A growth investor’s guide to Retail Food Group Limited

Credit: Dennis Wilkinson

There is a lot to like about Retail Food Group Limited (ASX: RFG).

As the name would suggest, Retail Food Group is a manager of various food brands, including the likes of Donut King, Crust Gourmet Pizza and Pizza Capers, to name just a few. It also added Gloria Jean’s to that list during the latest financial year, dramatically increasing its share of the Australian coffee market and thus providing the group with added scalability.

Who is Retail Food Group?

The company operates a master franchisor business model. What that means is that franchisees receive the right to use the banners and systems owned by Retail Food Group in exchange for a percentage of their revenues each and every year. That provides Retail Food Group with a very reliable income stream from thousands of individual franchisees.

Another attractive element to that model is that the franchisees themselves provide much of the capital to expand the businesses. Sure, Retail Food Group occasionally has to fork out huge amounts for new business lines (as it did with Gloria Jean’s in 2014), but for the most part, it runs a relatively low-capital intensive model. That’s great for investors.

Meanwhile, Retail Food Group also operates a wholesale division, which provides those franchisees with many of the products required to run their businesses.

Retail Food Group’s dominance was highlighted during the latest half-year period, which ended 30 June 2016. The company reported $148.3 million in revenue (an increase of 90.2% thanks largely to acquisitions), while the group’s underlying earnings before interest, tax, depreciation and amortisation (EBITDA) grew 36.4% to $53.5 million. Underlying net profit (NPAT) was also 27.1% better than in the prior corresponding period at $32.1 million.

Those figures reflect an EBITDA margin of 36.1% and an NPAT margin of around 21.6%. As I mentioned previously, Retail Food Group’s master franchise business model allows much of its revenues to drip straight to the bottom line.

What’s more, the company is quickly expanding its international operations as well. Just under 17% of the group’s EBITDA was generated internationally during the latest half-year, but that measure is expected to grow over the coming years.

It’s not without its risks

Retail Food Group has several key risks though. To begin with, a recent scandal involving the 7/11 retail and service station chain cast a shadow over the franchise model. Although the franchisees are all bound by laws and obligations under their franchise agreements, there is a risk of non-compliance which could become an issue for management if problems are detected.

It’s also possible that consumers could cut back on coffee from Retail Food Group’s stores if the economy were to take a hit, although I can think of plenty of other items consumers would likely cut back on before their morning coffee.

Foolish takeaway

Despite the risks facing the business, there are plenty of reasons to like Retail Food Group as an investment. To begin with, its shares are trading at a steep discount compared to the highs reached just over 12 months ago, while they also offer plenty of growth and a fully franked dividend yield of around 4.8%.

In addition, although there are plenty of differences between Retail Food Group and Domino’s Pizza Enterprises Ltd (ASX: DMP) (i.e. we’re not comparing apples with apples), RFG’s shares are considerably cheaper. They trade on a rather conservative price-earnings (P/E) ratio of 14.5x last year’s earnings, while Domino’s Pizza’s shares are trading on a P/E closer to 78x last year’s earnings.

As I said, they are different businesses (and Domino’s is a great business too!) but based on those measures, I know which I’d prefer to own today.

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Motley Fool contributor Ryan Newman owns shares of Retail Food Group Limited. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. You can follow Ryan on Twitter @ASXvalueinvest.

The Motley Fool Australia owns shares of Retail Food Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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