
More recently, management initiated on a global expansion strategy via store network acquisitions in the relatively under-penetrated markets of Germany (Nov 2016) and Netherlands (Sept 2017). CKF now operates 18 stores in Germany and 17 in the Netherlands, providing a solid platform from which to replicate the successful Australian growth strategy. The European business is set to add 6 more stores in FY19, with 8 to 10 stores per year over the next 4 years.
As shown in the chart below the combined total stores in Germany and the Netherlands of 217 is almost one-third of the 640 Australian store count, despite encompassing a population more than four times Australia’s.
TheTaco Bell menu on offer at the investor day was better than I expected. Some parts of the preparation have been tailored with the Australian consumer in mind, for example, taco shells are not fried and meat is cooked on site from start to finish. The price policy is designed to match McDonald’s while the restaurant experience somewhat replicates that of the “fast casual” Mexican operators. The price point is specifically designed to compete in “fast food” category, which is suited to drive-thru style restaurants. According to management Taco Bell will have similar restaurant economics to that of the KFC, and the roll-out will be entirely funded via internal cash flow.
On the valuation front, following a strong rally, we believe CKF is fairly priced at $6.45. Based on the stated expansion plans, CKF should be able to generate annual earnings growth over 10% over the medium-term, which is perhaps attractive against forward price-earnings multiple of 15 times. However, FY18 finished with $227m net debt on the balance sheet, which limits funding capacity in the near-term.