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Mortgage Choice Limited (ASX:MOC) just axed its profit to fix its franchising woes

Mortgage broker franchisor Mortgage Choice Limited (ASX: MOC) may have found a way to avoid a war with its franchisees. After losing 42% in the past 6 months, today the stock is up 2% to $1.46.

In June, a joint investigation by Fairfax and ABC revealed that Mortgage Choice brokers were struggling to profit from their work and many were considering a legal action against the company. The news contributed significantly to the stock’s poor performance.

Criticism over the mistreatment of franchisees recently hit other ASX-listed companies, including Retail Food Group Limited (ASX: RFG) and Domino’s Pizza Enterprises Ltd. (ASX: DMP), as the Senate launched an inquiry into the operation and effectiveness of the Franchising Code of Conduct.

Mortgage Choice has acted quickly on the issue, accepting brokers’ requests for higher and less volatile pay. While previously broker margins were linked to a monthly target of new loans, today the company announced a new remuneration model that gives brokers the highest monthly income based on either the volume of outstanding loans or the rolling average of loan settlements.

This change is expected to increase the average commission payout on residential lending from 65% to 74% and to provide better earnings certainty to franchisees.

The company will partially offset the cost of the more generous remuneration structure by saving on its services to brokers, which from now on will consist mostly of phone and online support.

For FY18, Mortgage Choice expects cash NPAT of about $23 million, in line with the previous year. The change in the remuneration policy will result in a $30 million non-cash negative adjustment to statutory NPAT.

The company should return to profit in FY19, with an expected statutory NPAT of $16.5 million. Based on this figure, the stock currently trades at 11x FY19’s earnings.

Foolish takeaway

Considering the attention that franchising businesses may receive in the future as the Senate inquiry progresses, I think it’s wise of Mortgage Choice to sacrifice some short-term profits to preserve its reputation and its network of brokers.

If you have a strong appetite for risk, you may consider investing in Mortgage Choice. For a safer option, I like the look of this dividend star.

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Motley Fool contributor Tommaso Autorino has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Domino's Pizza Enterprises 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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