One word summarizes both Rocky Mountain Chocolate Factory's
Recent months have been a mixed bag for the chocolate and confectionary industry. While Topps
A Mother's Day boost?
Jeremy: Bodhi, get us started. What's the winning recipe for Rocky Mountain?
Bodhi: The nickname "Sweetness" fits nicely for the company -- I'll stick with that. Its winning recipe, simply stated, is franchising.
Jeremy: Let's take a look, then. There were 6.9% more domestic franchise units in operation for the quarter, compared to the year-ago period. Meanwhile, the franchised retail outlets only managed to increase same-store sales by 0.4%. Explain in more detail -- where did the company get the additional double-digit growth to its top line?
Bodhi: CFO Bryan Merryman stated in the call that the main source of Sweetness's profitability is the 90% of net revenues driven by the top 75% of its retail units. Even though factory revenues provided the company's greatest growth, increasing nearly 39% for the quarter, they were helped by the 6.9% increase in stores available to drive orders. The strategy is simple: Open new units to fuel factory orders.
Hank: The first quarter benefited from more than franchises. Management is calling for full-year EPS to increase between 17% and 22%. Given that EPS in the first quarter increased 27%, I guessed that the company received an extra top-line boost in the first quarter that it doesn't expect to see through the remainder of the year. And when we listen to the call, that's exactly what we find.
Outside its traditional retail network, Rocky Mountain has two large vendors who regularly place bulk orders. One customer in particular placed a "fairly large shipment for their Mother's Day business." In response to one analyst's query, Merryman added, "We don't expect that kind of increase that we had in the first quarter to continue on in the second, third, and fourth quarter."
Still sweet, even with flat comps?
Jeremy: Still, overall, a very solid quarter. Can it continue?
Bodhi: For Sweetness? Of course it will continue. The company and its franchisees only have 304 units in operation to date. Management believes it can meet or exceed the target to add 40 more retail outlets this year. That alone represents about 15% in growth.
Hank: Too bad its existing units are of little help. I mean, you're giving all-time great running back Walter Payton's nickname to a company that couldn't even stir up 1% growth in comps. And management's lack of response on the issue troubled me. One analyst specifically asked Merryman to comment on its flat comps, and his response provided little comfort: "[I don't] have a whole lot of insight into that, other than it seemed like an OK quarter."
OK? It grew comps by 4% in the year-ago period. That's OK. Flat comps don't fit that description.
Bodhi: Give Merryman more credit than that, Hank. When pressed further on the issue, he said candidly, "The Chocolate Factory isn't what I would call historically a same-store sales play." He added that many of its retail outlets are located in tourist areas, which typically equates to the sites "maturing fairly fast." So if you're looking for it to build on comps every year like Cheesecake Factory
With 304 units in operation, this company has plenty of growth opportunities. One analyst asked about its international efforts, and I found Merryman's response encouraging: "We feel that there's still a lot of room for growth here in the United States."
Hank: But if this company can't figure out a way to begin building a solid customer base, and increasing in-store traffic annually, I'm afraid this concept's end will come sooner rather than later. There are only so many tourist locations it can expand to. What happens when they run out?
One analyst called in to give management a pat on the back, adding, "You keep on delivering, and in terms of the market, I guess it just doesn't care." Perhaps it does care, and it doesn't care to get burned by a company whose business appears to be driven purely by tourism and novelty.
The debate continues
Jeremy: Let the debate continue about whether Rocky Mountain Chocolate Factory represents a solid long-term play for investors. On the one hand, its lack of comps consistency would suggest the company has a shorter life span than other concepts -- a concern also raised by my colleague, Stephen Ellis. On the other hand, with only about 300 units in operation, there's still ample room for growth in United States, not to mention internationally.
If a prospective investor can accept the current business model, they can take comfort in knowing that management appears to be doing well within its given structure. The top line will continue to be driven by franchising, and though net income may trail slightly behind as margins get squeezed from a shift in product mix, a share buyback program should compensate enough to drive double-digit EPS growth. Top it off with a tasty dividend, and there may be just enough sweetness at Rocky Mountain Chocolate Factory to merit a closer look.