A local restaurant was deceptively quiet. Only a handful of customers dined in-store, but service and meal delivery were frustrating slow. The kitchen seemed to be in overdrive, pumping out one meal after another at breakneck pace.
I asked the manager about our family’s order. His response: “I’m sorry about the delay. We’ve been slammed by an unexpected rush of online orders”. Then I noticed a steady procession of MenuLog, Deliveroo and UberEATS drivers picking up food for delivery.
This anecdote is another example of technology-driven disruption in the fast food sector and a reason why quick-service restaurants have underappreciated prospects as long-term growth stocks. Australian and New Zealand fast food stocks, such as Collins Foods (CKF) and Restaurant Brands, look interesting at current prices.
Takeaway food was the fastest-growing category in the January 2017 NAB Online Retail Sales Index, up 34% over a year. Driven by online food ordering, takeaway food accounts for 6.4% of online spending in Australia and is rising rapidly.
A major shift in food consumption is firmly entrenched in developed economies. Americans now spend more at restaurants than grocery stores, says US researcher group Quartz. US spending on “food away from home”, as a share of US household food expenditure, was 43.1% in 2012, up from 18% in 1978.
Time pressures and lifestyle changes mean fewer people are cooking at home. Millennials (born between 1981 and 1997) are embracing food-ordering technology and restaurant or pre-prepared meals over cooking from scratch with raw ingredients.
An emerging trend in the US is the rise of “grocerants” – supermarket chains that sell pre-prepared, restaurant-style meals. That helps explains why David Jones is ramping up its food-hall strategy again and attempting to become a grocerant of sorts.
In developing economies, the boom in middle-class consumption is driving demand for western-style takeaway food. Witness the growth of fast food multinationals, such as Yum! Brands and McDonald’s Inc, in emerging markets.
Taken together, these trends suggest three things: consumers allocating more of their “wallet spend” to fast food and eating out each week; technology exposing the big fast food chains to a larger audience, particularly with weekday meals; and continued expansion of fast food companies in emerging markets and fragmented developing markets.
The intersection of technology and fast food partly explains Domino’s $5.4 billion valuation. As I have written before, the pizza group has a valuable technology advantage in online food-ordering and delivery technology, and latent pricing power.
Technology could also be a threat for the largest fast food chains as it opens the market to a larger base of suburban quick-service restaurants that can service a wider customer base. Also, the move towards healthier food is an enduring headwind in the sector.
But the big fast food chains have a lot more to gain than lose from food-ordering and delivery technology. Key chains, such as McDonald’s and KFC, have never cracked home delivery in a big way, but that will change as online food-delivery services and platforms such as AirTasker make it faster and cheaper to have junk food home delivered.
Stocks to watch
I outlined a positive view on Domino’s Pizza Enterprises [1] (DMP) for the Switzer Super Report in March 2017. Domino’s had fallen too far after revelations about underpayment of staff at some of its franchises. The stock has risen from $57.87 in late March to $61.50.
To avoid repetition, I have not included Domino’s in this report on fast food stocks, even though it still looks attractive for long-term investors at the current price.
The ASX-listed Retail Food Group (RFG) is another option for fast food exposure. I have mostly had a positive view on Retail Food over the years, based on its international growth prospects. But the stock can be volatile, its gourmet pizza operations face greater competition and Retail Food has several older franchise systems that need a revamp.
Restaurant Brands looks better value. The New-Zealand listed company has 215 stores: 131 KFC stores in NZ and Australia; 37 Pizza Huts, 25 Starbucks and 20 Carl’s Jr Stores (a US hamburger chain). Restaurant Brands serves around 60,000 customers in NZ each day.
Restaurant Brands’ Hawaii acquisition (it is buying Pizza Hut and Taco Bell stores there) caused it to issue FY17 NPAT guidance toward the bottom of its NZ$30-$32 million range. The company this month reported NPAT of $30.6 million. A highlight was strong store and margin growth from the KFC Australian division (which bodes well for Collins Food – see below).
Global fast food giant Yum! Brands also shows the benefits of looking offshore in the listed fast food sector. The big overseas fast food stocks offer far more choice and better value than their Australian peers.
At US$65.95, Yum! Brands, owner of KFC, Pizza Hut and Taco Bell, trades on a forward Price Earnings (PE) multiple of 21 times FY18, consensus analyst forecasts show. In contrast, Domino’s Pizza Enterprises, a much smaller company with far narrower product and geographic focus, trades on a consensus forecast PE of 35 times.
Collins Foods appeals
The owner of KFC and Sizzler outlets had a bad start to life after raising $232 million and listing on ASX through a float in August 2011. The company delivered a nasty earnings downgrade three months after listing and its $2.50 issued shares almost halved. Collins has been held up as an example of not to invest in private-equity-backed floats.
But beneath the float debacle was a solid business with good growth prospects. Collins has since rallied to $5.17, having traded above $6.70 in late 2016.
Collins has 194 KFC franchises, about two thirds of which are in Queensland. It operates 20 Sizzler restaurants in Australia, has 69 franchised Sizzler restaurants in Asia and recently acquired 12 KFC outlets in Germany, which could be the key to its long-term growth. Collins also owns the embryonic Snag Stand franchise system.
Collins delivered a better-than-expected interim FY17 result in November. Underlying earnings (NPAT) rose 17.2% to $16.8 million – an excellent result in a challenging market. Solid top-line growth in the company’s KFC chain underpinned the result.
But it was Collins’ acquisition of KFC outlets in Germany, and within months the acquisition of 16 KFC outlets in The Netherlands from Yum! Brands, that caught my eye. Collins, mostly a Queensland-based business, now has 27 KFC outlets in Europe and a platform to expand.
Collins says Germany and The Netherlands are both underpenetrated markets for KFC that have lower country risk. The Netherlands, with almost 17 million people, has 59 KFC outlets. Australia, with 24 million people, has more than 600 KFC stores.
I like Collins’ European strategy. The company is sticking to a food concept/brand it knows well, in markets that have significant scope for store rollouts. Watch Europe become a significant earnings engine for Collins in the next few years and drive its next leg of growth.
At $5.17, Collins trades on a forecast FY18 Price Earnings (PE) multiple of 13 times, based on consensus estimates. An average share-price target of $5.89, based on forecasts from seven broking firms, suggests Collins is undervalued at the current price.
Further short-term price weakness or consolation is possible as the market digests Collins’ European acquisitions and associated capital raisings. But I’m backing the company to export its KFC skills to a much larger market and, like all good small-caps, build an offshore presence so that its earnings are less reliant on a limited Australian market.
Longer term, I like the outlook for KFC sales. Granted, its fried chicken is not to everyone’s taste, but Australians continue to eat more poultry and KFC’s product innovation and value offerings are resonating with consumers, judging by same-store sales growth at Collins and Restaurant Brands’ Australian KFC operations.
The brand has huge potential in online ordering and home delivery. I noticed Airtasker promoting KFC home delivery in background research for this article. KFC offers home delivery in other countries, but has so far relied on new technology for product ordering and payment, via an app, here.
That will surely change as Australians eat more takeaway food, use technology to have it home delivered and favour cheaper fast food offerings.
As a small-cap stock, Collins suits experienced investors who are comfortable with higher risk.
Source: ASX
Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at April 27, 2017.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.