Hole in Donut King owner’s earnings could get bigger, analysts warn

The franchisor of Donut King, Gloria Jean’s and Brumby’s chains could suffer an even deeper fall in earnings if it changes its business model so store owners are more profitable, analysts predict.

The Retail Food Group, which also owns the Crust and Pizza Capers brands, warned on Tuesday that its statutory profit would fall by about $11.5 million to $22 million in the first half of 2018.

That shocked investors as RFG had previously said its full-year underlying earnings would grow by 6 per cent, contributing to a share-price free-fall that wiped 63 per cent from its value in eight days’ trading.

Now UBS analysts say they expect earnings will continue to fall in the second half of 2018, despite strength from its international operations, because of falling sales and foot traffic in its domestic chains.

Analysts led by Jordan Rogers said a “business-wide review” RFG was conducting could lead to permanent changes to how value is split between store owners and head office, presenting further risk to RFG’s earnings.

Fairfax Media has revealed that many RFG franchisees are struggling to survive under a model that demands they pay hefty fees, royalties and food bills to head office.

Former store owners have spoken of their lives being “destroyed” and their personal finances devastated after they become franchisees.

The expos?? included allegations of widespread wage underpayment within its network, as struggling franchisees could not afford to pay correct wages.

UBS revised its nominal terminal growth rate for RFG from 1 per cent to 0 per cent, and cut its 12-month share price target from $3.15 to $2.15.

Mr Rogers said there was also the potential that RFG would take on provisions for onerous leases as a result of the review. That would mean its accounts would show the potential liabilities if it had to take over leases when franchisees exited the business.

UBS has noted that Metcash took a more than $100 million lease provision when it bought the Franklins supermarket chain in 2012 to manage uneconomic leases.

RFG claims to have more than 2500 stores, but Fairfax has revealed at least 200 stores are currently up for sale and more than 200 have closed in the past 12 months.

Franchisees exiting their business without being able to sell them have created an unknown number of “ghost stores”, where RFG is paying rent for a shop that does not open its doors to customers.

Mr Rogers cut his dividend forecast for the group to zero for 2018, compared to 29.7?? last year and 27.5?? in 2016, because RFG needed to preserve cash as it tried to extend the deadline on debt repayments.

The company has net debt of about $250 million, and is trying to extend a $150 million, three-year debt facility past its current December 2018 due date.

The stock recovered more of the heavy losses inflicted over the past two weeks on Friday, jumping 8.37 per cent to $2.33. That remains 47 per cent lower than where it traded on December 8.

That follows some stockbrokers saying the stock had fallen below its true value in its share price dive.

It is understood several fund managers are considering buying a strategic stake in RFG in the belief they can help address some of its fundamental issues in the business.

RFG was contacted for commment.