Small Caps | Dec 02 2011
– UBS initiates with Buy rating on Retail Food Group
– Resilient category is attractive, online retail less of a threat
– Acquisitions should continue to assist growth
By Chris Shaw
Retail Food Group ((RFG)) is one of Australia's largest owners of food retail franchise systems in the Australian and New Zealand markets, its network covering more than 1,100 outlets. These include Donut King, Michel's Patisserie, Brumbies Bakery, Big Dad Pies, bb's Cafe and Esquires Coffee House brands.
To date the market has offered mixed views on Retail Food, the FNArena database showing RBS Australia rates the stock as a Hold while JP Morgan's recommendation is Overweight. The balance has now been tilted to the positive side, as UBS has initiated coverage with a Buy rating.
One major positive for UBS is Retail Food operates in a resilient category, as the group's franchises operate in the low basket size end of the market. This reflects the treat/impulse buy nature of the products on offer.
A further attraction in the view of UBS is given the nature of the businesses under the Retail Food umbrella, there is less competition from online retail offerings. As well, the franchisor system means a low fixed cost base, as Retail Food is not up for rents and store wages. This means low operating leverage risk.
The impact of such a structure on earnings is relatively significant. On UBS's numbers, a 1% change in network sales translates into a 1.7% change in earnings per share (EPS).
The core competency of Retail Food is optimising and expanding its franchise systems, examples being system improvement in terms of supplier consolidation, extending menus and increased automation in operations.
UBS expects this strategy will continue to be applied to future acquisitions, especially as the markets in which Retail Food operates remains highly fragmented and the business model is scaleable. A solid balance sheet should assist in this regard, UBS noting Retail Food has a debt to EBITDA (earnings before interest, tax, depreciation and amortisation) ratio of 1.5 times and generates strong cash flows.
Applying this strategy is expected to deliver solid earnings growth, UBS forecasting EPS growth of 7% in FY12 and 7.5% annually over the next three years. In terms of actual forecasts, UBS has EPS estimates for Retail Food of 27c for FY12 and 29c for FY13. These forecasts compare to consensus EPS expectations according to the FNArena database of 28c and 30.1c respectively.
Using these forecasts sees UBS calculate a valuation range for Retail Food of $2.85 to $3.15, with the broker setting its price target in the middle of this range at $3.00. This is broadly in line with the consensus price target according to the database of $2.91.
Post the full year result of Retail Food in August, RBS Australia cut its target to $2.65 from $3.09, the change reflecting a soft organic growth outlook given still tough retail conditions. While JP Morgan also lowered its target to $3.09 from $3.52 the broker retained a more positive view on the stock. This reflected the fact Retail Food could still grow earnings despite a poor operating environment, which supports the broker's view the market continues to undervalue the stock.
Over the past year the shares have traded in a range of $1.995 to $3.00, the current share price implying upside of around 16% to the consensus price target in the FNArena database.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
