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More On Rocky Mountain Chocolate Factory

November 24, 2009 – Comments (2) | RELATED TICKERS: RMCF

One of my favorite stocks currently is Rocky Mountain Chocolate Factory.  I was looking for a micro-cap company with fantastic prospects and I had found one in RMCF.  However, as much as I tried, my original analysis of the company found very little wrong with it.  This could have been because there is nothing wrong with the company or I overlooked something.  Considering that my eagerness to find a fantastic micro-cap company, I had assumed the latter.  For an investor, knowing the downsides of a company is as important as knowing the upsides so I kept looking.  Fortunately for me there are others who are looking into RMCF and there analysis has shown 2 downsides for RMCF.

The first was brought on by Saj Karsan who said that the financial health of RMCF is largely unreported.  While RMCF provides all the information the SEC requires, the majority of RMCF's business lies with the franchisees since very few stores are company owned.  I saw this as a strength, but it adds some complexity because the financial health of the franchisees are not reported in RMCF's SEC filings.  If the franchisees fail, RMCF won't be too far behind.  There is significant risk in this lack of transparency, but there is still the upside in this model that I had pointed out in my original analysis.  Franchisees are owned by their managers which means that they have a greater stake in seeing the success of their business than a manager who works for a store owned by someone else.  The trade-off is a lack of transparency for an increased probability of success.  It's a dangerous trade-off but I think it's a worthwhile one.


Wide Moat Investing mentioned that RMCF had a significant amount of share repurchases in between 2005-2008.  I don't share the belief that share repurchases are always good for the shareholder.  Like dividends, they should be made only when the company sees no other opportunities for investment in the business.  At the time of the purchases, RMCF was trading between $11 and $16 (it's currently less than $9).  The P/Es at the time ranged between 15-20.  I'm not saying that RMCF was an unattractive purchase at the time, but it certainly wasn't trading at a discount.  Share purchases may have been justified if management expected a great amount of growth, but that seems hard to achieve when you're spending money buying back shares instead of using it to expand the business.

There is a scenario where the share repurchases could have been a great idea (at the time).  If you take into consideration the fact that most of the business relies on franchisees, it could be that management had expected a rise in same store sales from those franchisees.  The increase in RMCF's earnings would not have needed any additional investment by RMCF itself and it would have been in the best interest of the shareholders to give them back the cash in the form of share repurchases and dividends.

None of this makes me want to sell my shares in RMCF.  In fact, having greater knowledge of the risks in the company makes me more comfortable with making a significant investment in RMCF.  I'm going to continue with my plan of increasing my position over the next year.