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Rocky Mountain Chocolate Factory (RMCF) – Valuation & Strategy Update

July 22, 2010 | About:
Rocky Mountain Chocolate Factory (RMCF), one of the stocks still part of theValueHuntr Portfolio, also one of our favorite investments, recently held an earnings call where management updated shareholders on the company’s future plans and strategy. Some of the updates, along with an updated valuation, are posted below.

Revenues and Earnings

For the three months ended February 28, 2010, revenues increased 13.6 percent to approximately $8.8 million, compared with approximately $7.7 million in the fourth quarter of the previous fiscal year. Same-store sales at franchised retail locations increased 1.4 percent in the fourth quarter of FY2010, while same-store pounds of factory products purchased by franchisees increased approximately 0.3 percent, when compared with the fourth quarter of FY2009.

The Company reported net income of $1,200,000 in the fourth quarter of FY2010, which represented an increase of 15.4 percent when compared with net income of $1,040,000 in the fourth quarter of FY2009.

Basic earnings per share rose 17.6 percent in the fourth quarter of FY2010 to $0.20, while diluted earnings per share increased 11.8 percent in the fourth quarter of FY2010 to $0.19, when compared with $0.17 and $0.17, respectively, during the fourth quarter of FY2009.

Although net income declined 3.7 percent for the fiscal year, we still generated an after-tax return on beginning shareholders’ equity (ROE) of approximately 27.0 percent – well above the ROE of the typical U.S. Corporation. Simply put, this company is a cash-generating machine.

Co-Branding With Cold Stone Creamery

During the past year, Cold Stone and Rocky Mountain Chocolate Factory have partnered to create co-branded stores that have increased sales and franchise owner profitability.

According to Dam Beem, CEO of Cold Stone Creamery, the co-branding partnership with Rocky Mountain Chocolate Factory was designed to leverage the complementary seasonality of both brands and maximize store operations throughout the year. The partnership drove same-store sales increases of 14% to 16% during the colder and typically slower winter months and outpaced industry averages during the down economy. Because the initial 13 Cold Stone and Rocky Mountain Chocolate Factory co-branded locations exceeded projected profitability, the program was expanded to additional Cold Stone franchisees to incorporate the premier confectionery brand into their stores.

Co-Branding Expansion

On the latest call, Rocky Mountain management indicated that the pace of co-branded store openings had accelerated from 1 store during the first fiscal quarter of 2010 to 7 in the first quarter of fiscal year 2011. According to Franklin Crail, Rocky Mountain CEO, the pace of co-branded openings will accelerate even more in the quarters to come.

stores.jpg?w=500&h=194

To date, 25 stores have either opened or been converted to the Rocky Mountain Chocolate Factory/Cold Stone Creamery co-branded concept, and management has identified several hundred CSC stores that they believe have the potential to be converted in coming years. The increase in cash flow generated by incremental sales at the co-branded stores appears to provide a return on investment sufficient to attract a growing number of CSC franchisees to the co-branding opportunity, and the number of cobranded stores is expected to increase significantly in the current fiscal year. At the end of fiscal 2010, RMCF’s retail store network consisted of 313 franchised Rocky Mountain Stores, 11 company-owned stores, and 19 stores cobranded with CSC.

storescomparison.jpg?w=298&h=223

Dividends and Buybacks

Because franchise growth does not require a lot of cash, Rocky Mountain has been able to return a significant share of its earnings to shareholdelrs. RMCF began paying cash dividends in 2003 and has increased its dividend payout ten (10) times during the past six years. The current dividend of $0.40 per share provides investors with a current yield of 4.2% based on a recent stock price of $9.55. Additionally, the Board has approved a repurchase program of up to $3.3 million of company stock, roughly 6% of all the shares in the company.

Valuation

Incorporating a lot of the provided updates in our analysis, we estimate the company is worth at least $11 per share. A range of outcomes is possible based on macroeconomic conditions and the execution of the co-branding partnership with Cold Stone. My analysis suggests a worst case scenario (stress test) of $7.7 per share, and $12.7 in the most optimistic case.

risk-return.jpg?w=500&h=357

Investment Payoff

We have concluded that our investment in RMCF is of very low risk, as the probability of a catastrophic loss of capital is remote. We have plotted the range of possible outcomes in what we call a “symmetry plot”, to evaluate whether or not the odds of positive return are in our favor. In the case of RMCF, it is evident that we would break even as long as we have a 30% or greater chance of predicting the right outcome.

payoff.jpg?w=500&h=359

Disclosure: I own shares of RMCF in my personal portfolio


Valuehuntr

http://valuehuntr.com/

About the author:

Valuehuntr
Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th-century Franciscan friar, William of Ockham. We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Please visit www.ockhamresearch.com for more information.

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Rating: 3.0/5 (10 votes)

Comments

David417
David417 - 3 years ago


It’s amazing that everyone associated with Cold Stone Creamery can make a profit except Cold Stone Creamery franchisees. Kahala’s earnings are at the expense of Cold Stone Creamery franchisees. They operate to benefit themselves at the expense of franchise owners who end up losing it all and filing for bankruptcy. They have known for years that Cold Stone Creamery franchisees cannot make a profit and they have been promising to fix it. Yet year-after-year we owners lose our retirement savings and kids’ college funds at an epidemic pace. More-and-more Cold Stone stores close down and their owners head straight to bankruptcy court while the company makes huge profits itself.

At first, they lied and said they did not take kickbacks. Later, they admitted to the franchisees that they did. They told us we could not buy products from Sam's, Costco's and other wholesalers, then they stated in a national article that we have always had that permission. You never know where the truth lies with Dan Beem and Kevin Blackwell, but if you're a franchise owner, you're better off going left if they tell you it's in your best interest to go right.

This I also know, for three years now I've been suffering in these franchises losing several thousand dollars each month while listening to their lies. No more! I'm now broke and have no more money to give to these deceitful--mean people. I, like so many other franchisees across the nation, am planning to close my store after the summer, file bankruptcy and be done with them. There is little wonder to me that cnn.com recently revealed that Cold Stone has a whopping 31% SBA failure rate. (That's incredible considering the SBA ceased financing Cold Stones years ago due to the large number of failures.)

A word of warning if you are considering buying a Cold Stone franchise: DON’T DO IT!!!!!

Cold Stone Creamery Franchisee

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