Rocky Mountain Chocolate Factory (RMCF) – Valuation & Strategy Update
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.
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.
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.
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.
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.
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.
Disclosure: I own shares of RMCF in my personal portfolio