The Retail Food Group Limited (ASX:RFG) share price dropped 22.5% to $3.41 this morning, following a 'Cup of Sorrow' report from Fairfax media over the weekend regarding the Retail Food Group's treatment of its franchisees.
In general the article alleges that among Retail Food Group's franchisee network there is:
- Systemic wage fraud and sham employment contracts
- Limited product innovation and too little advertising
- Stores are closing and a significant percentage of Gloria Jeans and Pizza Capers franchises are up for sale
- A significant numbers of franchisees under financial pressure
I consider the article well worth a read for Retail Food Group shareholders. From an investment perspective, the implications are clear.
Retail Food Group is carrying a meaningful amount of debt at the same time as many of its franchisees are reportedly losing money and placing their businesses up for sale.
The amount of receivables on the company's balance sheet has also ballooned. Management attributed this to the acquisition of Hudson Pacific, but it could also indicate that franchisees are taking longer to pay their bills.
At the same time, Retail Food Group appears to have been underinvesting in its brands, and this is something we've commented on several times previously. Apart from very recently with the addition of the 'Royal' range, Donut King (for example) is still selling virtually the same doughnuts it was 10 years ago.
Retail Food Group has also commenced an internal investigation into possible employee underpayments. Domino's Pizza Enterprises Ltd. (ASX: DMP) previously launched its own investigation following media allegations, and found numerous instances of underpayment.
Given the allegations launched by Fairfax there could be a chance that Retail Food Group will also find evidence of franchisees underpaying staff. Retail Food Group's management has generally avoided addressing criticism directly other than to acknowledge a tough business environment.
The potential risks however are not just confined to franchisees leaving or underpaying their staff.
From an investment perspective, Retail Food Group makes a lot of its money from selling franchises to franchisees, as opposed to selling doughnuts and pizza.
Should this investigation and others damage the company's reputation, it may find it increasingly difficult to attract new franchisees to its banner, hurting its results. On top of this, Retail Food Group may have to reduce the fees it charges franchisees to attract new ones or to improve the profitability of existing ones.
With all the concerns coming out, and the impacts of these not yet having worked their way through to the company's results, I'm avoiding Retail Food Group at today's prices.
