Food group has growth recipe
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| Summary: The food franchises operator has grown its operations considerably, with its net profit having increased substantially over recent years. In 2013 RFG recorded a core net profit after tax of $34.3 million and core earnings per share of 27.9 cents. Based on a current share price of $4.30, RFG is on a trailing price-earnings ratio of 15.4. |
| Key take-out: Continued outlets expansion will underpin earnings growth, and a re-rating of the company is possible given its low-risk business model, high dividend, significant management ownership and excellent track record. |
| Key beneficiaries: General investors. Category: Shares. |
| Recommendation: Outperform. |
Retail Food Group (RFG) holds the franchise rights for a number of well-known food outlets in Australia. The main ones are Brumby’s Bakery, Michel’s Patisserie, Donut King, Crust Gourmet Pizza and Pizza Capers.
We first invested in RFG in October 2007, which was around the time it acquired the Brumby’s Bakery and Michel’s Patisserie franchises.
One of the main aspects of the RFG business that appealed at the time was that the profitability of RFG does not directly depend on the profitability of the underlying food outlets. The main source of revenue for RFG is franchise fees that outlets pay to RFG as a percentage of their revenue. This means that the revenue and profitability of RFG is not volatile, and is closely linked to the number of franchised outlets.
The earnings before interest and tax (EBIT) and net profit after tax (NPAT) of RFG have grown every year since we invested. This is particularly impressive, as this period included the global financial crisis. The number of outlets has grown from 360 in June 2007 to 1,374 in June 2013. This growth has been through a combination of outlet growth in existing franchise systems, and the acquisition of new franchises such as Crust Gourmet Pizza and Pizza Capers.
In 2013 RFG recorded a core NPAT of $34.3 million and core earnings per share of 27.9 cents. Based on a current share price of $4.30, RFG is on a trailing price-earnings ratio of 15.4. RFG has given guidance for 15% NPAT growth in 2014, which equates to a forward PE ratio of around 14. This is in line with overall market PE ratios, but I believe that RFG should trade at a premium due to its low-risk business model, and excellent track record of growth.
RFG also pays high fully franked dividends. In 2013, 19.75 cents of dividends were paid, equating to a dividend yield of 4.6%, or 6.6% once the dividend is grossed up for franking credits.
Management ownership of RFG is significant, with managing director and CEO Tony Alford owning 17.3% (as per the latest annual report). I like to see the interests of management and shareholders aligned through significant management shareholdings.
In summary, I believe that continued outlets expansion by RFG will underpin EBIT and NPAT growth, and a rerating to a PE ratio of 18 to 20 is possible given the low-risk business model, high dividend, significant management ownership and excellent track record of RFG.
Chris Garrard is investment manager for Cadence Asset Management.
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