Retail Food Group: Value through the haze

Historical profit growth has been impressive

In times of economic uncertainty, investors tend to shun risk, turning instead to consumer staples businesses that have lower prices and repeat purchases. While IT managers might put off the multi-million dollar computer upgrade, consumers are less likely to forgo their daily coffee.

If you walk through your local suburban shopping centre, you’ll likely never come across the name Retail Food Group (ASX: RFG), but you are exceedingly likely to notice the company’s brands.

Coffee, cake, donuts and pizza

Retail Fool Group is the brand owner, manager and franchisor of some of the most popular and ubiquitous tenants in our malls, including Michel’s Patisserie, Brumby’s Bakeries, Donut King and bb’s cafes.

The company has also pushed hard into the gourmet pizza market, with its ownership of the Pizza Capers brand and recent acquisition of Crust Pizza.

RFG’s core skill is brand and franchise management. It has around 1,150 stores in its various franchised retail brands in Australia, 87 in New Zealand and a handful in Asia and elsewhere, including 14 Donut King stores in China.

The company has hit on what is so far a winning formula, growing net profit almost four-fold in the last five years. Revenue growth hasn’t been as strong, however, continuing to be relatively flat over that time, with margin improvement doing all of the heavy lifting to improve profits.

Adjusting the adjustments

RFG’s financial statements are somewhat cloudy, with management making use of multiple adjustments when presenting its results. ‘Adjusted revenue’ and ‘Core earnings’ both make an appearance. The adjustments look reasonable to more accurately reflect the reality of the business.

However, the arbitrary removal of Queensland sales for Michel’s Patisserie so the company can say that sales for all brands (excluding that state) are positive, is a little too much spin. After all, all of the shares I’ve ever bought have gone up (except for the ones that are down).

It’s not a huge red flag, but at The Motley Fool, we’d prefer that management not sugar coat their commentary.

It also carries a fair swag of debt. For a repeat-purchase business selling low-priced items, the cash flow is likely to be regular and predictable enough to meet its obligations, but we’d be nervous about any significant further borrowings.

Value through the haze

Perhaps because of its debt load, Retail Food Group’s shares have continued to trade on a relatively low price/earnings multiple, currently sitting at just under 10 times consensus 2013 earnings. The company also carries a trailing 5.7% fully-franked dividend yield, making it an interesting candidate for income investors.

RFG has a lot of moving parts – quite a few franchise brands, and an acquisition that needs to be bedded down. We’d also want to see significant revenue and profit growth, given the amount of debt the company has on its books – you can grow your sales and earnings by acquisition, but if they’re not carefully handled, that debt can come back to bite a company.

On the other hand, a cheap price (based on earnings) and an attractive dividend yield help to make up for a number of sins, and the historical profit growth has been impressive, if not stellar.

Foolish takeaway

RFG is a good business that seems to be heading in the right direction.

We’ll want to see how well it can bed down the Crust acquisition, and measure its desire for more debt-fuelled acquisitions in the coming months, but if it can successfully integrate the new business and make low-risk capital allocation decisions or if the price were to drop further, RFG could be a tasty addition to your portfolio.

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