Collins Foods: 1H23 earnings - Margin recovery pushed back

Author name:: By Alexander Mees
Job title:: Co-Head of Research and Senior Analyst
Date posted:: 30 November 2022, 8:00 AM
Sectors Covered:: Gaming and Retail

The dynamics of Collins Foods' (ASX:CKF) 1H23 result was actually much as we had anticipated. Sales were resilient, at least in the KFC business units, as menu price increases took effect. Operating margins took a big hit as input cost and wage inflation put the squeeze on profitability. This was no surprise, though. Post-AASB 16 EBITDA margins were 15.5%, 40 bps above our estimate (but 100 bps below consensus).
What surprised, and caused the negative share price reaction today, was the indication that margins are unlikely to bounce back in 2H23 as previously guided. CKF reduced its margin guidance ranges for both KFC Australia and Europe, leading us to lower our post-AASB 16 EBITDA forecast for FY23 by 6.4%, flowing through to 16.1% lower NPAT.
There are signs that some commodity prices may have peaked, but inflation in the major inputs (notably poultry) appear to account for the reduction to guidance. In addition, CKF’s Mexican adventure appears to be stalling, with sales and margins at Taco Bell under pressure in 1H23 and the rollout of new stores put on ice.
The cost environment is clearly volatile (and less predictable than we’d thought) at present, but value remains in an investment in CKF, especially after today’s share price movement. We retain an ADD with a reduced target price of (login to view).

Event

1H23 earnings.

Analysis

Sales resilient, margins were not (but this was expected). CKF delivered robust sales in its KFC businesses in Australia and Europe in 1H23, but experienced significant margin pressure, which saw underlying EBITDA come in broadly flat on the PCP.

Same store sales (SSS) growth was +5.1% in KFC Australia and +10.4% in KFC Europe. EBITDA was in line with our expectations (in fact, it was slightly better), but we note that our estimates were below consensus.

CKF has reduced its margin guidance for the full year. CKF has booked an impairment to the carrying value of Taco Bell stores and has also paused development of new stores. There was a 12.0c interim dividend, in line with the PCP.

A 2H23 margin recovery is no longer on the cards. Margin guidance has been reduced for FY23. CKF now expects KFC Australia to be in the range 15-16% (pre-AASB 16) compared with previous guidance of 16-17%.

We expect 2H23 margins to be the same as 1H23 and forecast an FY23 margin of 15.8%, down from 16.5%. KFC Europe is now guided to a 2-3 ppt reduction, compared with previous guidance for a 1-2 ppt decline.

We forecast a 2.5 ppt decline (pre-AASB 16) from 1.2 ppt before. Continued margin pressure is also expected at Taco Bell.

Taco Bell is at a fork in the road. 1H23 SSS declined by (7.8%). In our opinion, the brand is not getting as much traction as expected with consumers. CKF has a new marketing agency and Taco Bell International-employed CMO and will be looking to turn the brand around in 2H23.

Initiatives include expansion of the partnership with Uber Eats, enhanced value-oriented pricing and marketing, upgraded food quality and increased investment from Yum! Brands. CKF says that new Taco Bell builds have been paused so that focus can be put into improving sales efficiency and profitability.

Forecast and valuation update

Our revenue remains broadly in-line as previously forecasted however we have reduced our post-AASB 16 EBITDA estimates by both (6.4%) and (7.2%) in FY23 and FY24 due to lower margin guidance. We have decreased our post-AASB 16 EBITDA margin forecasts by 100 bp in both years.

This flows down to a (16.1%) decrease in our NPAT estimates in both years to $48.6m and $54.5m respectively.

Our 12-month target price declines from (login to view) due to the changes in our earnings estimates and use of a higher risk free rate in our DCF valuation.

Investment view

We maintain an ADD rating.

We believe the forward multiples are sufficiently low to warrant a consideration of the medium-term recovery in margins.

Risks

Key risks include constraints to consumer spending, especially in Europe, and possible failure to achieve the revised EBITDA margin guidance.

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