Is Collins Foods Ltd a delicious decision for income and growth?

What does it take to deliver earnings and dividend growth over the long term? Ask shareholders of Domino’s Pizza Enterprises Ltd. (ASX: DMP) or Retail Food Group Limited (ASX: RFG) and they’ll probably tell you it’s a mixture of a delicious product offering and operational excellence leavened with a healthy dose of acquisitions.

That’s what Collins Foods Ltd (ASX: CKF) offers, yet it appears significantly cheaper than either of its larger cousins. Here’s a brief overview of the company, as of its most recent annual report:

  • 171 KFC franchises, 22 Sizzler restaurants, and five Snag Stand stores throughout Australia, plus 65 Sizzler stores in Thailand, China, and Japan
  • Predominately franchises, with some corporate stores
  • Medium levels of debt, with possible increases in the near term to fund opportunities that might arise
  • Dividend of 3.1%, underpinned by strong free cash flows and the dividend represents just over one third of net profit – well below payout levels at some other companies

Growth comes from store expansion, as well as same-store sales growth (at KFC) and through increased royalty revenues from the south-east Asian Sizzler restaurants. Sizzler Australia revenues look to be in terminal decline, and sales have been plummeting – fortunately they’re becoming increasingly less relevant to the company as a whole.

For better or worse, Collins is a KFC story with the vast majority of revenues (87%) and earnings coming from this segment. While this industry is highly competitive and margins are tight, it also appears to be somewhat defensive in demand. Investors might worry that consumer health concerns will lead to a drop-off in popularity, and indeed this could happen, but KFC’s same-store sales growth of 3.8% last year suggests it’s not on the cards yet. There are many factors involved in consumer decisions to purchase takeaway food (price, convenience, taste, etc), not just health-related ones.

Why is it cheaper than Domino’s and Retail Food?

Probably because investors aren’t expecting strong growth from Collins Foods going forward. As a franchisee of Yum! Brands (which owns KFC), a key risk for Collins is its business relationship with Yum!, while Domino’s and Retail Food own their own brands. Concerns about the future of the Sizzler restaurants are likely hurting market sentiment, while Collins’ Net Tangible Assets are also a negative $0.63 per share (i.e., its liabilities are greater than its assets).

Yet Collins appears to be conservatively run, with a focus on the long term (a necessity given its liabilities) and at a price to earnings (P/E) ratio of 14 times it is cheaper than the ASX average. If management can continue to grow same-store sales whilst incrementally increasing store numbers, Collins could prove a nice little earner for patient shareholders.

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Motley Fool contributor Sean O'Neill owns shares of Retail Food Group Limited. The Motley Fool Australia owns shares of Retail Food Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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