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Why the Retail Food Group Limited share price is swinging wildly

Credit: Paul Ritz

Belt-widening pizza, cake, donut and coffee retailer Retail Food Group Limited (ASX: RFG) has seen its share price swing wildly in trade again today on the back of a UBS research note guessing the impact of upcoming accounting changes for the retailer.

Yesterday the stock dropped 11% to $4.63 on the negative UBS report and large “share price target” downgrade and today the company responded by brushing off the UBS report as “speculative guesswork”.

RFG stated it will update the market on the the accounting changes when reporting its full year results in August 2017 and noted that UBS did not attempt to contact it to verify the “unsubstantiated assumptions” in any of the report.

For investors it’s important to note that the changes to how operating leases as liabilities are accounted for will have zero impact on RFG’s real world operating cash flows as it is essentially just a non-cash change to how a liability is recorded on the balance sheet.

Of course the changes may adversely impact RFG’s debt ratios for example and this is a negative, but the savage share price falls demonstrate the febrile nature of equity markets.

It should also be noted that UBS’s prime broker division is probably the most active in Australia in lending out securities (including those of RFG) recently to hedge fund clients to short sell in return for paying UBS prime brokerage fees as the asset lender.

Prime brokerages are essentially back office or “asset servicing” functions at investment banks entirely separate from the buy or sell side capital-market facing operations that produce equity research.

However, since the start of stock exchanges it has been in the interests of sell side analysts to drum up trading volumes through overly optimistic, or pessimistic “share price targets”.

Sell side research functions exist off hard commissions in terms of lucrative trading (brokerage) fees from large asset managers trading vast sums of stock, or soft commissions in terms of being passed capital markets work (including IPO, advisory, or stockbroking work for example) in exchange for equity research provided to the buy side asset managers, or buy-side short selling hedge funds who will also conduct their own in-house equity research.

Yesterday for example around 8x the daily volume in RFG shares was traded thanks to the publicity around the report which means brokers will have collected 8x their daily trade commissions. In fact the research arms of sell side brokers everywhere are constantly upgrading or downgrading their somewhat nugatory 12-month share price targets on every company going to drum up trading volumes for their brokerage arms more often than not.

Buy side research tends to be more of a closely guarded secret as large asset managers like to keep their cards close to their chest for multiple reasons, including that the vast sums they have to invest can easily move stock prices.

Outlook

Still, UBS’s analysts may be correct in raising concerns and until RFG properly updates the market again as to its full year profit forecast the stock is likely to remain under pressure due to uncertainty over its accounts and true level of organic growth.

For now I would rate the stock as a hold, as I would not be surprised if the company has some bad news to release to the market soon enough, although if it is tracking to full year guidance for 20% profit growth the stock is almost certainly a bargain at $4.80 this afternoon.

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Motley Fool contributor Tom Richardson owns shares of Retail Food Group Limited.

You can find Tom on Twitter @tommyr345

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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