Gloria Jean’s Boosts Retail Food’s Potential

This story features RETAIL FOOD GROUP LIMITED. For more info SHARE ANALYSIS: RFG

-Multiple growth drivers
-36% FY15 profit growth forecast
-Some structural issues
 

By Eva Brocklehurst

Gloria Jean's has put extra sugar into Retail Food Group's ((RFG)) morning coffee. Retail Food has substantially raised the ante on its medium-term earnings potential after announcing it has acquired the coffee shop chain.

Retail Food now boasts multiple growth drivers and the acquisition has inspired Morgans to upgrade to Add from Hold. The acquisition involves around 800 franchised Gloria Jean's outlets across 42 countries with 358 in Australia. While acknowledging the risks in an acquisition of this size, Morgans believes the potential is hard to ignore. The company also has a wholesale coffee business with two roasting facilities. The $163.5m price with $16.4m in milestone payments will be funded by a capital raising of $55m, $10m worth of scrip for the vendors, and debt. Morgans expects 25% underlying earnings growth in FY15/16 and sustainable double digit returns over the medium term.

Risks centre on the sustainability of the Gloria Jean's domestic footprint, given the decline in local outlets has not yet stabilised, after peaking at 500 in 2012. Retail Food has made provision for a further 40 shop closures. This may raise some questions about the brand but Morgans believes franchise capabilities, along with the broader opportunity within the segment, should deliver a solid outcome. A large part of the store rationalisation to date has been company-owned stores. After incorporating the acquisition Morgans' calculations suggest, at a valuation of $6.06, the stock would trade at a FY16 price/earnings multiple of 14.6 times and a 4.5% dividend yield.

JP Morgan is not so buoyant, believing the acquisition is at the top end of the range paid for historical acquisitions, although acknowledges 25% accretion to earnings in FY16. There are synergy opportunities and the potential for leveraging the wholesale coffee business but the broker questions the health of the Gloria Jean's model, given it re-exposes Retail Food Group to shopping centres. The company has upgraded FY15 guidance for profit growth to 36%, including both Cafe2U and the Gloria Jean's acquisition. This compares with 18.5%, including Cafe2U, that was previously forecast. Guidance is based on the closure of those 40 stores identified with extremely high rent-to-sales ratios. JP Morgan notes the company has actually only planned for the closure of 22, although provisioning for 40, which means there is upside to guidance.

Despite market studies conducted by Retail Food which found that Gloria Jean's had the best coffee sales up to 11am, JP Morgan is reminded that Gloria Jean's was close to insolvent in 2010. Still, Retail Food believes this background is outweighed by the synergies and the wholesale and international opportunities. JP Morgan maintains an Underweight rating, pending results from the capital raising.

To UBS the acquisition is transformational and deserves an upgrade to Buy from Neutral. This is based on achieving targeted synergies which would imply additional earnings of $37m by FY17, translating to earnings per share of 47c or higher. In the broker's sums the valuation range works out at $5.40-6.15, well above the current share price at around $5.30. UBS envisages abundant scale and network benefits but also a number of structural growth issues. Ultimately the broker's Buy thesis rests heavily on supply/cost synergies while execution remains the key risk.
 

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