Business model fit for a king
From time to time, a national dialogue is raised about Australia’s position in the Commonwealth. For a period, the public questions the role of the British monarchy in Australia, before ultimately deciding that if the system isn’t broken, don’t fix it.
Monarchs have historically served a very real purpose within society by maintaining order while expanding the empire. Of course, it would demand payment for providing these services. While history is scattered with fallen kingdoms, the fact that many are still functioning today is a sign of the long term potential of such arrangements.
Comparisons can be drawn to the franchise model in business. The franchisor packages a chain of stores with established suppliers, controls the marketing of the brand, and coordinates the expansion of the portfolio. To participate in this arrangement, the franchisee will pay a royalty on sales, and will also be required to pay for the majority of the costs associated with the store fit-out.
This arrangement removes a lot of the expenses and capital from the franchisor’s financial statements, while providing the franchisee with favourable operating metrics. Much like a monarch, this model is very attractive as long as the franchisees are happy (i.e. profitable). So how do franchisors successfully grow their empires?
The (Donut) King of all franchises in Australia is the Retail Food Group (ASX: RFG). Along with the deep-fried treats, the company also controls the following well-known brands: Michel’s Patisserie, Brumby’s Bakeries, Esquires Coffees, Crust Pizzas and Pizza Capers. While the company has over 1,300 outlets in Australia and New Zealand, only in recent years has management been able to capitalise on this scale.
RFG has experienced prolonged issues with its supply chain, considerably reducing the range of products sold by its brands. The company is putting the final touches on a distribution model that it hopes will be attractive to a national supplier. The crown jewel of RFG’s wholesale network is its coffee roasting facilities, which distribute 1.35 million kilograms of beans annually to its network. It is unlikely the company will release this asset while it continues to clip the ticket twice on every cup of coffee sold – once for the beans, and once for the beverage.
A robust supply chain will allow management to focus more attention on invigorating its existing brands. The company has expanded the Donut King menu to be more appealing to parents, and is introducing freshly made sandwiches in Brumby’s stores. Michel’s Patisserie is also being rebranded with a European flair. Such endeavours are important to improve foot traffic and keep existing franchisees happy, while significant growth to the empire will likely be achieved via acquisitions.
The core driver of RFG’s recent growth has been the acquisitions of Pizza Capers and Crust Pizzas, which added 228 stores to its network. The divisions contributed meaningfully to earnings in the 2013 financial year, and management is hoping to capitalise on this success by rolling out a further 130 outlets in the next two years.
RFG has historically funded expansions and acquisitions with debt, which resulted in a high level of gearing. While current debt facilities provide $40 million for an acquisition, the company has used its rising share price to conduct a $55 million capital raising. The company now has a war chest to acquire a food chain of similar scale to Pizza Capers and Crust.
Much like the British monarchy, RFG’s share price has experienced a surge in popularity in recent times, as positive sentiment abounds in the market. This popularity is certainly warranted with RFG, appeasing both franchisees and investors.
This article was first published in The Australian on 16 November 2013.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
mario caruana
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Rfg have to leave something on the table for the franchisee so as they can make a profit, potentially a good business to buy if management get their act together and get their supply chains working better.