Rocky Mountain Chocolate Factory: A Sweet Portfolio Treat

| About: Rocky Mountain (RMCF)

If you're looking to diversify your portfolio with a micro cap growth stock trading at a good value, then investing in Rocky Mountain Chocolate Factory (NASDAQ:RMCF) is a sweet idea.

Rocky Mountain has a large upside opportunity with relatively low risk, as the company is debt-free and has seen consistent annualized revenue growth of 6% since 2003. The international confectionery manufacturer and retail franchiser/operator is an undiscovered micro cap stock, hidden behind the large cap competitors such as Hershey (NYSE:HSY). Rocky Mountain sees major growth potential in the next few years, as brand recognition and retail sales will heighten due to a licensing agreement with Kellogg (NYSE:K) to use the RMCF trademark on specialty cereal brands, its 100-store master licensing agreement for expansion in Japan and Asia, and new stores to open overseas in South Korea, Hong Kong, Shanghai, and Saudi Arabia before the end of the year.

Company Profile

Rocky Mountain Chocolate Factory, Inc., was founded in 1982 and sells a line of gourmet chocolates and other confectionery products through factory sales, franchising/operating retail stores.

Rocky Mountain Chocolate Factory stores operate in tourist areas, malls, and street fronts with high levels of foot traffic. Based on FY2013 results, 15% of revenue is derived from retail sales, 68% of revenue through direct factory sales (to franchise/licensed stores and direct to consumer sales), and 17% of revenue from royalty/marketing/franchising fees.

A new store design concept places a stronger emphasis on the company's unique strength; preparation of 40% of its products on the premises in its upscale in-store kitchens. The allure of freshly made products gives RMCF an edge over other confectionery retailer competitors.

A smart management decision was made in late 2012 to step away from its Aspen Leaf and Yogurtini frozen yogurt stores, and instead to own a 60% controlling equity stake in U-Swirl, Inc. which franchises and operates self-serve frozen yogurt cafes. This decision allowed the company to focus on its core chocolate products and on co-branding development, rather than direct involvement in the tough competitive environment of frozen confectioneries.

The company operates a total of 424 RMCF and self-serve frozen yogurt stores as of February 28, 2013 (229 RMCF franchise stores in the United States, 6 company-owned stores, 55 co-branded Cold Stone Creamery stores, 69 U-Swirl stores, and 66 international license stores in Canada, Japan, UAE, Saudi Arabia, and South Korea).

Financials

The company has a strong debt-free balance sheet and shows a steady increasing revenue growth. From FY2012 to FY2013, Rocky Mountain Chocolate Factory reported 4.9% increased revenues, 0.2% increase in same-store sales, 4.5% increase in factory sales, 4.1% increase in retail sales, 6.9% increase in royalties and marketing fees, and 14.8% increase in franchise fees.

The $0.11 quarterly dividend (yield of 3.4%) is relatively sustainable with a payout ratio of 65% in 2012. However, be wary that the FY2013 EPS of only $0.24 as compared to $0.62 in FY2012, is due to a non-recurring losses and restructuring from the sale of Aspen Leaf Yogurt. Although RMCF's balance sheet was marred by this expense, the company's solid growth indicates good future financial health. Despite an attractive dividend yield, the company will likely incur major capital expenditures as its international expansion grows. Chocolate is currently manufactured at one factory location in Durango, Colorado, but an additional factory overseas is eminent with master licensing agreements and new store openings in Asia.

Chocolate has also proven to be a natural inflation hedge. With pricing dominance in confectionery sales, Hershey has reported increased revenues and profits along with price increases.

The risks of investing in RMCF are the low trading volume, micro market cap of $70 M, and a low institutional ownership of 31%. However, the company's good financial health indicate that the potential rewards for investing in RMCF are high.

Growth

The catalyst for growth in the Rocky Mountain Chocolate Factory lies in the aggressive expansion in international markets, and the increased brand recognition to come.

The consumer enthusiasm for chocolate products, along with popularity of American brands in Asia, shows great growth potential for RMCF. A minimum of 100 stores will be opened within the next 10 years through its master licensing agreement in Japan and Asia. The opening of Japan's first five stores was well received, with initial sales significantly higher than the average US retail store. A new test store has opened in South Korea on May 20, 2013, with other international stores to open in Hong Kong, Shanghai, and Saudi Arabia.

In addition, national brand recognition of the company will improve as more co-branded U-Swirl and Cold Stone Creamery stores open. Kellogg's limited edition "Rocky Mountain Chocolate Factory Chocolatey Almond" cereal will bring the RMCF brand into grocery store shelves. Not only will RMCF increase revenues from licensing and royalty fees, but this opportunity will open the door to another outlet for chocolate sales. The company has plenty of room for expansion within the domestic market to sell their products within grocery stores and at retailers outside of current RMCF factory and retail stores.

A Long Opportunity

Rocky Mountain Chocolate Factory proves to be a low-risk investment for a long-term position due to the company's continued revenue growth in a high margin industry, paired with a dividend yield of 3.4%. Now that Rocky Mountain Chocolate Factory is back on track from its sidestep towards frozen confectioneries, the company will see increased profits as short-term plans are in motion for growth in both national and international markets. RMCF is a solid stock to own now, before large institutions and everyone on Wall Street take notice.

Disclosure: I am long RMCF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.