Retail Food Group: Result 2016

2016 was another year of acquisitive growth for Retail Food Group, but it would take a lower price to whet our appetites.

In The Future for Investors, Jeremy Siegel and Jeremy Schwartz identified that 11 of the 20 best-performing stocks over 46 years to 2003 were ‘consumer staples’. Companies like Coca Cola and Proctor & Gamble, that have great brands and loyal customers, show that where recurring consumption leads, strong shareholder returns often follow.

Retail Food Group shares many of their characteristics, giving its customers the experiences they crave on an almost daily basis. Following 2014’s transformational acquisition of Gloria Jeans, Retail Food is much more of a coffee-driven business – which is not a bad place to be, with Australians consuming an average of 3kg of coffee annually. Consistent, daily demand for coffee and baked goods has been a strong driver of RFG’s success.

In the year to June, RFG produced another year of strong growth, benefitting from full-year contributions from its acquisitions of Gloria Jeans, Cafe2U, Roasting Australia and DiBella Coffee. Revenue rose 25% to $275m, leading to a 21% increase in underlying net profit to $66m.

But while net profit advanced 21%, earnings per share (EPS) only rose 14% because of all the shares issued to pay for the acquisitions. This continues a decade-long trend, as net profit has grown 27% a year since listing, but only 16% a year on a per share basis. Still impressive, but not as juicy as the headline figures. Encouragingly, return on equity rose to 15% in 2016, arresting a year-on-year decline that began in 2008. The final dividend of $0.145 marks the 20th consecutive biannual dividend increase.

Year to June ($m) 2016 2015 /(–)
(%)
Table 1: Retail Food Group result 2016
Revenue 275 210 31
U'lying EBITDA 110 89 24
U'lying EBIT 104 85 22
U'lying net profit 66 55 21
U'lying EPS (c) 40.5 35.6 14
DPS* (c) 27.5 23.3 18
* Final dividend of 14.5 cents, fully franked, ex date 9 Sep

Another acquisition

RFG’s earnings mix continues to diversify away from the domestic franchise business following the acquisition of Hudson Pacific Corporation (HFC), which was announced alongside the result.

HFC is a holding company that owns subsidiaries Hudson Pacific, a food service distributor (with, somewhat confusingly, almost the same name as its parent), Dairy Country and Bakery Fresh, producers of cheese and bread respectively. RFG will pay $88m, which equates to 5.7 times EV/EBITDA.

The acquisition is a further step down the vertical integration path that RFG first began with coffee wholesaling. Hudson Pacific and Bakery Fresh are important suppliers to RFG, with the former having supplied the company for 20 years. By owning internal production management hopes to reduce costs. The acquisitions will increase RFG’s sales by 50%, but earnings by much less due to HFC’s lower margins.

Caution

There are always risks with integration, but RFG has a great track record at making and integrating acquisitions. As the core franchises are growing slowly, we expect management to continue to make more acquisitions. This increases the risks, as RFG is becoming increasingly complex, and ever larger acquisitions will be needed to move the dial. Things might be going well today, but history is littered with acquisitive growth stories gone wrong, so we prefer to err on the side of caution.

We’re also uncomfortable with some of RFG’s accounting. The company takes 2–3% of its franchisee’s sales and puts it into a fund which it then spends for national marketing campaigns (and occasionally other costs incurred to support franchisees – see below). RFG records this as revenue in the profit and loss account, and as an ‘other financial asset’ on the balance sheet until it is expensed. However, these look like normal business expenses to us, and we’d rather they just went straight through the profit and loss account.

While the fund may be earmarked for marketing purposes, it seems RFG has far greater discretion, as a large chunk of it was used to subsidise Michel’s Patisserie franchisees during a supply disruption. Again, that looks like a normal business expense to us – at the very least it will reduce the funds available for marketing expenditure.

With EPS of $0.49 expected in FY17, RFG is trading at 13.2 times its forward earnings. For a business of RFG’s ilk, that seems about fair. So while we’d need a lower price to be tempted to buy it, the stock has some attractive qualities and we're putting it back on our formal coverage list. HOLD.