Rocky Mountains Chocolate Factory (RMCF) is a 30 year old international franchiser, manufacturer and retailer of chocolate candies and other confectionery products from Colorado. The company, with a market cap of $82 million, operates through 457 stores and kiosks located in the United States, Canada, Japan, South Korea and the United Arab Emirates. The company manufactures its products at its 53,000 square foot factory which are then supplied to its franchisees. Most of these stores are located in the United States. The business delivers its products using its fleet of refrigerated trucks to its franchise stores.
In its most recent fiscal year (FY-2013), Rocky Mountain Chocolate Factory's production facility produced 2.67 million pounds of chocolate candies, up 2% from in FY-2012. The company's annual production capacity is 5.3 million pounds. The company has expanded in international markets and has significantly increased its store count after the U-Swirl transaction. However, it has struggled with no organic growth and an average of just a 3% increase in annual revenues in the last five years.
U-Swirl Transaction
Rocky Mountain Chocolate Factory was also the founder and owner of Aspen Leaf Yogurt, a franchiser and retailer of frozen yogurt. Earlier in January, Rocky Mountain Chocolate Factory acquired all of the franchise rights of YHI Inc and Yogurtini International who are the franchisers of the brand "Yogurtini". Then two weeks later, Rocky Mountain Chocolate Factory sold Aspen Leaf Yogurt's assets to U-Swirl (OTCQB:SWRL) for a 60% controlling stake in U-Swirl. As its name suggests, U-Swirl offers frozen desserts at it outlets, called U-Swirl Frozen Yogurt. Following the transaction, U-Swirl, that currently has a market cap of $12.6 million and trades at the OTC Market, also franchises and operates Aspen Leaf Yogurt and Yogurtini. Through these two transactions, Rocky Mountain Chocolate Factory has become the majority owner of U-Swirl, that owns 86 stores, including 6 Aspen leaf stores, and franchise rights to Aspen Leaf Yogurt and Yogurtini. Besides these, U-Swirl also owns franchise rights of Josie's Frozen Yogurt.
Revenue Sources
Rocky Mountain Chocolate Factory generates its revenues from 3 primary sources:
1. by selling its products (chocolates and confectionery) to franchisees,
2. by collecting the initial franchise fees and regular royalty payments from its franchisees, and
3. by selling products at the company-operated stores.
As mentioned earlier, Rocky Mountain Chocolate Factory has more than 450 stores, of which 6 are operated by Rocky Mountain Chocolate Factory and 12 are operated by U-Swirl. The rest are either franchise stores or co-branded stores with the ice-cream parlor chain Cold Stone Creamery. Since 2007, Rocky Mountain Chocolate Factory has been opening co-branded stores in those locations where it is not feasible to open a standalone store.
(click to enlarge)
Source: RMCF 10-Q
The company primarily establishes its stores in areas that offer high foot traffic, particularly regional centers, outlet centers, community or festival centers and famous tourist areas.
Rocky Mountain Chocolate Factory has four main reporting segments: Franchising, Manufacturing, Retail and U-Swirl. The manufacturing segment also generates sales by selling its chocolate and candy products to other segments. However, all inter-segment revenues are eliminated from the final calculation which represents net revenues, or "revenues generated from external customers."
The company generates most of its revenues and income from the manufacturing segment. In its previous fiscal year, Rocky Mountain Chocolate Factory generated 67% of its revenues while the unit's profits were 2.7 times greater than the company's overall profits. Last year, the company's income was hit by an increase in expenses (discussed below), $2.2 million losses from the retail segment and the nearly $320,000 losses from the newly established U-Swirl segment.
Investors should note that the company's manufacturing segment gets nearly 20% of its revenues from a single external customer.
The Last Few Years
Rocky Mountain Chocolate Factory went public just a couple of years after its formation. In the last five years of its operations, Rocky Mountain Chocolate Factory has not shown consistency in top and bottom line growth. Compared to FY-2009, revenues have risen by 27% while its net income has dropped by 60%.
FY2009 | FY2010 | FY2011 | FY2012 | FY2013 | |
Revenues | 28,539 | 28,437 | 31,128 | 34,627 | 36,315 |
Op Income | 5,819 | 5,671 | 5,950 | 5,853 | 2,540 |
Net Income | 3,719 | 3,580 | 3,911 | 3,876 | 1,478 |
Rev Growth | -10.47% | -0.36% | +9.46% | +11.24% | +4.87% |
Amount in US$ Thousands
The company's fiscal year ends on February 28th or 29th
As indicated in the table above, Rocky Mountain Chocolate Factory's bottom line growth has been far from impressive. In its previous annual results, the company's earnings halved due to a significant increase in, virtually, every single expense head. But more importantly, the company recorded a $2 million loss on the sale of Aspen Leaf Yogurt's assets and restructuring charges of more than $635,000.Without these two charges, Rocky Mountains Chocolate Factory would have reported operating income of $5.187 million. This would still show a drop of 11.4% from FY-2012 and a drop of 10.9% from FY-2009. Without the loss on sale of assets and restructuring charges, a drop in earnings would not have been as severe, but nonetheless, it would still have reported a double digit decline.
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Source: RMCF 10-Q
As mentioned earlier, Rocky Mountain Chocolate Factory has produced 2.67 million pounds of chocolate candies in the previous fiscal year, which shows a modest growth from FY-2012, but is 6% below its pre-financial-crisis level of 2.84 million pounds in FY-2008.
The global financial crisis had an adverse impact on the demand for discretionary items, including Rocky Mountain Chocolate Factory's products. Due to the persistent weakness in the economic environment, Rocky Mountain Chocolate Factory has struggled with growth, which is evident from the table above. For the fiscal year ending February 2008, Rocky Mountain Chocolate Factory reported revenues of $31.8 million, which dropped by 10.5% in FY-2009 to $28.5 million.
In short, the company's performance is closely linked with the economic environment. A strong economy and higher consumer discretionary spending will translate into a healthy business environment for Rocky Mountain Chocolate Factory. Otherwise, the company will either lose customers altogether, or to its competitors.
Rocky Mountain Chocolate Factory's competitive advantage lies in its high-quality products, ambiance of its outlets and its brand name. The company does not compete on price and faces tough competition from several competitors that offer lower-quality products at lower prices. In times of weak economic environment that drag a consumer's purchasing power, Rocky Mountain Chocolate Factory will lose customers to these competitors.
Rocky Mountain Chocolate Factory has not used the national conventional media advertising to drive its sales. Instead, the company has relied on brand recognition to fuel its growth. The business has participated in local and regional events and charitable causes. It has also used social media to create brand awareness. More importantly, the company's store location in areas of high foot traffic has played a crucial role in creating the brand awareness. However, on the back of a tough economic environment, the company has reported a significant decline in the number of stores and kiosks in the U.S (discussed later in the article). For a company that does not use traditional media advertising and relies heavily on brand recognition, Rocky Mountain Chocolate Factory will end up losing customers altogether due to the significant reduction in the number of domestic stores.
However, on a positive note, despite the challenging business environment, Rocky Mountain Chocolate Factory has recorded three consecutive increases in annual revenues.
Performance This Year
Earlier in October, Rocky Mountain Chocolate Factory announced its quarterly results in which its total revenues increased by 12% year-over-year to $8.66 million due to a 7% increase in sales to $6.69 million and a 32% increase in franchise and royalty fees to $1.98 million. The significant jump in franchise revenues came due to the acquisition of 60% stake in U-Swirl. However, when comparing the company's results with the previous quarter, it should also be noted that in Q2-FY2013, the business witnessed a drop in both operating income (down 10% YoY) and net income (down 9% YoY). Therefore, some of the increase in the recent quarterly earnings can be attributed to a drop in income in the corresponding quarter last year.
Its total costs and expenses rose 9%. The relatively smaller increase in costs as compared to revenues caused a 26% increase in operating income to $1.59 million. This translated into a 24% increase in net income to $1.02 million.
Meanwhile, U-Swirl reported operating income of $172,000 for Q2-FY2014 as opposed to the operating loss of $172,000 in the same quarter last year related to Aspen Leaf Yogurt.
Although a turnaround at U-Swirl was one of the main reasons behind the strong quarterly performance, the same-store sales at domestic franchise stores and the same-store pounds purchased by domestic franchisees rose 1.7% and 2.2% from the same quarter last year. On the other hand, the same-store sales at the company-owned stores fell 0.4% from last year.
In short, the company's results were good, but they were certainly not great.
Organic growth
In terms of number of stores, Rocky Mountain Chocolate Factory has grown by 26% for the five years ending February 2013 from a total of 344 stores to 432 stores. However, nearly all of this growth can be attributed to the U-Swirl transactions.
A comparison of the 2008 data with the most recent store count highlights Rocky Mountain Chocolate Factory's struggling growth. The business did not report the number of co-branded stores in 2008 as the project was initially in the testing phase. Moreover, back in 2008/09 Rocky Mountain Chocolate Factory also did not have any U-Swirl, or Aspen Lead Yogurt Stores. Therefore, eliminating these store numbers from the 2013 data would give a rough idea about the company's organic growth over the last five years.
These store numbers are shown in the table below. In more than five years, Rocky Mountain Chocolate Factory has opened just one additional company-owned store and 29 new franchise stores in the international markets. However, this was completely offset by the closure of 70 franchise stores and kiosks in the domestic market and as a result, in these comparable terms, Rocky Mountain Chocolate Factory has 40 fewer stores now than it had back in early 2008.
Feb-08 | Aug-13 | Change | |
Company owned stores | 5 | 6 | +1 |
Franchise stores - Domestic stores | 280 | 222 | -58 |
Franchise stores - Domestic kiosks | 18 | 6 | -12 |
Franchise stores - International | 41 | 70 | +29 |
Total Stores | 344 | 304 | -40 |
As the table clearly points out, Rocky Mountain Chocolate Factory has struggled with domestic growth but it has improved its international footprint, with a particular focus on Middle East and Asia. However, the growth has been rather slow.
Long term growth: International Expansion
A key component of the company's long term growth strategy has been international expansion. Through this, Rocky Mountain Chocolate Factory believes that it will reduce its reliance on the struggling domestic market. Moreover, there are enormous opportunities for growth in the Middle East and Asia Pacific. In Asia, Japan has been the biggest consumer of chocolate with per capita consumption of 1.84 kg (2012). Here, Rocky Mountain Chocolate Factory has been eying its long term future as it was planning to open hundreds of stores within 10 years.
Last year, Rocky Mountains Chocolate Factory announced its aggressive expansion plans for the Japanese market but has failed to deliver on its promise. As per the Master Licensing Agreement, at least 10 new stores will be opened in Japan, each year, for the next 10 years. This way, Rocky Mountain Chocolate Factory will have opened at least 100 new stores within 10 years. However, the expansion seems to have stalled at just 5 stores. In its annual filing, the business pointed out that, as of March 2013, it had 5 stores in Japan. Then, at its recent conference call held earlier in mid-October, the management revealed that they are still at 5 stores. That is 5 stores in 19 months when, as per the agreement, Rocky Mountain Chocolate Factory should have opened around 15 stores by now.
The slow growth of its Japanese operations can be attributed to its partner but Bryan Merryman, the company's CFO believes that "we still have business development activities going there and we still continue to seek another partner in Japan." The weak Yen also had an adverse impact on its operations but now the company is eyeing a "resumption of growth here in the next 6 to 12 months."
On the other hand, Rocky Mountain Chocolate Factory has shown relatively better performance in South Korea. The business opened its first store around 6 months ago and by September, the company has 5 stores in the country.
Back in 2008, besides the United States, the business had operations in Canada and the United Arab Emirates. The business had an agreement with the Al Muhairy Group through which the Emirati group purchased exclusive rights to open Rocky Mountain Chocolate Factory's stores in the stores in the United Arab Emirates, Qatar, Bahrain, Saudi Arabia, Kuwait and Oman. Back then, they had just 3 stores. By the end of March, 2013, this number improved to 5 stores. In other words, in the last 5 years, just 2 more international stores have opened in the United Arab Emirates. In its recent conference call, the management also hinted towards development in the license agreement for operations in Saudi Arabia.
Conclusion
Rocky Mountain Chocolate Corporation is a relatively low-risk small cap stock with no debt, a current ratio of 3.44, which is twice as high as the industry's average, and has regularly paid dividends for 41 consecutive quarters. The business gives a healthy yield of 3.4%, which is above the industry's average of 2.1%. The company has successfully grown its top line revenues over the last three years and its recent quarterly results were good (though not great).
However, the company's growth over the last five years has been extremely slow. Therefore, it is no surprise that over a period of 5 years ending February 2013, Rocky Mountain Chocolate Factory has generated lower cumulative total returns as compared to its peer group comprising of Hershey Company (HSY), Paradise Inc (OTCQB:PARF), Tootsie Roll Industries (TR) and Valhi (VHI), as well as the broader Russell 2000 Index (IWM), and the NASDAQ Composite Index.
Rocky Mountain Chocolate Factory is still feeling the impact of the financial crisis. The company has clearly struggled in the domestic market while it has not delivered on its promise of international expansion. The company has been focusing on international expansion for around 2 years but has very little to show for it. The Japanese agreement was a big step in the right direction but it has failed to materialize. Similarly, the company has little to show for its +5 years of operations in the Middle East. This brings into question the management's conservative approach and their execution capability.
In the last six months, Rocky Mountain Chocolate Factory's stock has dropped by 2% while Russell 2000 has been up 13%. Similarly, with the exception of Valhi, the shares of its competitors mentioned above have easily outperformed Rocky Mountain Chocolate Factory. Moreover, Rocky Mountain Chocolate Factory's shares are trading 46 times their trailing earnings. The shares are expensive since they are considerably above the industry's average P/E of 23 and are closer to the company's 5-year high P/E of 52. This is expensive for a company that has consistently underperformed in the last few years.
More importantly, there are serious question marks over the company's ability to deliver long term growth due to which it may continue to underperform in the future. Therefore, I believe investors should avoid this stock.
Notes:
Rocky Mountain Chocolate Factory's CEO Discusses F2Q 2014 Results - Earnings Call Transcript
Rocky Mountain Chocolate Factory's CEO Discusses F3Q 2013 Results - Earnings Call Transcript
Rocky Mountain Chocolate Factory - SEC Filing 10Q [Pdf]
Rocky Mountain Chocolate Factory - SEC Filing 10K [Pdf]
Rocky Mountain Chocolate Factory - SEC Filing 10K 2008 [html]
Rocky Mountain Chocolate Factory - SEC Filing 10K 2009 [html]
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Business relationship disclosure: This article expresses my own opinions and does not constitute investment advice.The article contains information that was obtained from company's official documents and/or other sources which I believed were reliable, but has not been independently verified. Therefore, I cannot guarantee its accuracy. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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