Ask the analyst: How reliant are Guzman shares on international growth?

Welcome to Ask the analyst, where I put questions from Morningstar readers (and myself) to members of our equity research team.

If you have a question about an ASX company or industry that we cover, please send it to joseph.taylor@morningstar.com.

Today’s question

Today’s questions came from your author. A year on from the public debut of Guzman y Gomez (ASX: GYG) shares, I wanted to catch up with our analyst Johannes Faul and discuss what may or may not be baked into the company’s valuation at these levels.

I was especially interested in hearing about the company’s potential for international expansion. After all, I have been back home in the UK recently and couldn’t help but thinking that Guzman might do well here.

As always, let’s start with a quick look at Guzman’s business before we get to the questions.

The burrito baron

As you are probably well aware, Guzman y Gomez (ASX: GYG) owns the brand behind Australia’s largest chain of Mexican quick service restaurants.

By the time GYG hit the ASX in June 2024, it had grown into the sixth biggest player in Australia’s QSR space.

Figure 1: Estimated market share in Australian QSR industry as of June 2024. Source: Morningstar, using Euromonitor data.

Capital light growth

Strong profitability and proven returns on capital at the store level opened the door Guzman to successfully franchising its offering.

In Australia, 130 of Guzman’s 194 stores as of its June 2024 annual report were operated by franchisees.

This has reduced the amount of capital Guzman needs to fund the rollout. It is these franchise operators, and not Guzman, that stump up the capital expenditure, setup and operating costs of stores. Guzman then receives a royalty based on store sales.

Guzman still runs around a third of its Australia locations itself, which allows it to retain control over the customer experience and test new ideas in a live setting. And it is fair to say the company’s approach has continued to work well since IPO.

Guzman’s results covering the six months to December 2024 reported 23% growth in Australian system sales versus the same period in 2023. This after the firm reported 27% growth in Australian sales for the year to June 2024 versus 2023.

Guzman is attempting to replicate its Australian success in other countries. The biggest store rollouts so far have been in Singapore and Japan under master franchise agreements. The company also has six corporate-owned stores in the US.

Given that Guzman shares have continued to trade far above our estimate of Fair Value since IPO, I wanted to know what Johannes thinks is baked into the price. But first, Johannes wanted to clear something up.

Not bearish on the Australian business

Morningstar’s $16 per share Fair Value estimate for Guzman y Gomez shares is nowhere near the current share price of around $27.

Yet Johannes was at pains to point out that this does not make him bearish on the company’s prospects. Not at all.

This Fair Value estimate, Johannes says, accounts for a view on Guzman’s Australian business that could barely be more bullish.

This is true for both key levers: 1) how quickly the Mexican QSR category can grow in Australia and 2) how much of that market Johannes thinks Guzman will capture.

Johannes thinks Mexican food can grow from around 5% of Australia’s QSR market to a “double-digit” share within a decade. That would be impressive when you consider that Mexican’s share of the highly receptive US market is only 8% according to Euromonitor.

As for Guzman’s share of the pie in Australia, Johannes expects its ‘category queen’ status to strengthen even further in the years ahead. He forsees a truly dominant share of the domestic market north of two-thirds.

Again, that is very bullish. Competition is likely to be fierce if the market for Mexican food grows as quickly as Johannes expects. Not that there isn’t already plenty of it from the likes of Zambrero, Mad Mex and Taco Bell.

Optionality, but at what price?

Johannes is bullish on the Australian business then. But his Fair Value estimate for Guzman of $16 per share still lags the current market price of $27 by some way.

The disconnect, he says, comes in how investors are valuing Guzman’s international potential.

The forecast underpinning Johannes’ valuation covers the next decade of Guzman’s operations, and he does not see markets other than Australia making a material contribution to earnings in that period.

There hasn’t been any evidence yet, he says, that efforts to establish the brand in the US will deliver meaningful profits in this time frame. Meanwhile, profits from Singapore and Japan are expected to remain very small compared to those from Australia.

This is not to say that Johannes is completely dismissing Guzman’s international prospects.

The world is full of big existing or potential markets for Mexican food. And Johannes recognises the optionality that comes with owning a brand that could be monetised on a global scale.

Johannes says this provides investors with “blue sky potential”. Who is to say, for example, that a Master Franchisee won’t emerge and drive growth in other potentially attractive markets?

The issue, however, could stem from how that option is being priced. Given Johannes’ bullish forecasts for the domestic business, it could make up all of the $11 gap between his Fair Value and the recent share price.

Will investors have the patience?

At that kind of valuation, there may be a risk that investors run out of patience. Especially when the process could take a long longer than investors expect.

Johannes says that it takes a long time to build a proven offering in new countries – not only to customers but to potential franchise partners who want to be relatively assured of a good return on investment.

Guzman’s strong position in Australia today, for example, is almost twenty years in the making.

Johannes also thinks it would be understandable if Guzman’s management keep them waiting for meaningful international expansion. After all, capturing the Australian opportunity, which still has a way to go, is going to require a lot of focus amid fierce competition.

He also says that management may be reluctant to self-fund an entry into other markets without a master franchiser stepping in. As the US efforts have shown, doing this with the company’s cash can be a big drain on capital and earnings for a long time.

Taken together, Johannes would rather not pay up for an ‘option’ on Guzman’s global growth. Success is highly uncertain and establishing a food chain in new markets generally takes a very long time.