KFC - Crossing the regional roads

KFC Holdings UPGRADE TO BUY
Price/Target: RM7.86/ RM9.40 Mkt Cap:
US$0.5b Daily: Vol 0.2m 1-Yr Hi/Lo: RM8.00/6.51

Poised to expand regional presence beyond involvement in India, backed by impressive resume with Yum! and strong balance sheet. 2009 earnings could throw up a pleasant surprise. Upgrade to BUY and raise target to RM9.40.


Corporate Event

QSR/KFC Bhd Group is likely to have more opportunities to expand its KFC franchise operations in the greater Asian region, having clinched in recent years franchises in Singapore, Cambodia and India.

Meanwhile, we expect KFC Holdings (KFC) to deliver a strong set of results for 2009, perhaps above consensus, led by margin expansion on the back of easing raw material costs, rising average selling prices (ASP) and ongoing store expansion.

Stock Impact

Yum! returns with larger regional bites. In the intermediate term, KFC is in a strong position to secure more lucrative KFC franchises in the greater Asia region from Yum! Brands (Yum!), in recognition of its impressive
Malaysian operations (consistently a top-performing KFC franchisee in the region) and steady store expansion (thus feeding Yum!'s growth in royalty payments). To recap, the Group clinched the Singapore franchise, followed by QSR clinching the sole KFC Cambodian franchise (which started its first
store in 1Q08), and most recently, KFC was appointed a key KFC restaurant franchise operator in Pune and Mumbai, India, where it intends to open 10-12 outlets in 2010.

As such, KFC could be in a good position to secure a concessionary foothold in more developed countries in the intermediate term. This implies a much larger outlay but also swifter translation to the bottom line. From time to time, KFC could be invited to bid for such opportunities which could lift its earnings by at least 10%.

Meanwhile, the existing overseas franchises should deliver attractive returns over the long term, beyond the expected start-up losses in the first 1-2 years of operations. For example, KFC Singapore, which was
bought for S$55m in 2002, turned around in 2005 and today delivers about RM10m in pre-tax profit. KFC Cambodia, which has seven outlets, made a modest loss in 2009.

Earnings Revision

Upgrade outlook for 2010-11. We maintain 2009's net profit estimate, but raise 2010-11 forecasts by 4.9% each to RM146m and RM154.2m respectively after lowering raw material cost assumptions. Our 2010-11 forecasts
conservatively assume rising raw material costs in 2H10 and start-up losses in the region.

Valuation/Recommendation

Upgrade KFC to BUY (from HOLD) with a revised target price of RM9.40. KFC is expected to enjoy the strongest earnings momentum among the consumer stocks under our coverage on the back of improving consumer sentiment. It is still trading at cheap valuations of 10.0-10.7x PE for 2010-11. Our
target price is based on a lower discount rate of 35% to our RNAV of RM14.50/share in recognition of a rising likelihood of further expansion in Asia, indicating an effective use of its surplus cash. The revised target
price implies 12.8x 2010F PE and 12x 2011F PE. There could still be upside to our target price should the company realign its use of surplus cash and provide a more generous dividend policy, noting that established
multi-national F&B companies like Nestle and F&N trade at over 20x PE.

Analyst: Vincent Khoo, CFA/ Malaysia Research Team