2023-08-04 02:25:27 ET
Summary
- Hopes pinned on new strategic transformation plan to reverse years of soft performance.
- The plan could generate some positive results, but execution risks could impact near term financial performance. Liquidity risks cannot be ruled out.
- Long term growth targets look ambitious.
New management at Rocky Mountain Chocolate Factory ( RMCF ) is implementing a transformation plan to reverse years of soft performance. In theory, the plan which addresses branding and operational gaps could deliver positive results, however, execution risks are significant; near-term financial performance may take a hit and long-term results remain to be seen. Liquidity position is worrying as well.
Strategic transformation plan underway
Rocky Mountain has so far delivered soft performance with revenues contracting consistently over the past several years along with a shrinking store count which has decreased 30% over the past decade; FY2022 and FY2023 were exceptions as a recovery from pandemic-related sales impacts spurred YoY revenue growth during those two years but in absolute terms revenues remain below pre-pandemic levels.
Along with the appointment of a new CEO last May, the company also announced a new transformation plan which includes implementing logistics improvements and channel expansion (to include channels outside their franchisee network such as big-name retailers like Amazon and Costco), modernizing their Durango factory equipment, rebranding franchisee stores, increasing eCommerce sales (from 2% of sales currently to 10%), and closing 25-35 of its underperforming stores while opening 75-100 new stores over the next five years in partnership with multiunit operators (currently just 25% of store operators operate more than one store, a figure Rocky Mountain hopes to increase). Progress to date include the divestment of the company's U-Swirl yogurt franchise business in May this year, continued store footprint rationalization, a rebranding effort with the appointment of a new branding and creative agency, as well as a renewed focus on product development with the hiring of a new R&D director .
Transformation plan could be positive, but question marks remain and much depends on execution
The U-Swirl divestment could free up capital and help the company focus on their core chocolate business (U-Swirl's financial performance has been declining since 2017, so the divestment should not have a material impact on earnings prospects), store rationalization, rebranding and product innovation could help improve Annual Unit Volumes (which the company aims to increase to $800,000 by FY2028 from $574,000 in FY2023) and enhance the brand's appeal for prospective franchisees (thereby supporting their target of opening 75-100 new stores over the next five years). Rebranding and product innovation, assuming positive customer reception, could also increase marketing efficiency and therefore improve margins. At $2 million in FY2023, Rocky Mountain's marketing spend amounted to 6% of revenues for the year. There are no directly comparable competitors to RMCF however peers in the franchise business such as McDonald's could offer some perspective; McDonald's spent less than $350 million , or around 2% of revenues on marketing expenses during its most recent fiscal year.
Going forward, management plans to increase focus on high volume products, which could be positive for factory capacity utilization (which is extremely low at an estimated roughly 20% based on their average selling price of $27/lb according to their FY2023 10-K, revenues of roughly $25 million and factory production capacity of 5.3 million pounds annually) and gross margins. However, a high-volume strategy also suggests a product mix likely tilted towards lower-priced products which could limit margin expansion if volumes fail to sufficiently pick up. In addition, there are question marks over the company's pricing strategy with some comparable products being considerably more expensive than peers. For instance a 24-piece box of truffles from See's Candies, the leading player in America's chocolate shop space, is less than half the price of a 9-piece box of truffles from Rocky Mountain chocolate factory based on prices from their respective online stores. Some may argue that See's is focused on the value segment while Rocky Mountain is focused on the premium segment, however, the price disconnect is apparent compared with premium chocolate players as well; Belgian premium chocolatier Godiva's 24-piece box of truffles is slightly more than three-quarters of the price of Rocky Mountain's 9-piece box of truffles. Rocky Mountain's margins are already lagging behind peers like See's Candies and a pricing reevaluation along with a shifting product mix may affect margins and cash flows which are already likely to come under pressure near term due to increased investments in brand building, logistics, and operational improvements, barring a larger than anticipated increase in volumes. See's profit margins are around 21% ( $80 million profit on $380 million revenues), considerably higher than Rocky Mountain whose operating margins have hovered below 20% over the past decade.
RMCF's longer-term performance depends to some extent on their ability to expand their store count. Management is aiming to open 75-100 stores over the next five years however this remains to be seen. Unlike See's Candies who owns all their stores, Rocky Mountain's capital-light franchise model could support rapid store expansion however this still looks quite ambitious; for perspective, market leader See's Candies which has a very strong brand, superior per store economics (See's Candies generates average store sales of roughly over $1 million based on revenues of $380 million mostly generated in the U.S. where See's Candy has an estimated 275 stores), and scale advantages (See's sells 20.1 million pounds of candy annually compared with an estimate of roughly less than 2 million pounds for Rocky Mountain) opens roughly 6-10 locations annually. Godiva meanwhile shut all their U.S. and Canada stores a few years ago, deciding instead to focus on online sales.
Financials
Rocky Mountain's CAPEX spend has been stepping up recently but still remains low; for perspective CAPEX spend is around 3% of revenues for Rocky Mountain compared with 10% for chocolate giant Hershey and 8% for McDonald's. Going forward Rocky Mountain's CAPEX needs may continue trending upwards along with the company's turnaround ambitions, but unless the company can successfully reverse its consistently declining operating cash flows, they may be forced to turn to external sources to fund their turnaround.
Operating cash flows turned negative during their most recent fiscal year, largely driven by their deteriorating bottom line; net losses ballooned to $5.7 million in FY2023, from a loss of $300,000 the previous year, driving their operating cash flows towards negative territory (negative $2.1 million for the year) for the first time over the past decade. Including CAPEX of $1 million, the company burned through nearly $3 million in cash in the last fiscal year, and with just $4 million left in the bank, at their current burn rate the company is likely to require external financing barring an unforeseen material improvement in profitability. Free cash flows remained negative during their latest quarter (quarter ended May 2023 ) and at this stage the likelihood of requiring external financing remains high.
With virtually zero debt on their balance sheet, there is ample room to take on debt. However, with the current tight lending environment, banks may hesitate to lend to a business with deteriorating cash flows, and the company may be forced to turn to other funding sources (such as PIPE funding) which could negatively impact shareholders.
Risks
Execution risks
Although management's transformation plan has merits, execution risks could dampen turnaround prospects. Revenues continued to drop during their latest quarter (down 6.7% YoY) and margins continued their downward trajectory as well; gross margins dropped to 13.9% during the quarter from 15% the previous quarter and 26% the same quarter a year earlier. Net margins worsened to negative 12.8% during the May quarter from 1.7% the same quarter a year earlier. At their current trajectory, executing a turnaround plan could become more and more challenging and profitability could continue trending downward further worsening earnings prospects and therefore market value.
Liquidity risks
The company's free cash flows are currently negative and with further business deterioration possible in the near term and a cash balance that could last about a year or so, the company's liquidity position is worrying.
Conclusion
Rocky Mountain has limited analyst coverage.
Rocky Mountain Chocolate Factory has a new management and transformation plan which is hoped would reverse years of consistently sluggish performance. The plan could deliver positive results helped by a refreshed brand image (assuming positive customer reception), streamlined operations and wider omnichannel presence. However, execution is key and if sales volumes fail to pick up in response, margins (which are already lower than peers) and cash flows (which have been steadily declining and have turned negative recently) could be affected near term. Meanwhile, the company's long-term growth partly rests on expanding their store network but their target of 75-100 stores looks ambitious currently based on available information on their strategy. The stock may be a hold for investors willing to tolerate the risks.
For further details see:
Rocky Mountain: Transformation Plan Underway But Significant Risks Remain