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How strange that Australia has so few listed fast-food stocks, given the nation’s love affair with takeaways and franchised food chains. Markets such as the United States are full of listed quick-service restaurants but Australia has only a handful.

Some key US fast-food stocks have shot up in the past year. Sector bellwether, McDonald’s Inc, has rallied from US$90 at the start of 2015 to US$127, aided by signs of a more sustainable earnings turnaround and growth in emerging markets.

Coffee behemoth Starbucks Corporation has also rallied since the start of last year, and Yum! Brands, operators of KFC, Taco Bell and Pizza Hut also rallied before giving up some gains. Consumers’ increasing preference for healthier food options, if true, is not hurting the global fast-food giants, particularly in Asia and other developing markets.

Back home, Domino’s Pizza Enterprises continues to defy the sceptics who say its valuation has been too high for too long. The $5.2-billion company is clearly priced for perfection, trading on a breathtaking forecast price-earnings (PE) multiple of almost 60 times. It’s remarkable that Domino’s is more than twice the size of JB Hi-Fi by market capitalisation and rapidly catching up to the $6.2-billion Coca-Cola Amatil.

The market has underestimated the growth prospects of Domino’s for years. I rate it one of the market’s best-run companies. Few billion-dollar companies have a CEO who knows their product and customer-base needs as well as Don Meij, or drives as much innovation. 

Meij has successfully led Domino’s into Europe and more recently Japan, and overseen the development of a valuable competitive advantage in technology-based food ordering. I have written for years that Domino’s was becoming more like a technology company than traditional fast-food outlet, hence its technology-like market valuation.

I note Domino’s has recently dropped ‘Pizzas’ from its brand and marketing. There’s more to that than brand simplification. Domino’s has potential to disrupt other parts of the fast-food sector through its cutting-edge ordering, food production and delivery technology by selling a wider range of fast-food. 

It is a classic example of the benefits of investing in companies with strong, sustainable competive advantages. Other pizza operators cannot match its prices or deliver goods as efficiently and quickly because they do not have the same scale. This advantage gives Domino’s significant pricing power, which it unloaded on the pizza sector when its dropped the price for its basic pizza to $5 – almost unthinkable in the industry.

I am not a regular consumer of Domino’s or pizzas generally, but an impromptu family gathering meant a quick dash to the nearest Domino’s outlet. Six standard pizzas and a few sides came in under $50 and it took less than 10 minutes. The pizza was surprising tasty and it was obvious there was a strong customer-value proposition. 

However, after a 65 per cent total return over 12 months (including dividends), Domino’s is long overdue for a share price consolidation or pullback. I would not chase it higher or buy at these levels because it has run too far, too fast, despite being a great company.

Five of 11 brokers who cover Domino’s have a buy recommendation and six have a sell. A median share price target of $58.82 suggest Domino’s is fully valued, but not excessively so after strong recent price gains. 

Nevertheless, investors should watch and wait for better value in Domino’s during a market correction or pullback. It is a clear candidate for profit-taking, given the extent of its 12-month gains and nosebleeding valuations. A share price between $45 and $50 would bring Domino’s closer to value territory and provide a rare buying opportunity.

Chart 1: Domino’s Pizza Enterprises

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Source: The Bull

Other fast-food stocks offer better value. Retail Food Group, owner of Donut King, Brumby’s Bakery, Michel’s Patisserie, bb’s café, Esquires, The Coffee Guy, Gloria Jeans, and Pizza Capers Gourmet Kitchen and Crust Gourmet Pizza franchise systems, are worth watching.

Retail Food has been pummelled in the past 12 months. It slumped from a 52-week high of $7.22 to a low of $3.98 before improving to $5.45. The selling looks overdone. Five broking firms that cover Retail Food have a consensus share price target of $5.65.

That suggests Retail Food is fully valued at the current price but it can do better than the market expects as it beds down recent acquisitions, improves its legacy franchise systems in donuts and pastries, and expands its pizza and coffee operations overseas. I suspect the market is undervaluing Retail Food Group’s growing international footprint.

Chart 2: Retail Food Group

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Source: The Bull

Collins Food, owner of KFC and Sizzler outlets, has delivered a 65 per cent total return (including dividends) over 12 months, despite being well down from its $5.34.

The market might be concerned by Yum! Brands’ recent news about refurbishing and revamping its store network and if that would require Collins to invest more capital in its KFC stores. The news does not seem too significant, given Collins has already upgraded its network and is delivering higher profit margins as a result. 

Collins’ PE of about 11 times is not excessive for a well-run company in a defensive, growing sector and it is approaching price support on its chart around $3.50. It and Retail Food offer reasonable value at their current price, but both suit long-term investors who are comfortable with small-cap stocks.

Chart 3: Collins Food

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Source: The Bull

 

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Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis are at April 14, 2016