When it comes to trend forecasting, there is no safer bet than Australia’s love affair with fast food. Stocks such as Domino’s Pizza Enterprises, Retail Food Group and, more recently, Collins Foods, have zoomed in the past year and may have further to run in the next 12 months.
Their defensive qualities appeal in an uncertain market. Weak consumer confidence hurts all retailers, but should have relatively less effect on fast-food providers as more people cut back on discretionary spending and maintain their low-cost “treats” and affordable luxuries.
Fast food is huge business. The Australian fast-food services industry was worth $12.6 billion in 2012-13, according to business forecaster IBISWorld. It predicts the industry will grow at 2.5 per cent annually over the next five years, from 2.1 per cent annually during the past five years.
Healthier menus, more upmarket offerings (at fast-food prices), the internet and mobile-based ordering systems are transforming fast-food operators. Domino’s is the best example: its clever use of mobile pizza-ordering technology has strengthened its competitive advantage and reduced costs.
It has been a tricky stock for fund managers in the past few years. Most recognise it is an exceptional company, despite a lingering market view that its stock was overvalued.
Domino’s was hard hit during the sharemarket correction in May and June. It fell from a 52-week high, or $13.74 to $11 as fund managers were quick to profit from stocks that seemingly had been “priced for perfection”. Domino’s was an obvious candidate to sell after soaring last year.
At $11, it trades on a forecast 2013-14 Price Earnings (PE) multiple of 22.4 times, according to consensus analyst estimates compiled by Morningstar. That high PE still unnerves some fund managers who do not want to pay big valuation premiums for small-cap stocks in this market.
But recommendations on Domino’s are surprisingly mixed. Of the six analysts who contributed forecasts, two had a strong buy on Domino’s, one had a hold, and three had a moderate or strong sell. Morningstar, for example, has a reduce recommendation on Domino’s and a $9 valuation early this year. Lincoln (not included in consensus estimates) has an $8.24 valuation and rates Domino’s a “star stock”.
While Domino’s attracts most attention, smaller fast-food rivals Retail Food Group and Collins Food have rallied in recent months. Retail Food Group has soared from a 52-week low of $2.52 to $4.50, despite no significant news (other than buying two Queensland properties for $4.3 million).
The fast-growing franchisor owns the Donut King, Brumby’s Bakery, Michel’s Patisserie, bb’s café, Esquires, The Coffee Guy, Pizza Capers Gourmet Kitchen and Crust Gourmet Pizza franchise systems. It also has a large coffee-roasting business.
Retail Food Group posted an excellent first-half result for FY13: core net profit after tax rose 10.5 per cent to $16.5 million, exceeding guidance of 7.5 per cent growth. In a market rife with downgrades, it has been rare for small-cap companies to beat their profit guidance, let alone smash it.
More importantly, Retail Food Group’s gearing ratio fell to 27.4 per cent in the half, its lowest since 2006. High debt has been a turn-off for Retail Food, but as it expands, it should be able to fund more growth out of surplus cash flow and repay debt.
It has an interesting mix of franchise systems. The Crust acquisition and Pizza Caper brand make it the market leader in the fast-growing gourmet segment, which is attracting more health-conscious pizza lovers. Brumby’s Bakery has plenty of growth potential, Donut King continues to chug along, and Michel’s Patisserie is being strengthened. The company’s “Project Evo”, designed to modernise and upgrade the franchise system, should support stronger medium-term growth.
This year’s big fast-food surprise has been Collins Foods, the operator of 117 Kentucky Fried Chicken restaurants in Queensland and 26 Sizzler restaurants.
Collins Food was quickly written off after raising just over $200 million in a 2011 float at $2.50 a share. Within three months of listing, it issued a surprise profit downgrade, and by June 2012 it traded at about $1.10. It was yet another reason to avoid private equity-vended floats.
Collins has since recovered to $1.83 a share – still a long way off the $2.50 issue price, but a big lift on a year ago.
Its full-year result for FY13, reported in late June, was an improvement. The KFC stores had same-store sales growth of 4.2 per cent, compared with negative 1.8 per cent in FY12. Statutory net profit rose from $11.4 million to $16.4 million – all in all, an okay result given the subdued retail climate.
Efficiency improvements and store openings should support continued solid growth for KFC, while the underperforming Sizzler chain is expected to improve amid a renewed focus on better pricing and value, and improved store layouts, which could take time to flow through to profits.
Of the three stocks mentioned, Domino’s is easily the highest-quality listed fast-food provider, and a stock to watch on any sustained price weakness. Retail Food Group has impressed and Collins, a higher-risk stock, has some claim as a turnaround idea, after a terrible start as a listed company.
If these companies can deliver profit growth in a subdued retail climate, they might surprise the market when interest rates are cut once or twice again 2013, and consumers finally start to release the spending handbrake next year – and drive straight for the nearest fast-food outlet.
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Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at Feb 14, 2013. The author implies no stock recommendations from the above commentary. Readers should do further research or talk to their financial adviser before acting on themes in this article.