CKF Deep Dive

I’ve spentthe last couple of weeks working my way through the Collins Foods FY25 annualreport, conference call and shareholder presentations.

I’ve been a shareholderin this company since the middle of 2017 (just prior to the capital raisingwhich allowed them to purchase a larger portfolio of Australian stores andlaunch the Netherlands operation). I’ve added to my position each time there’sbeen share price weakness and my average purchase price currently sits at$7.08.

As is oftenthe case when a stock falls out of favour I think that CKF has suffered from afew things that were mostly in it’s control and own goals (Taco Bell floppingand the Netherlands business declining) at the same time as a few externalthings hit it (Drew O Malley resigning due to a personal tragedy and high inflationin their ingredients and labour costs) which smashed the SP.

If we feelconfident on their guidance for FY26 then we’re currently trading at around 19times underlying earnings from continuing operations and if we assume a 15%dividend increase we’re at a fully franked forward yield of 3.4% with the bigasterisk over the dividend being the future cap ex involved in their Germanyexpansion. They did say on the earnings call that the majority of thoseexpenses will be in FY27 and if you look at the current store foot print it isn’toverly significant (16 stores vs 62 in the Netherlands) so we’re probably notlooking at a huge initial cost.

These guyscertainly have their issues but I’ve felt for a couple of years that they’vebeen dragged down alongside DMP despite being a far more conservatively run businessand being largely a franchisee rather than a franchisor and I think this overlygloomy attitude was partially reflected in the big share price jump post thislast set of results which resulted in a speeding ticket from the ASX (as an asidereading that announcement only cemented to me that public companies face somepretty bizarre challenges….. With all the moving parts involved in a business likethis operating across multiple countries it’s pretty insane for them to have tojustify how they outperformed analyst models by a few percentage points hereand there).

Listeninginto a few of those analyst calls really does cement my view that there’s stillsome opportunity for active investors out there willing to take a longer termview and trying to think more like a business owner…. Almost every question isjust about making adjustments to their models so they can get closer toearnings forecasts in the next half.

My key observationshave been as follows

ThePositives

For me Ithink the operating cash flow actually growing (181 million before accountingfor capex) was a major positive along with the outstanding debt being reducedto 138 million. CKF always has such messy financials with non-cash impairmentsetc. that the underlying performance of the business often gets lost in the jumble(as another aside I would really like to understand the methodology forinvestment impairments better. The CFO mentioned on the conference call thatthey can never write up a good performing restaurant only write down a poorlyperforming one).

The Germanopportunity does sound exciting and very much underpenetrated (they willinitially focus on just two states where they have a period of exclusivity).Amazingly there are just 200 KFCs in Germany currently with 1400 McDonaldsoutlets all though this does make me question whether there’s something in thatmarket that’s holding them back aside from the stated reason which is that the previousmaster franchisee was running it poorly? The store level EBITDA margins thereare actually slightly better than our Aussie stores which certainly a big changefrom The Netherlands which I’ll discuss further under the negatives section.

I alsothought the new KFC CEO (Krystal) spoke extremely well on the call and wasthrilled to learn that she’s been with Collins Foods for 24 years. It’s hard toget a better endorsement of the company than that. It’s also interesting thatshe’s been moved across from managing the Taco Bell expansion which has clearlygone horribly wrong.

Managementseemed really bullish on productivity improvements at the store level being akey driver for profitability improvements rather than same store sales growth whichsurprised me. I would have thought that the KFC operating model in Australia isso clearly defined after all these years that it would be hard to find ways torun them more efficiently but judging by their comments a lot of it has to dowith software that will allow them to better manage the amount of team members instore at peak periods and reduce them at times of lower demand.

TheNegatives

I’ve comeaway from this attempted deep dive feeling pretty grim about the Netherlandssituation in general and thinking we might be 12 to 18 months away from anotherTaco Bell situation where they give up completely on that market. They’ve (sensibly)renegotiated their expansion deal with Yum to slow the pace of new storeopenings and focus on the profitability of existing stores but it’s stunning tome just how much less profitable they are at the EBITDA margin level vsAustralia (12.6% in FY25 vs 19.3% in Australia). There was also some talk inthe last presentation about “unique challenges” in the Netherlands market particularlyaround the regulatory environment.

I would reallylike to see management get more thoroughly questioned on how well thought outthe Netherlands expansion was and what the path is to it becoming more profitable.

In the listedlife of CKF we’ve now had Sizzler Australia, Snag Stand and Taco Bell all fail alongwith some serious struggles at KFC Netherlands. Has there been a lot ofpursuing growth for the sake of growth and not enough consideration given toprofitability? Maybe dividends and share buy backs would have been a better useof capital.

I also feelthat the Taco Bell failure needs to be more deeply explained rather than justblaming external factors like the cost of living as that just never seemed tobe able to get off the ground and going off reviews (I’ve never actually eatenat one myself) it seems like the food quality just wasn’t there from the startand Taco Bell never had a clear position in the market. These are the kind ofquestions that I would like to hear far more of on analyst calls!

I’m also alittle concerned with the lack of QSR experience that our new CEO has. Drew OMalley had basically spent his whole career in this specific industry where theclosest equivalent for Xavier has been a period running Kathmandu. I clearlyhope he totally proves me wrong.

OngoingThoughts On My Investment

I’ve builtmy investment up to around 12% of the portfolio due to the share price weaknessin the past 18 months. I’m happy to stay around this level and overall I’m satisfiedwith the role that CKF plays in my portfolio.

A key lessonfor me in the past couple of years with this stock has been that fast food ismore economically sensitive than I thought it was and I also would like tobetter understand lease liabilities in a business like this along with their processfor impairments.