Fat-food fears weigh on Priszm


Sep 18, 2007

Increasing minimum wage, costlier chickens put additional pressure on income fund


When it comes to Priszm Income Fund, forget about making a fast buck on fast food.

Priszm's restaurant offerings in Canada - including KFC, Pizza Hut, Taco Bell and Long John Silver - could give investors indigestion, analysts say.

All six analysts covering the income trust are now in the hold-or-sell camp. Some predict distribution cuts because they expect weak same-store sales when Priszm reports third-quarter results next month.

Units of Vaughan, Ont.-based Priszm have dived 52 per cent from a peak of $13.40 a year ago. Last Friday, they closed up 31 cents at $6.43 on the Toronto Stock Exchange.

Aging baby boomers worried about waistlines and seeking healthier food choices are putting pressure on Priszm, said National Bank Financial analyst Gareth Tingling. "Our belief is that consumers have a lot of difficulty seeing KFC outside of fried chicken," he said in an interview. "It's the key brand within Priszm's portfolio."

KFC, formerly known as Kentucky Fried Chicken, also faces rising labour costs - as the minimum wage is set to rise in its core market of Ontario over the next three years. Chicken costs are also climbing.

To make matters worse, consumers already pay more for a meal at KFC than at rival fast food outlets, so they may balk at future price hikes to offset higher costs, Mr. Tingling said.

He recently cut his rating on Priszm units to "underperform," and slashed his one-year target on their price to $4.00 from $9.00. Based on a revised annual same-store sales growth forecast of 1.7 per cent, he expects Priszm to chop its annual distribution by 50 per cent, to 64 cents a unit.

Another problem for Priszm is that it differs from eight other publicly traded restaurant income trusts, such as Boston Pizza, in that they are franchisors, paying distributions from collecting royalty fees from franchisees, while Priszm is a franchisee, paying fees to Louisville, Ky.-based franchisor Yum Brands Inc. Prizm's distribution comes from its profits, which are vulnerable to rising labour or food costs.

McDonald's Corp. stock hit a record high last week as it has reinvented itself with healthier food offerings, but KFC will have a much harder time, Mr. Tingling said. One reason: McDonald's is top of mind for children; KFC isn't.

"KFC's Colonel Sanders is not in any way a kid-oriented character," he said. "If you look at KFC's communications strategy, they have always chosen the mom as the focal point of the family to drive the purchase. But you have women in their forties concerned about their weight and health."

Yum's second-quarter profit of $214-million (U.S.) beat Wall Street estimates, but it can't be an indicator of Priszm's prospects because its growth stems from China and other international sales. Same-store sales in the United States, which has similar demographic profile to Canada, were flat.

RBC Dominion Securities analyst Walter Spracklin - who was alone with an "underperform" rating on Priszm for more than a year since late 2005 - expects a distribution cut of 35 per cent, to 83 cents a unit. He became negative partly after seeing sales slow despite Priszm's move to multibranding - combining two restaurants in one location like a KFC-Taco Bell combination. "Marketing costs were going up with no impact on sales," he added.

Mr. Spracklin has a one-year target of $7.50 (Canadian) on Priszm, but that would fall to $5.50 if his expectation of a distribution cut proves to be right. "The payout ratio of 132 per cent for the first half of the year is unsustainable," he said.

In July, Priszm's president, Jeff O'Neill, said his focus at KFC on getting rid of trans fats (a common ingredient in fried and processed foods linked to health problems) as opposed to product innovation, hurt sales and profit in the second quarter.

While Priszm has been optimistic that its summer promotion would lead to higher third-quarter sales and offset rising costs, checks with KFC operators indicate that sales will be flat to lower than the same period in 2006, Mr. Spracklin said.

"Summer is when they earn all their money. This is a make it or break it for the company."

By the numbers

Number of restaurants: 484, including 97 multibrand locations

Controlling shareholder: Priszm chief executive officer John Bitove

2006 revenue: $503.4-million

2006 profit: $15.6-million

Second-quarter results: $1.9-million loss.

Second-quarter same-store sales: 5-per-cent drop

Annual distribution

per unit: $1.28