They say the best time to buy is when there's blood in the streets. Does that mean Retail Food Group Limited (ASX: RFG) ("RFG") is now a buy?
It's an interesting dilemma. Surely if shares were priced at 12x earnings at $5 a share, they must be an absolute bargain now at $1.14, especially if the company is able to cut costs and improve its sales and profits?
Maybe, but I'm not so sure. As we wrote last week, RFG has had strict banking covenants imposed on it, and cut its dividend. Among many other things, Retail Food needs to earn $90 million in underlying earnings before interest, tax, depreciation, and amortisation (EBITDA) per year and repay $12.5 million in debt by 2 March 2019.
The $12.5 million in debt likely won't be an issue (RFG currently has $8 million in cash) but the $90 million EBITDA could be a hard act to follow. RFG's underlying EBITDA in the first half of 2018 was $45.7 million ($90.4 million if we double it to approximate a full year), down from $55 million in the first half last year. This is barely above the $90 million minimum and does not leave much room for error.
RFG declined to provide full year guidance, but it would be safe to assume that earnings are going to remain weak, given the commentary on the tough retail environment. The number of franchisees quitting the network will also prove key – further store closures would be bad news for RFG.
The EBITDA covenant might be survivable, but Retail Food Group also has to bring its net debt to EBITDA ratio down below 2.5x within 24 months. If earnings continue to weaken, that might force the company to start selling assets to pay down debt.
There's also a question about whether the franchise network is as rotten as media reports have made it out to be. It's difficult to form an accurate opinion on that, but if it is true, then surely there is a fair chance that more franchisees could fail or leave their franchises behind instead of renewing them?
Given the financial pressures detailed above I don't think Retail Food Group can make any changes to make franchisees lives easier.
The $1.5 million earmarked in the annual report for 'enhanced franchisee field service model' is almost laughably small – or would be, if the business wasn't under so much pressure. It pales in comparison to the $10 million in annual cost savings that RFG is targeting, and as a result I doubt that there will be much improvement to franchisee conditions. Therefore, if the franchisee base really is financially stretched, it could continue to deteriorate.
Retail Food Group is a company I'm very familiar with, having been a shareholder for several years (I sold my shares in August). I would be open to buying it at the right price and I do think that the time to buy a stock is usually when the uncertainty is at its highest.
However, I don't have a good feel for the business' underlying strength and whether it can meet its targets or if earnings will continue to deteriorate. As a result I'm avoiding Retail Food Group for now.
