Rocky Mountain Chocolate Factory: A SWOT Analysis

Summary

• Rocky Mountain Chocolate Factory has underperformed the market.
• The company is well run, but the business faces serious challenges.
• Here is a summary of strengths, weaknesses, opportunities, and threats.

I suspect that Rocky Mountain Chocolate Factory (NASDAQ:RMCF) attracts investors who are hoping to find their own "See's Candies." I put that name in quotes because the California-based candy shop is a famous case study. Warren Buffett acquired See's in 1972 and his $25 million investment has thrown off more than $1 billion in cash. Meanwhile, Rocky Mountain Chocolate Factory operates a similar business and pays a generous 3.92% dividend yield. That sounds attractive, but as much as I love dividends, there are other factors to consider when investing.

I've owned Rocky Mountain Chocolate Factory for years, and though my enthusiasm for the stock has waned, I haven't found an inspiring reason to sell the stock. There are growth opportunities for the company to seize, and there are challenges that the management team must overcome. The future is undecided. To help you clarify your own investment thesis, I've prepared a "SWOT" analysis that highlights the company's strengths, weaknesses, opportunities, and threats, as I see them.

Strengths

Rocky Mountain's dividend yield is fully supported by cash flow. The company has a strong balance sheet and is led by a conservative management team that is unlikely to make a rash decision. That team has navigated a brutal retail environment better than others have, and its executive compensation is reasonable. The company is generally well reviewed (by employees) on Glassdoor. You'll also find that most of the company's retail locations are well reviewed on Yelp. The locations with truly bad reviews are almost all permanently closed. I've eaten at several of the company's franchises in the U.S. and Canada and have been consistently impressed by each store's confections and customer service. In a nutshell, I'd summarize the company's strengths as good products, good people, and good finances.

Weaknesses

I'm not confident in the leadership team's ability to make meaningful acquisitions or positive business development arrangements. Rocky Mountain Chocolate Factory began launching co-branded locations with Cold Stone Creamery in 2007. Sadly, Cold Stone's cachet has faded since then. In 2014, the company finished acquiring a string of frozen yogurt concepts. None of these deals have driven value for shareholders. And here is the truly disappointing thing: The rationale for these deals was smart! Demand for frozen treats peaks in the summer. On the other hand, chocolate sales are strongest in the fall and winter.

Source: Google Trends

Rocky Mountain's management team sees the value in this seasonal diversification, but it's struggled to capture the trend. Meanwhile, competitors have fared better.

Let's talk about Kilwins. The chart below is also from Google Trends:

You can see that search demand for "Kilwins" has grown significantly in recent years, peaking in the summer months, but also jumping each December. I believe that two of the reasons for Kilwins' success are a clear weakness in Rocky Mountain Chocolate Factory's strategy:

1. Kilwins seems authentic - I first saw a Kilwins in Ft. Lauderdale, FL, and I mistook it for a family-owned candy shop from the 1940s. I immediately wanted to support its business. Rocky Mountain Chocolate Factory feels like a franchise, and a lot of people today reject corporatism.

2. Authenticity is more powerful than healthy - Many "health conscious" adults eat junk food without regret if they believe a product is novel, artisanal or nostalgic (e.g. flavored Oreos).

Finally, and unrelated to the points above, Rocky Mountain Chocolate Factory's website is poorly optimized for search engines (Thankfully, this can be fixed with a little thought and elbow grease).

Opportunities

Every weakness is an opportunity. Rocky Mountain's management team can leverage consultants to find potential deals or use its operational expertise to test new franchise concepts that focus on authenticity. The corporation can also drive repeat sales to existing franchises if it finds a technology partner that helps unite buyers and sellers who are near each other. For example, consider how Rocky Mountain's products can serve weddings and wedding planners.

Specialty apples are a popular wedding favor. A couple getting married might buy 200 apples in one shot, but a wedding planner might buy 200 apples each week. These are the repeat customers who can drive year-round sales and develop relationships with store owners.

I also see an opportunity, odd as it sounds, to create products that are tailored to government workers. Chocolate is a popular gift among state officials and diplomats because cash gifts are prohibited. Some hypothetical ways to tap into this market are a "letterbox" of chocolates for postal workers or a "50 States of Chocolate" gift set that highlights regional flavors (e.g. a chocolate-covered macadamia nut for Hawaii, a maple creme for Vermont, etc.).

Threats

Specialty chocolate shops tend to be regional. You can see in the map (of Google search demand) below that See's Candies (Red) is dominant in its home state of California, Rocky Mountain Chocolate Factory (Blue) fares well in the midwest and Kilwins (Yellow) is successful on the east coast. If any of these companies grows its national footprint in a sustainable way, the other chains will be threatened.

The price and availability of cocoa beans is a lingering threat for all chocolatiers. I'm not confident that customers will bear a sharp rise in costs, so chocolate-makers may need to find other high-margin confections to sell without betraying their brands.

(It's worth noting that cocoa prices are depressed now because of bountiful crops and weak demand. The weak demand for chocolate may be a reflection of healthier consumer preferences, which is a threat to chocolatiers unto itself. But I believe this threat can be countered by clever marketing and product development).

Lastly, the U.S. retail scene is in a woeful downtrend. Malls and shopping centers are struggling and closing, and this puts pressure on specialty shops that have historically relied on these high-foot traffic areas. I believe that retail will rise again, but I can't predict how it will happen, and the down-cycle may last for years or decades. Creative solutions and pain management will be necessary to survive in the meantime.

Conclusion

Imagine if you found 10 challenged businesses that had growth opportunities and were selling at a reasonable price. Some of those businesses are likely to disappoint or even fail outright. Yet, the entire portfolio of investments can be successful if just one of these investments was very successful.

Investors considering Rocky Mountain Chocolate Factory must ask themselves whether the potential rewards are great enough to offset the risks of investing in a challenged company. I don't think an investor should bear these risks if his or her hope is that the company will be acquired. The 30% pop that might come with that kind of news is a minor reward, in my opinion, and not strong enough to offset the potential losses (or opportunity costs) that he or she would bear by investing across a pool of similar retail stocks. The question is whether Rocky Mountain can grow in many multiples from its current size and, if there are other investment opportunities that fit the same bill, allowing an investor to diversify the risk of failure.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s 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.