FRG - Franchise Group: Retirees Buy This Stock For Strong Dividend Yield

Summary

• Franchise Group pays annual dividend of $2.5 per share which represents a dividend yield of 8.64% at current share price.
• The company is constantly focusing on diversification of its portfolio with acquiring businesses with strong unit economics.
• After comparing the forward P/E ratio of 9.70x with the sector median of 13.01x, we can say that the company is undervalued.

Investment Thesis

Franchise Group (FRG) is a franchising platform which deals in acquiring and managing franchise companies. It focuses on diversifying its portfolio with emerging and market-leading brands. The company has an impressive history of stable and consistent dividend growth which I believe makes it an attractive investment opportunity for retired and risk-averse customers who expect to earn regular income along with capital appreciation.

About FRG

Franchise Group is a leading franchising platform which deals in owning and operating franchisee businesses that focuses on diversifying the company's portfolio of market-leading brands. It highly focuses on acquisition activities and organic brand development as being a multi-brand operator and in order to generate strong and consistent cash flows. The company's business brand consists of Pet Supplies Plus, The Vitamin Shoppe, American Freight, Badcock Home Furniture and More, Buddy's Home Furnishings and Sylvan Learning. Pet Supplies Plus is a franchisor headquartered in Michigan which deals in pet supplies and services. It has multiple revenue streams such as franchise royalties, revenue from company-owned stores and through distribution of products to its franchises. The Vitamin Shoppe deals in vitamins, sport nutrition products, minerals, various herbs and supplements including other health and wellness products. Its broad product offering has significantly increased customer engagement with improved customer experience. The American Freight is a retail chain business dealing in furniture, mattresses, innovative home appliances and other household accessories. This segment has low overhead costs as the business directly buys from the manufacturers and sells it to the wholesale stores which helps in providing goods to the customers at a low price. The Badcocks segment is a showroom format business which sells furniture, electronics, bedding, appliances, equipment used in home offices, accessories and other seasonal products. The business is headquartered in Florida and has future plans of shifting consumer financing business into third party vendors. The Buddy segment conducts its business through rent to own agreements and deals in consumer electronics, home accessories, appliances and residential furniture. The rental transactions allow customers to use high quality products without long term obligations. Sylvan Learning is a franchisor dealing in supplemental education mainly for Pre-K-12 students and families based in the US and Canada. It is an omnichannel business which provides a wide variety of academic curriculum including various other services on the Sylvan platform itself.

High Dividend Yield

The company's dividend payout has seen a stable and impressive growth since 2018 which is one of the factors signaling the well-positioning of the company in this competitive market. During the year 2022, the company distributed a cash dividend of $0.625 per share in each of the four quarters, making the annual dividend of $2.5 per share. This dividend payout represents a dividend yield of 8.64% at current share price. I believe the company can sustain and further grow this dividend payout in the coming years as it is constantly focusing on diversification of its portfolio with acquiring businesses with strong unit economics. Besides the acquisitions, the business is highly scalable and has a lot of growth opportunities by means of organic brand development. It is also highly focused on refranchising strategy which has significantly helped the company to create cash flows to the business and further ensure sustainability of dividends. Some of the company's brands are planning to expand in new markets which can also highly contribute to the company's revenue growth. As per my analysis, all these above factors can play a crucial role in the company's performance and help it to achieve a long-term upside with consistent dividend growth. I think the high dividend yield makes the company an attractive investment option for those who are seeking regular income in the form of dividends along with capital appreciation.

What is the Main Risk Faced by FRG?

The company has substantial indebtedness which can have a negative effect on its financing options and liquidity positions. If the level of debt increases it can affect the company's ability to acquire additional financing for the purpose of acquisitions, capital expenditures and working capital. High debt can also result in increased cost of future borrowings which can further affect the company's profit margins.

Valuation

The company has a lot of growth potential fueled by diversification of portfolio, expansion in new markets and refranchising strategy which I believe can act as a catalyst to push the stock upwards. After considering all the above factors, I am estimating EPS of $2.98 for FY2023 which gives the forward P/E ratio of 9.70x. After comparing the forward P/E ratio of 9.70x with the sector median of 13.01x, we can say that the company is undervalued. I believe the company can gain significant momentum in the coming times as a result of its growing and diversifying portfolio and can help it to trade above its sector median. I estimate the company might trade at a P/E ratio of 14.39x, giving the target price of $42.88, which is a 48.27% upside compared to the current share price of $28.92. High debt levels of the company can affect the company's performance and reduce its profit margin. I believe in that case, it can contract the profit margins and EPS of the company.

I believe in the bear case scenario of high debt, the EPS of FY2023 might be $2.90 and estimate that the company might trade at a P/E ratio of 14.00x, which gives a target price of $40.60, representing an upside of 40.38%.

Conclusion

Franchise Group is a global franchising platform designed for emerging and leading brands of various industries. The company is exposed to the risk of high debt levels which can affect its refinancing cost further contracting its profit margins. It has an impressive history of dividends payouts and I believe the company can further grow and sustain this payout as a result of its diversifying portfolio, organic growth opportunities and growing focus on refinancing strategy. After considering all the above factors, I assign a buy rating to Franchise Group.

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