This week GC1 began accumulating shares in Australia’s largest KFC franchisee, Collins Foods Ltd (ASX:CKF). Collins operates 264 KFC and 24 Taco Bell restaurants in Australia, and a further 62 KFC restaurants in Germany and the Netherlands. CKF is also a franchisor of the Sizzler brand in South East Asia, with 66 franchised restaurants in Thailand and Japan.
A few weeks ago, one of our analysts, Max Canfield, briefly discussed some of the reasons why we like Collins Foods, which you can watch here. Whilst we were advocating CKF’s favourable characteristics, at the time, we did not have a position in CKF. However, the recent sell down has provided a favourable long-term entry point.
The sell-off was due to short-term concerns around margin compression (due to inflationary pressures, particularly in Europe) and disappointing trading results from its Taco Bell restaurants, putting a cloud over the brand's growth prospects. In this post we will outline the reasons why we like CKF as a long-term holding within GC1’s portfolio and why both those concerns are overblown/not key to our long-term thesis.
At the time of writing, CKF’s enterprise value is ~$1.1 billion (~$920m market cap plus $280m debt less $90m cash). This implies a market value of ~$3 million per restaurant and a multiple of 0.8x NTM sales and 5.2x NTM EBITDA (pre-G&A) (our estimates). These multiples are the lowest that CKF has traded at since 2016 (see table below). Further, KFC restaurants typically trade hands for around 6.5x EBITDA (pre-G&A) in the private markets.
We believe CKF is conservatively worth >$12/share, with its future value primarily driven by three key variables:
1. Number of restaurants
Over the past decade, CKF has grown its restaurant count from 122 restaurants in FY13 to 343 restaurants at the end of FY22, representing growth of ~11% per annum. This was achieved through a combination of organic rollouts and bolt-on acquisitions.
We expect growth in restaurant numbers to compound at no less than mid-single digits over the coming decade, supported by:
CKF’s Australian Development Agreement with Yum! Brands (franchisor of KFC) to build a minimum of 56 net new restaurants by 2028. (Management has indicated that they plan to build ahead of the required rate at between nine to 12 restaurants per annum). Despite there currently being over 700 KFC restaurants in Australia, we believe there still is significant room for growth when you consider CKF only owns approximately one-third of those restaurants and McDonald’s has over 1,000 restaurants.
CKF’s Corporate Franchise Agreement with Yum! to build 130 net new restaurants in the Netherlands over the next 10 years. These new restaurants will be a mix of independent franchisees and company-owned restaurants. Collins currently has a 55% market share of KFC in the Netherlands, and we expect this share to grow over time (i.e., most of these new restaurants will be owned by CKF, not sub-franchisees).
There is also further upside to growth in restaurant numbers, which we have not factored into our valuation:
Net new KFC restaurant openings in Germany. Unit economics are not as attractive in Germany as compared to the Netherlands or Australia, but penetration of KFC restaurants in Germany relative to other countries is low (see chart below). This provides a source of further reinvestment opportunities in the future, albeit earning lower returns on incremental capital.
Net new Taco Bell restaurant openings in Australia. CKF has a Development Agreement with Yum! to open more than 50 Taco Bell restaurants in Australia. This rollout has been put to a halt for the moment, due to its existing restaurants trading below expectations. However, if management can regain traction on existing store sales then this will only add further upside to CKF’s value.
Bolt-on acquisitions. Collins Foods regularly acquires KFC restaurants from smaller franchisees in addition to making large, infrequent acquisitions (e.g., 16 KFC restaurants in the Netherlands (2017) and 28 KFC restaurants in Australia (2017)). Future acquisitions are likely to be accretive to CKF’s value, based on management’s track record of past acquisitions.
2. Average Unit Volume (AUV)
Historically, Collins Foods’ Australian KFC restaurants have achieved positive same-store sales growth every year over the past decade, averaging 3.6% per annum. This has helped boost average sales per restaurant (AUV) to ~$3.7 million per annum compared to ~$2.6 million in FY2013.
We believe this provides a reasonable proxy for same-store sales to grow at a low single-digit percentage over the next decade, supported by the pricing power of its franchise brands and store volume growth.
3. Restaurant-level EBITDA margins
The final key variable is restaurant-level EBITDA margins. Referring to the chart below, these have been consistently stable over the past decade, hovering between 17% and 18% of sales. Consensus expectations are that margins will likely fall below 16% in FY23, which was part of the reason why CKF’s share price declined sharply during the week.
The drop in margins is primarily due to rising input prices (mainly poultry), labour costs and utilities prices, which have more than offset multiple price increases implemented by CKF over the past six to 12 months. However, we believe this trend will revert, eventually returning to its historical range of 17% to 18% of sales, due to the pricing power of CKF’s brands.
Further, we also expect G&A to decline as a percentage of sales over the next decade due to scale benefits, supporting future earnings growth.
In summary, we like CKF as a long-term holding within the GC1 portfolio as it:
Currently trades at a multiple below what it would sell for in the private markets (6.5x EBITDA, pre-G&A vs 5.2x today); and,
We expect earnings to compound at double-digits over the long term, supported by new restaurant builds, growth in AUV and margin expansion
As inflationary pressures abate and CKF’s restaurant-level margins recover within its historical range of between 17% to 18%, we believe the stock should re-rate and trade above private-market multiples, as the stock has historically done.