Rocky Mountain Chocolate - See's Candies In The Making?

| About: Rocky Mountain (RMCF)


This chocolatier sells at a cheap 14x earnings.

Their main problem seems to be where to allocate the cash flows.

If this business can be half as good as See's Candies it will be an incredible investment.

One of the few businesses Warren Buffett absolutely loves is the chocolate business. See's Candies may be his most beloved of acquisitions as its earnings exploded over the decades with very little capital expenditure and relatively little volume growth. Moreover it fits his mold of cherished branded goods. That is the type where if someone were to walk into a store and the store not have the product they would walk out. See's is that kind of product and Rocky Mountain Chocolate (NASDAQ:RMCF) is not far behind.

Rocky Mountain Chocolate is a predominantly west coast business and as the name implies they are based out of Colorado. The company has limited its growth to high foot traffic locations and this scarcity in itself has created a strong level of interest. But like See's this business is a cash machine. The company has the enviable problem of what to do with so much cash flows. Regrettably management has botched some acquisitions, namely in the yogurt business. But the company has since written down the goodwill and are surely licking their wounds.

This blunder has weighed on the stock and may still be the leading cause of the softness in price. Quite frankly any further writedowns are not something that can't be cleansed with strong cash flows that would merely be a blip in the company's earnings. The wonderful thing about this mistake is that it flows not to outside shareholders primarily as is typically the case, but to management also. The CEO/founder holds some 10% of the shares and so he felt the shrinkage in his net worth when these mistakes were made.

When Warren Buffett absorbed See's into his empire it fit splendidly. The cash flows would have been used for more capital intensive businesses as well as Buffett's own capital needs - that being buying stocks when they become cheap. Unfortunately for Rocky Mountain Chocolate it isn't being run by anyone close to a Warren Buffett. So in this case a rich dividend is being paid and while shares were bought back in years past the company now intends to pay back all its debt which could easily be done with 2 years of current free cash flows. The company also plans to reinvest in their factory, but in all likelihood it will come back to buying back shares or ramping up the dividend after their long-term debt is paid.

I've been trying to wrap my head around the cheapness of this company at 14x earnings and a price to book of 3.3. Hershey (NYSE:HSY) sells for 30x earnings, Tootsie Roll (NYSE:TR) and Lindt (owner of Ghiradelli and Russell Stover) for over 40x earnings. These are more recognizable brands, they have more bargaining power with distributors and they don't have significant franchise revenues and franchise dependency like Rocky Mountain Chocolate. But they are all in the chocolate business and all have carved out their niche with their respective captive consumers. Keep in mind Buffett paid 12x earnings for See's and in hindsight he said he would have paid much more.

If distribution through mass retail was a good thing then See's would've taken that route. But the company still primarily sells direct through their stores much as Rocky Mountain Chocolate does. Warren Buffett seems to prefer this distribution model as even his Benjamin Moore paints are sold exclusively through their stores and this business model is probably not a bad thing for Rocky Mountain Chocolate either.

Same store sales have softened in the trailing 12 months, but 1 year trends are less important than decades long trends as shown below. What should be noted is that factory sales have grown through the recession in spite of a period with little to no inflation. See's Candies suffered an 8% same store sales decline (in pounds of chocolate) during the latter half of the 70's. Buffett was of course indifferent as earnings and dollar sales grew strongly in the inflationary environment. But these kinds of macro problems including cocoa prices should not be worrisome to investors in these strong brands. As long as the brand is in solid shape there shouldn't be concern about the short-term macroeconomics.

I hate to trumpet the great attributes of any company, but I've found a few chinks in the armor of Rocky Mountain Chocolate (if you have found some please share in the comments). The company is a microcap at about $66 million and that surely prevents any interest on Wall Street and with hedge funds as it's far too tiny to invest in and dedicate analyst time. The smallness in size for our readers' sake should not be a concern. If you know the intrinsic value to be much greater don't let the volatility in the stock bother you. Personally I'm in favor of more volatility and much sharper swings downward as I'll be adding shares.

Disclosure: I am/we are 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.

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