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People haven’t stopped craving chocolate, which has helped Rocky Mountain Chocolate Factory, Inc. (NASDAQ:RMCF) and its stock rise significantly since early 2020 when Coronavirus hit the stock market.
However, with the company’s stock being at about $7.50 per share, is there any room left for optimism and further price appreciation?
Recovery Coupled With A Pristine Balance Sheet
RMCF is a global confectionery manufacturer, international franchisor and retail operator offering gourmet chocolate, confection and self-serve frozen yogurt that operates more than 300 Rocky Mountain Chocolate Factory and self-serve frozen yogurt stores across the United States, South Korea, Qatar, the Republic of Panama, and The Republic of the Philippines.
In 2020, RMCF experienced significant business disruptions due to COVID-19, including the vast mandated self-quarantines of customers and closures of non-essential business throughout the United States and internationally. As a result, revenue in FY 2021 was negatively impacted by public health measures taken in response to COVID-19 and were down 26.3% to $23.5 million compared to $31.8 million in FY 2020 while the company recorded a net loss of $900K compared to net income of $1 million during FY 2020.
However, from an operational standpoint, things have gradually returned to normalcy over the last quarters with revenue and margins recovering to decent levels in FY 2022.
Specifically, revenue increased 57.5% to $24 million in the first nine months of FY 2022 compared to $15.3 million during the first nine months of FY 2021. And we project that annual revenue in FY 2022 will exceed FY 2020 revenue of $31.8 million given also that the strongest sales of RMCF’s products occur during key holidays (i.e., Dec-Jan-Feb) and the summer vacation season.
The deal with Edible Arrangements that was extended in March 2020 has played a key role in this recovery because privately-held Edible Arrangements is the world’s largest franchisor of stores offering all-natural fruit snacks, dipped treats and fresh fruit arrangements with more than 1,100 locations worldwide.
Moreover, thanks to the aforementioned profit margin expansion, adjusted EBITDA increased from a loss of $(2.6) million in the nine months of FY 2021 to positive adjusted EBITDA of $3.7 million in the nine months of FY 2022, but we project that adj. EBITDA in FY 2022 will not reach pre-pandemic levels. Actually, we forecast that adj. EBITDA in FY 2022 will be about $5 million versus $6.2 million in FY 2020.
Given also that the Enterprise Value currently is about $42 million, RMCF currently trades approximately 1.3 times its FY 2022 revenue and 8 times its FY 2022 adj. EBITDA, so it’s fairly valued.
It’s also noteworthy that RMCF has generated positive operating cash flow and positive free cash flow in the first nine months of FY 2022, so it has managed to remain debt-free while having $6 million in cash at the end of Q3 FY 2022. For comparison purposes, RMCF entered the pandemic period in March 2020 with zero debt and $4.8 million in cash. This is a significant accomplishment given that many retailers with brick and mortar stores burned a significant amount of cash due to the mandatory lockdowns and store closures associated with Coronavirus. However, RMCF is not ready to resume dividend payments that were suspended in May 2020. RMCF still has work to do in order to return to solid profitability and consistently generate positive operating cash flow and positive free cash flow in the next quarters.
Tailwinds And Headwinds
We will start with the tailwinds. And the global premium chocolate market is projected to witness a CAGR from 5% to 9% from 2021 to 2027, according to industry reports here, here and here. Although the major brands will continue to dominate the industry, we believe that there’s room for quality artisanal chocolate makers to grow their businesses.
Second, RMCF has a tradition of handcrafting chocolates for four decades, and therefore, it’s a trusted recognizable brand in North America. In other words, RMCF does not need to build its brand from scratch, which is a key factor when it comes to growth in the retail sector.
But the headwinds for RMCF’s business can’t pass unnoticed. First, RMCF’s chocolate products are expensive and will most likely remain expensive due to high inflation in the foreseeable future. Given also that the competition in the chocolate industry will remain fierce, the consumers will have plenty of choices in their effort to find quality chocolate at affordable prices.
Second, we’re not fans of frozen yoghurt because frozen yoghurt does not taste good. But this is something subjective and we realize that many other people don’t share our view. However, there’s no question that the frozen yoghurt is something between ice cream and yoghurt, which reminds us of someone who is trying to sail on two boats. But you can’t sail on two boats for long. You have to choose and give priority to one of them, because you will fall into the water sooner rather than later.
In other words, we believe that most consumers finally choose to go with either ice cream or yoghurt when they pick their dessert. They don’t usually crave something in between. And we guess that this is one of the key reasons why frozen yoghurt is one of those American concepts which has struggled to find popularity in Europe and Asia. The initial craze for frozen yogurt has faded over the last few years despite the fact that it’s a low-fat dessert. As such, we forecast that frozen yoghurt’s future is not promising, so the international expansion for RMCF’s frozen yoghurt business (U-Swirl) will be difficult and hardly profitable.
Growth
We projected above that FY 2022 revenue will return to pre-pandemic levels exceeding FY 2020 revenue of $31.8 million, but we forecast that they will hardly reach FY 2019 revenue of $34.5 million. Therefore, the key question is whether RMCF can return to growth mode given that its annual revenue has been declining since 2015. We project that growth is a sure thing, if the company does the followings:
1) Resolution of the disagreements with Edible, as quoted from the latest quarterly report (emphasis added):
During the nine months ended November 30, 2021, certain disagreements arose between RMCF and Edible related to the strategic alliance and ecommerce agreements resulting in continuing discussions, the result of which are not currently determinable. Purchases by Edible during the three and nine months ended November 30, 2021 were approximately $413,400 and $1.2 million, or 4.9% and 5.0% of the Company’s revenues, respectively. Purchases by Edible during the three and nine months ended November 30, 2020 were approximately $1.2 million and $2.1 million, or 16.3% and 13.9% of the Company’s revenues, respectively. There can be no assurance historical revenue levels will be indicative of future revenues.”
2) Resolution of the issue with Immaculate Confections, as quoted from the latest quarterly report (emphasis added):
During FY 2021 the Company initiated formal legal proceedings against Immaculate Confections (“IC”), the operator of RMCF locations in Canada. In its complaint, the Company alleged, among other things, that IC has utilized the Company’s trademarks and other intellectual property without authority to do so and that IC has been unjustly enriched by their use of the Company’s trademarks and intellectual property. In June 2021 a court order was issued declaring the original 1991 Development Agreement for Canada between RMCF and IC had expired. In September 2021, the Company and IC reached a Settlement Agreement (the “IC Agreement”) whereby the parties agreed to a six months negotiation period to explore alternative solutions. During the six-month period, IC will continue to operate locations as Rocky Mountain Chocolate Factory. The IC Agreement contains provisions that would require IC to de-identify its locations if a solution is not reached. As of the date of this filing, IC operates 49 locations in Canada. During the nine months ended November 30, 2021 the Company recognized approximately $116,800 of factory revenue from locations operated by IC in Canada compared with no revenue recognized from locations operated by IC in Canada during the nine months ended November 30, 2020.”
3) Product innovation and expansion of the product range: Currently, RMCF has a limited range of products. And we believe that two of the main growth drivers for every retailer are product innovation along with expansion of the product range, which also applies to RMCF. This is how RMCF will attract more gourmet food lovers and customers with a sophisticated feel.
For instance, the recent launch of the ruby chocolate is an excellent move and hopefully, the company will continue with additional carefully-crafted gourmet chocolates blended with fruits (i.e., exotic fruits, fig, pomegranate, etc.), specialty tea (i.e., matcha tea) and popular cocktails (i.e., mojito, daiquiri, pina colada, cosmopolitan, etc.).
We also forecast that the CBD-infused chocolate can contribute to the company’s growth in the next years. Actually, RMCF needs to hurry up because the competition in the CBD-infused chocolate market has increased a lot over the last years.
4) Improvement of the operational efficiency: Revenue breakdown by segment in the first nine months of FY 2022 is illustrated below:
|
Nine Months Ended November 30, 2021 |
Franchising |
Manufacturing |
Retail |
U-Swirl |
Other |
Total |
||||||||||||||||||
|
Total revenues |
$ | 4,289,116 | $ | 17,434,641 | $ | 829,542 | $ | 2,334,487 | $ | – | $ | 24,887,786 | ||||||||||||
|
Intersegment revenues |
(4,258 | ) | (856,106 | ) | – | – | – | (860,364 | ) | |||||||||||||||
|
Revenue from external customers |
4,284,858 | 16,578,535 | 829,542 | 2,334,487 | – | 24,027,422 | ||||||||||||||||||
|
Segment profit (loss) |
1,866,829 | 3,254,726 | 61,029 | 262,202 | (6,323,294 | ) | (878,508 | ) | ||||||||||||||||
|
Total assets |
1,590,914 | 10,988,056 | 651,372 | 4,824,466 | 9,243,856 | 27,298,664 | ||||||||||||||||||
|
Capital expenditures |
1,832 | 593,043 | 3,688 | 14,150 | 91,749 | 704,462 | ||||||||||||||||||
|
Total depreciation & amortization |
$ | 27,732 | $ | 469,562 | $ | 4,194 | $ | 350,047 | $ | 53,437 | $ | 904,972 | ||||||||||||
As illustrated above, the retail business and the U-Swirl segment (frozen yoghurt) have the lowest profit margins, so the company has to improve operational efficiency in both segments. Additionally, RMCF needs to be very cautious with the international expansion of the frozen yoghurt business due to the headwinds mentioned in the previous paragraph.
5) Expansion into street fronts and airports: RMCF’s stores are in six primary environments. Specifically, based on the latest annual report, the company’s domestic franchise locations in operation as of February 2021 are illustrated below:
|
Outlet Centers |
21.5 | % | ||
|
Regional Centers |
20.3 | % | ||
|
Festival/Community Centers |
18.4 | % | ||
|
Tourist Areas |
17.0 | % | ||
|
Street Fronts |
7.6 | % | ||
|
Airports |
5.7 | % | ||
|
Other |
9.5 | % |
Given that RMCF has limited presence in street fronts and airports, it needs to target growth in both areas. Actually, we would give priority to the airports because people usually spend money at the airports for buying pricey items mostly for gifts.
Risks
From an operational standpoint, there are key uncertainties both in the short-term horizon and the mid- to long-term horizon.
When it comes to the short-term uncertainties, the negotiations are ongoing, so nobody knows the outcome from the negotiations with Edible Arrangements and Immaculate Confections. And a negative outcome will hurt the company’s top and bottom lines in the next months.
When it comes to the mid-term and long-term uncertainties, the company is searching for a new CEO, so we don’t currently know whether the new CEO will have the skills to improve the operational efficiency while also implementing a successful growth strategy amid fierce competition.
Last but not least, RMCF is a low float microcap stock, and therefore, the volatility is high, so it’s not for day traders, momentum traders or short-term traders. The potential buyers need to have a 12-month investment horizon (at least).
Takeaway
Investors have to go off the beaten path if they want to find undiscovered stocks with strong upside potential and beat the market. And most of these outperformers are among the small-cap stocks. They’re not among the popular billion-dollar names. This is why we advised subscribers to our research to buy RMCF in August 2020, when it was at $3 per share.
From a fundamental standpoint, the balance sheet remains strong with zero debt and a significant amount of cash, but the dividend should keep paused until operations stabilize.
From an operational standpoint, there are many moving parts, including the disagreements with Edible Arrangements, the issue with Immaculate Confections, and the new CEO who will be tasked with growing the business and increasing profitability at the end of the day.
After all, the water currently is cloudy, so we’re neutral and advise investors to stay on the sidelines. There are safer and cheaper investments with stronger upside potential out there.
