How can I say that Retail Food Group Limited's (ASX:RFG) decline isn't over yet? Surely after a horrible 80% decline in 12 months, the company must have hit rock bottom?
Surely?
I think there is still more pain to come for shareholders however, for one key reason – the banking covenants.
As we mentioned here and here, Retail Food Group doesn't have any room for error in its banking covenants. Even in the ordinary course of business, the company could struggle to hit its targets, with minimum EBITDA (earnings before interest, tax, depreciation, and amortisation) of $90 million per year required by lenders – and RFG earned just $45.7 million in the first half of this year.
The other concern is the health of the franchise network, which is something most shareholders won't be in a position to evaluate for themselves. However, if the negative media coverage is representative of the health of the network, then surely many franchisees are under a high degree of pressure. They may elect to leave the network rather than renew their franchise, which would result in lower earnings for Retail Food Group.
To appease franchisees and put the network on a more sustainable footing, RFG may have to let franchisees keep more of their earnings. However, that is impossible right now because giving more to franchisees would likely see RFG unable to meet the minimum earnings requirements for its loans. Not appeasing franchisees of course could see them leaving – with a similar effect.
I have noted before that RFG management has been very slow to respond to, or attempt to falsify, media accusations about the health of the franchise network. It's possible that the media coverage has been exaggerated and sensationalised, but on the other hand RFG hasn't exactly gone out of its way to prove anybody wrong.
Given management's almost total lack of response to media reports and the decision to blame franchisee troubles on a 'tough retail environment' I doubt that this management team will attempt to renegotiate more equitable arrangements with franchisees.
If earnings don't keep up, another choice is to sell businesses, which would be a terrible outcome given that most would have to be sold cheaply, having been acquired at much higher prices price over the past few years.
Alternatively, RFG could have to raise capital and I think this is the most likely outcome – yet given the lack of foresight shown by the company so far, I wonder if it will pre-emptively look to raise capital or if it will wait until it is forced to. Either way I think there is a good case to be made that the tough times aren't over yet.
