Collins Foods: A feast for investors 1H22 earnings

About the author:

Alexander Mees
Author name:
By Alexander Mees
Job title:
Co-Head of Research and Senior Analyst
Date posted:
02 December 2021, 9:00 AM
Sectors Covered:
Gaming and Retail

  • Collins Foods' (ASX:CKF) 1H22 EBITDA was 12% higher than forecast at $94.9m, with better margins in KFC Australia and, notably, KFC Europe driving the out performance.
  • Although SSS growth was zero at KFC Australia (against a +12% comp) and slightly lower than our +1% forecast, KFC Europe more than made up for it with +15% SSS growth, exceeding our +9% estimate comfortably.
  • We have increased our EBITDA estimates for both FY22 and FY23 by 5% and NPAT by 13% in each year. This is a result of higher EBITDA margin assumptions in both KFC businesses. Our sales estimates are largely unchanged.
  • Investors must be aware of the risk to earnings of a possible return to lockdowns in key markets such as the Netherlands.
  • We retain a HOLD rating, but with an increased target price of (login to view).

European recovery has been faster than we expected

The key positive surprise in the 1H22 result was the strength of the recovery in European margins. With SSS growth moving into strongly positive territory, a flow-through to profitability was expected, but not on the scale that CKF achieved.

On a post AASB-16 basis, KFC Europe’s EBITDA margin was 14.7% in 1H22, up 620 bp on 8.5% in 1H21 and 520 bp above our (in hindsight, far too timid) 9.5%.

SSS growth also outperformed expectations at KFC Europe: +14.6% was 560 bps better than our forecast of +9.0%. Combined with the margin expansion, KFC Europe’s EBITDA of $12.5m was 83% above our forecast of $6.8m and the biggest source of upside surprise in the result.

We think the investor needs to be careful not to get too carried away with all this. True, CKF believes it can get margins in KFC Netherlands to the level of KFC Australia (the low-20s). But the near-term outlook must inevitably be tempered by the potential risk of a return to COVID restrictions in Europe as we move through the winter months.

On top of that, inflation cannot be ignored, especially as CKF does not have chicken prices locked in in Europe as it has in Australia. Nonetheless, CKF is clearly in a better place in terms of its European profitability and we have taken that into account in increasing our FY22 EBITDA estimate for KFC Europe by 36% and for the group by 5%.

KFC Australia held margins despite flat SSS growth

We estimate that, as a rule of thumb, SSS growth needs to run at around 2-3% for margins to be held flat at KFC Australia (all things being equal).

The fact that CKF managed to limit margin decline to just 20 bp despite SSS growth falling away to +0.1% means the business has controlled costs well and achieved efficiencies to offset inflationary pressures. Those pressures are there, notably in canola oil, flour, labour and packaging, but chicken prices are locked in until the end of next year.

We believe it is not unreasonable to expect a bit more margin contraction in 2H22. We expect SSS growth to remain below the 2-3% ‘sustainable’ run-rate, which is likely to compound the effects of the inflationary pressures discussed above.

Whether or not KFC Australia takes a little price itself in 2H22 will determine where margins ultimately land, but at this stage there is limited change to our FY22 estimates for KFC Australia.

CKF is prepared to be patient with Taco Bell

By its own admission, (11.2)% SSS growth at Taco Bell in 1H22 was disappointing, but the brand is at its early stages of development in Australia and such bumps in the road are not unexpected.

We think it is likely SSS growth will continue to be volatile until the business reaches ‘scale’ - perhaps around 60 stores from the current 18 - which will probably take 3-4 years.

Taco Bell is huge in the US (it’s much bigger than KFC there) and it’s hard not to agree with CKF that the potential in the Australian market is also considerable, as Australians are increasingly acquiring the taste for Mexican flavours.

We think CKF is right to persevere, provided it can continue to avoid incurring material EBITDA losses.

Risks

A return to lockdowns in Europe would impact SSS growth and margins.

CKF may be prepared to tolerate more losses in Taco Bell than the market would.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.


Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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