Hot Stock - Collins Foods (CKF)

Monday 25th July 2016

Investor doubts remain despite the palatable FY16 results.

What’s new?

As highlighted by the jump in Collins Foods’ share price following the announced acquisition of 13 KFC restaurants across New South Wales and Victoria, the market has been encouraged by the news. Unfortunately for investors, all of the acquisition-related gains in Collins Foods’ share price were quickly erased as concerns regarding a possible Brexit from the European Union were compounded by the release of the FY16 results.

We view the recent acquisition of 13 KFC stores across New South Wales and Queensland as a positive development for the company’s shareholders. In fact, given the recent positive performance of Collins Foods’ KFC business (the key laggard for the Group has been Sizzler), we see little downside risk to the acquisition. This is particularly given the fact that management has established a positive track record of acquiring and integrating KFC sites.

In terms of the acquisition multiple, Collins Foods has agreed to pay the vendors $25.46 million (this is subject to adjustments for inventory and employee liabilities at the time of purchase), which based on trailing EBITDA equates to 5.93 times. As evidenced by management’s expectations that the deal will be immediately earnings per share accretive on a pre-synergies basis despite $10 million of the purchase price being funded through new shares, the purchase price looks reasonable.

Looking now at Collins Foods’ FY16 results, which were released to the market in late June, we note that the company’s headline result was strong. Of particular note was Collins Foods’ ability to convert negligible revenue growth into a 10.7 percent increase in EBITDA and 22.3 percent increase in net profit, with the key drivers of the differential between operating and net earnings being lower depreciation and amortisation and net debt.

While the negligible growth in Collins Foods’ FY16 revenue appears to be the weak link in an otherwise solid result, we note that the company’s underlying performance is more palatable than the headline number suggests. For instance, we note that revenue from Collins Foods’ KFC segment actually increased, with same store sales (i.e. like for like) growth of 3.1 percent and reported sales growth of 3.8 percent.

The key drag on Collins Foods revenues in FY16 was the Sizzler business, which has recently been classified by the company as noncore. That said, what is also clear from Collins Foods’ FY16 results is that management’s efforts to stabilise the Sizzler business appear to be working, with the segment’s adjusted EBITDA having increased despite the lower revenue base and store number. While this explains some of the improvement in the FY16 profit margin, the KFC business also reported gains.

Outlook

Management has stated that “with further growth anticipated in the 2017 financial year, we expect continued increased shareholder returns as we deliver on our growth plans”. As per our previous reports on Collins Foods, these growth plans comprise restaurant refurbishments and integrations across the KFC business, and ongoing investment in the company’s Snag Stand and Sizzler Asia businesses.

Price

From a fundamental perspective, Collins Foods is trading at 11.7 times the earnings estimate for FY17 and a prospective dividend yield of 4.2 percent. Encouragingly for shareholders, Collins Foods’ per share metrics are currently being complemented by the technical set up, with the longer term outlook remains firm as company’s share price has managed to respect dynamic support at the $4.15 region being the 50-week moving average.

Worth buying?

As evidenced by Collins Foods’ share price performance over the last three months, investors remain undecided about the company’s future growth prospects. This is despite the fact that Collins Foods has continued to deliver on its growth strategy, with the solid FY16 results having been underpinned by the inherent resilience of the company’s KFC business and ongoing investment in management’s various growth and restructuring initiatives.

James Lennon is a senior analyst at investment research and funds management house Fat Prophets. To receive a recent Fat Prophets Report, CLICK HERE

Disclosure: Collins Foods is held within the Fat Prophets Concentrated Australian Share, Income and Small/Mid-Cap models.

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