Crash: Retail Food Group Limited’s share price drops 44% upon return to trade

The Retail Food Group Limited (ASX:RFG) share price fell 44% to $1.14 after the company returned to trade this morning. Retail Food Group shares are now down 81% in the past 12 months.

A selloff was probably a given after the revelations of last week, including a suspension from trade after a delayed audit report followed by negotiations with lenders and a cut to the dividend.

As noted in our earlier article, Retail Food Group will close as many as 200 stores and wrote off some of the value of its brands in its recent result, which lead to a statutory loss of $88 million after tax. The company cut its dividend to preserve cash and was forced to agree to strict new covenants with its lenders.

Is Retail Food Group a potential opportunity at these prices?  Companies that lose 81% in a year can be a fertile hunting ground for turnarounds, if investors have overreacted. I had a discussion with several Foolish contributors about this just last week.

On the one hand, highly indebted companies whose share price has been destroyed can be big winners on the turnaround, if investors can establish with a high degree of probability that the company won’t go bankrupt. On the other hand…the company could go bankrupt.

The biggest question is, how reliable are Retail Food Group’s earnings?  Some of them, such as annual franchise fees, would appear to be very reliable as franchisees are locked in for a period of years. Other parts of company’s earnings are fuelled by franchisees buying into a franchise. Given the recent media coverage I expect that the number of people interested in buying into an RFG business will be approximately zero in the near term, which could result in a hit to earnings.

Given that RFG’s banking covenants require the company to maintain a minimal level of earnings, and given that earnings seem almost certain to take a hit due to store closures and lack of interest from franchisees, I would be inclined to avoid the company.

Alternatively, if I did invest, for example by attempting to forecast company earnings and comparing this to the minimum requirements, I would want to make sure that I had a significant margin of safety in my figures, and I would also keep the investment size small.

In theory, with all the problems and the negative press, now is surely the time to look closer Retail Food if you are not already a holder. Just be aware that it appears a high risk situation, and I think most investors are better off on the sidelines for now.

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Motley Fool contributor Sean O'Neill has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended 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 Scott Phillips.

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