A tale of two fast-food stocks: Collins Foods versus Domino’s Pizza

Retail spending appeared remarkably resilient in May, rising 0.7% month-on-month and more than 4.2% on the same time a year earlier, according to Australian Bureau of Statistics data released today.

But economists say the unexpected jump in retail turnover is a once-off and expect the drop off in discretionary spending to continue as inflation continues to rise, AFR reported.

The latest retail data is just another example of the uncertainty that has been rampant since the economic environment turned down some 18 months ago. That’s something Marcus Today’s Henry Jennings commented on during a recent chat.

“Retailers have been completely decimated in some respects this year, where we’ve seen some big falls as they’ve now been downgrading their outlooks,” Jennings said.

“Some things we thought would do well in recession, or a slower environment, haven’t,” he said, pointing to Domino’s Pizza (ASX: DMP) as an example.

“We were told, and the market expected, it would do well because of the cheap price point of its $5 pizzas. And yet Domino’s has fallen like a domino,” Jennings said.

“Whereas KFC, which you would think is not dissimilar, has nailed it, with the 20% rise reported yesterday…extraordinary.”

“Some of the things we thought would happen as the economy has slowed, haven’t occurred. And some we thought would suffer – you look at a stock like Cettire (ASX: CTT), at the top end of luxury goods, yet the stock price is at all-time highs”.

Collins Foods (ASX: CKF)

Rating: NEUTRAL

Price target: $9.65

The broker research team at UBS recently assessed Collins Foods’ performance across FY2023, describing it as a “strong result despite broader consumer weakness.”

“In our view, volatility remains the key swing factor but KFC’s strong value offering positions it well to benefit from trading down,” write UBS analysts Tim Plumbe, Apoorv Sehgal and Tim Piper.

(Note: “Trading down” refers to consumers adapting their purchases to lower-priced options in line with tighter household budgets.)

The UBS team believes CKF’s pricing versus value promotional strategy enables it to successfully adjust to changes in consumer sentiment.

“We question how much cost inflation may have been pulled forward into FY23,” UBS writes. The analysts remain optimistic that either:

• Margins for the full year will beat expectations, or
• Favouring value strategies inside the business will reduce sales volume declines in FY2024.

“Our previous analysis suggests every 1% improvement in volume added more than 10% to earnings per share,” it writes.

Among the highlights that UBS cites for the prior 12 months are:

• Stronger top line but softer margin, resulting in a 2% miss to UBS’s estimated EBITDA
• KFC Europe was the key “upside surprise” where $16.4 million in EBITDA was nearly double its forecast of $8.8 million
• Taco Bell booked an EBITDA loss of -$5.9 million, down 1.8% in the second half of the year.

“We factor in stronger FY23 European performance and KFC Australia and Europe top line in FY24, offset by softer margin expectations and the sale of Sizzler Asia,” write the UBS analysts.

Citi’s take on Domino’s Pizza Enterprises

Rating: SELL

Price target: $40

The research team at Citi suggests that Collins Foods’ FY23 result provides insights into the “underperformance” of Domino’s.

“It appears Domino’s may have been too focused on protecting margins as opposed to its customer value proposition,” write analysts Sam Teeger, CFA and Keshav Parti.

“We would like to see Domino’s take a longer-term view regarding its brand and increase its focus on providing value to consumers across its entire menu range.”

Citi questions whether the pizza retailer’s new menu will resolve the “frequency of consumption” issues it faces, particularly in an environment where consumers are under increasing financial pressure.

“The price of Domino’s legacy menu items remain relatively higher for solo consumption versus other quick service restaurant categories,” say Teeger and Parti.

They also emphasise Collins Foods management’s strategy of not trying to completely offset inflationary pressures through price increases, instead “prioritising longer-term brand health over short-term margin pressures.”

Teegar and Parti point to Collins’ expectation that margin headwinds will continue into FY2024, “which in our view may suggest downside risk to Domino’s FY24 margins.”

“In order to turn more positive, we need evidence that the company has found a sustainable way to improve its customer value proposition with volumes still declining."

The article was first published on Market Index on Thursday 29 June 2023.