Rocky Mountain Chocolate Factory

rmcflogoLately I’ve been sleuthing for rational capital management. Impressed by FortuNet’s cash distribution, disappointed by Moody’s stagnant buyback plan, and annoyed by KSW’s passivity, it is clear to me that rational management can be found in unlikely places, and that even the most virtuous can settle into vice (which in this case is sloth—sitting lazily on shareholders’ cash).

Reader Sam highlighted Rocky Mountain Chocolate Factory (RMCF)—a franchiser and confectionary manufacturer with 334 stores (as of 2/29/08)—as an interesting wide moat business whose current market price resembles what Warren Buffett paid for See’s Candies, on a number of important metrics. And a quick glance at the recent 10-Ks and Qs depicts a management who has a habit of returning excess cash to shareholders—via dividends and share repurchases. In fact, on its $5.64 share price (as of 4/22/08), RMCF offers a 10 cent quarterly dividend, bringing the stock’s yield to over 7%.

Though the share repurchases seem to have stopped since February 2008 (filings reveal no share repurchases from March 2008-November 2008), management was an aggressive purchaser in better times. And their 10-K reveals their record:

“between January 9, 2008 and February 8, 2008, the Company repurchased 391,600 shares at an average price of $11.94. Between August 15, 2007 and August 28, 2007, the Company repurchased 16,000 shares at an average price of $15.96 per share. Between March 1, 2007 and May 15, 2007 the Company repurchased 76,335 shares at an average price of $13.12 per share. Between May 1, 2006 and February 28, 2007 the Company repurchased 253,141 shares at an average price of $12.94 per share. Between March 24, 2006 and April 28, 2006 the Company repurchased 74,249 shares at an average price of $14.90 per share. Between October 7, 2005 and February 3, 2006 the Company repurchased 185,429 Company shares at an average price of $14.6 3 per share. Between April 18 and April 20, 2005, the Company repurchased 18,529 Company shares at an average price of $13.28 per share.”

All told, that amounts to over 1 million repurchased shares in a three year period, or about 14% of outstanding shares.

Over that same period, RMCF also paid out significant quarterly dividends. Combined with its share repurchases, shareholders basically saw 100% of RMCF’s FCF returned to them.  Perhaps shareholders should rename them the Rocky Mountain Cash Factory.  In fact, it would be hard to ask for much more as an owner; one would only wish that the school that teaches such value creation would open its enrollment to a few more students.

Perhaps in future posts, we’ll look more carefully at RMCF’s financials, and do a comparison with Buffett’s purchase of See’s Candies. But trading less than 9x FCF, and with a management that has demonstrated sound capital management, it certainly warrants that closer look.

Disclosure: I, or persons whose accounts I manage, own shares of Rocky Mountain Chocolate Factory at the time of this posting.

13 responses to “Rocky Mountain Chocolate Factory

  1. I’ve been following RMCF for close to 2 years and I really like the management.

  2. I too have been watching Rocky Mountain. However, I’ve had trouble discovering a moat. Why do you think they have a wide moat business?

  3. How is it we’re all watching the same businesses? Coincidence?

    In the candies and chocolate business, the most well-known brands are Mars and Hershey, and perhaps Cadbury. These chocolatiers sell through grocery stores and retail chains, which distribute about 60% of total confectionary sales (Datamonitor, 2005). Rocky Mountain cannot and likely should not try to compete with these brands, as their price points would not be competitive ($10-25 per lb) and their target customer is not the weekly grocery store patron.

    So their moat in my view lies in their strategic focus on their desired customer–tourists, “impulse buyers,” those on a daylong shopping excursion (e.g., at large outlet malls)–and on the durability of high-end chocolate as a perceived affordable luxury. In my view, these competitive advantages show up in their gross margins and return on equity numbers.

    How wide is this perceived moat? Not as wide, all things considered, as Mars or Hershey’s. If another gourmet chocolatier set up shop across the street–like a Lindt or Godiva–would RMCF’s customers be sticky? My guess is that few of their current customers would definitively prefer their chocolate over Godiva’s or See’s. But I think that is the nature of the business–like wine, subtle differences in taste are interesting, and few would consistently drink the same bottle for their whole life.


  4. How is it rational to stop purchasing shares prices at around $6 when you were just buying them at $12.54? I would call that irrational capital allocation…

  5. If they haven’t bought any at $6, and cash balances have risen during that time, I would agree Scott. They may have been buying since Nov. I’ll just have to see what the upcoming 10-K shows.

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  7. The thing that has always stopped me from investing in RMCF is the lack of growth in the industry. FCF is what will increase the value of the business but RMCF hasn’t been successful in doing so for so many years.

    I’ll really get interested only if it becomes a net net.

  8. Jae, you’re saying just what I imagine Buffett was saying before he bought See’s, so you’re in good company. As the story goes, Charlie Munger had to persuade him to be comfortable buying excellent businesses at fair prices, rather than only looking for Graham’s cigar butts. (I’m not suggesting that RMCF is as excellent a business now as See’s was then, but it is a very good business.)

    In Buffett’s letters in the early 1980s, he lists the pounds of candy sold at See’s, and it hardly increases (if you adjust for new stores and population increases). Chocolate is not one of those businesses that will have much growth. Just from a caloric perspective, you can only eat so much of such a calorically dense food. So, I agree, there isn’t much growth, but I don’t think there has been for the better part of thirty years. Yet, I still think they can do well for shareholders if their excess capital is used well.

    I’ll drop you a line if it becomes a net-net.

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  10. I am still trying to learn more about the company, but I am not thrilled with one thing I came across in its most recent conference call:

    the company has been swallowing most of the price increases to make their franchises more profitable in the last few years.

  11. @echang–do you have a transcript or sound file for the Q309 CC? You’ve piqued my interest.

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  13. They just published a press release regarding their international expansion plans:
    “The Licensee also expects to open test stores in Hong Kong and Shanghai, China later this year. With our entry into Japan and potentially into China, we believe an international expansion in Asia and other countries could play a very significant role in our Company’s growth for the foreseeable future.”

    Are you still interested in the company?

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