The Motley Fool

Collins Foods – Finger Lickin’ Good?

I wrote yesterday about the phenomenal success that McDonald’s (NYSE: MCD) has enjoyed throughout its history, and most recently in the last financial year, growing earnings per share by 15%.

McDonald’s arch-rival in the multinational fast-food game is Yum! Brands (NYSE: YUM), previously a unit of Pepsico (NYSE: PEP), but now standing on its own three feet.  Yes, three – Yum! is the parent of a triumvirate of fast-food giants – Pizza Hut, KFC and Taco Bell.

While McDonald’s is the clear leader in most developed nations, Yum! Brands – in particular KFC – is making massive in-roads in the developing world, particularly in China and India where the company’s products are more in keeping with local tastes, and menu variations have been tailored to national and regional preferences.

Like McDonald’s, Yum! has pursued a franchise-led strategy to help speed expansion and to harness the entrepreneurial talents of its partners to deliver great service with a local touch.

Making the global, local
The largest KFC franchisee (by number of stores) in Australia is the newly-listed Collins Foods (ASX: CKF).

Collins, which opened its first store in 1969, operates 119 KFC restaurants in Queensland (including two in Tweed Heads, NSW) as well as 26 Sizzler restaurants across Australia, and owns the Sizzler trademark in 68 other countries.

In the most recently completed financial year, the company achieved sales of $410 million, and net profit of almost $23 million, and listed on the Australian Securities Exchange (ASX) in August of 2011.

An early shock
Unfortunately for investors who stumped up the offer price of $2.50, things quickly turned ugly for the business. In the first two days of trading, the shares fell around 15 per cent, before settling around $2 by the beginning of September.

That wasn’t to be the last bad news investors received. In early November, merely 3 months after listing, Collins announced a profit downgrade, blaming fragile consumer confidence for the weakening result. Investors were clearly surprised – and not surprisingly upset – by a profit downgrade so soon after the listing.

Shares fell another 25 per cent after the announcement, settling around $1.25… a full 50% drop from the offer price. Investors, many of whom would have bought into the float for the company’s presumed defensive nature, found that half of their initial investment had evaporated in the space of three months.

Clearing the decks
Now that the business has a few months – and its first profit downgrade – behind it, the question is whether the newly discounted company is a good place to invest our hard-earned investing cash.

Many investors shun buying shares in companies listing on the share market for the first time, preferring to see a company operate for a year or so under the glare of the public markets. In this case, that aversion would have been a profitable strategy.

Noted contrarian investor Orbis has clearly put its money where its mouth is buying 11% of the company in December – the question for the rest of us is whether we should follow Orbis’ lead, or give Collins a wide berth.

Collins has a lot going for it. Despite initial pricing (and profit expectations) being shown to be too high, this is a business operating at the cheaper end of the ‘out of home’ consumption market. Its largest operating business – KFC – is a well known brand with a loyal following and a franchisor prepared to spend money on marketing and product development.

An achievable forecast?
One of the problems with a newly listed business – let alone one that has already missed its maiden earnings forecast – is how much stock to place in its forecasts. The company has forecast (lowered) earnings of between $18 – $20 million for the current financial year, which places the business on a price earnings ratio of between 6.5 and 7 times – undemanding in anyone’s language.

The debt load of around $100 million should be manageable, and the company originally planned to pay a dividend of 11.8 cents per share (fully franked) according to the prospectus. It’s anyone’s guess what (if any) final dividend will be paid, but if the Board was to declare a dividend around half of what was previously expected (which is likely to be a pessimistic expectation), the company would be trading on a prospective dividend yield of 4.3%.

Foolish take-away (no pun intended!)
Whether or not the shares represent good value is wholly dependent on the ability of management to deliver on their newly lowered forecasts – and deliver subsequent growth. If the profit downgrade truly is a one-off that sets a new base, today’s price represents an attractive opportunity. If management disappoints again, the shares may have further to fall.

Like Fox Mulder in the X-Files, I find myself wanting to believe. On balance, Collins may be worth a small proportion of a risk-tolerant investor’s portfolio, but I couldn’t blame you for giving this Queensland fried chicken king a wide berth.

Are you looking for quality stock ideas? Click here to request a new free report titled The Motley Fool’s Top Stock For 2012.

Scott Phillips is The Motley Fool’s feature columnist. Scott owns shares in McDonalds, and you can follow him on Twitter @TMFGilla. The Motley Fool’s purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

5 stocks under $5

We hear it over and over from investors, "I wish I had bought Altium or Afterpay when they were first recommended by The Motley Fool. I'd be sitting on a gold mine!" And it's true.

And while Altium and Afterpay have had a good run, we think these 5 other stocks are screaming buys. And you can buy them now for less than $5 a share!

*Extreme Opportunities returns as of June 5th 2020

Related Articles...

Latest posts by Scott Phillips (TMFGilla) (see all)