Australia | Nov 06 2012
– Weekly sales growth for Retail Foods franchises is slowing
– JP Morgan sees this as impacting on group growth
– Adds to risk given growth will need come from acquisitions
– Broker downgrades to Underweight rating
By Chris Shaw
Average weekly sales growth for the core franchise systems of Retail Food Group ((RFG)) has slowed in recent years to less than 2.0% across all systems, with falling shopping centre traffic seen as a major contributor.
In JP Morgan's view this trend of slowing sales growth is likely to continue across the medium to long-term, meaning the primary way for the company to achieve growth going forward would be through increases in average transaction value.
One problem with this according to JP Morgan is that given the price elasticity of customers to snack items, there is limited ability for Retail Foods to continue to grow average transaction value.
As JP Morgan notes, this limits the ability of Retail Foods to add outlets to its core franchises, as there is less appetite from new franchisees and potential franchise owners are put off by stringent lending requirements.
This leaves Retail Foods needing to grow via acquisition and here the company continues to be active, having entered into a conditional agreement to acquire New Zealand-based “The Coffee Guy Group” for NZ$5.5 million.
The deal represents vertical integration of the existing coffee division of Retail Foods and in JP Morgan's view offers good potential for expansion in the New Zealand market from the existing 55 mobile espresso vans, one drive-through and two retail outlets.
The deal follows the recent acquisition of Pizza Capers and Crust Pizza for $71 million. This was partly funded by a capital raising that lowered gearing for Retail Foods to just over 28%. While management has a good track record in integrating new businesses, JP Morgan suggests the need for acquisitions to deliver growth increases execution risk for the stock.
As an example, JP Morgan points out the terms of the Crust acquisition were changed so that earn-out provisions were removed. This has the effect of shifting risk to shareholders, something the broker suggests justifies a valuation discount for Retail Foods.
This discount has been incorporated in the broker's model, as base case valuation for Retail Foods for JP Morgan stands at $3.28. This model assumes the company can increase sites for new acquisitions in accordance with existing plans.
JP Morgan's price target for Retail Foods has been lowered to $2.95 from $3.01 as the broker has factored in a discount for execution risk. JP Morgan's revised price target now sits below the consensus price target according to the FNArena database of $3.13.
At the same time JP Morgan has downgraded its rating on Retail Foods to Underweight from Neutral, this to account for the increased risk from acquisition-based growth. The downgrade puts JP Morgan at odds with other brokers to cover Retail Foods, as both RBS Australia and UBS rate the stock as a Buy.
RBS's positive rating reflects the view earnings growth for Retail Foods will remain solid, while the broker also sees the dividend yield on offer of better than 6% in FY13 and 7% in FY14 as attractive. RBS's forecasts are for earnings per share (EPS) of 27.8c in FY13 and 31.8c in FY14, which compares to JP Morgan's estimates of 30c and 32c and consensus EPS estimates according to the database stand at 29.3c and 32.3c respectively.
In a slightly stronger market shares in Retail Foods today are higher and as at 12.00pm the stock was up 3c at $3.05. This compares to a range over the past year of $2.34 to $3.30, the current share price implying upside of around 3% relative to the consensus price target in the FNArena database.
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