In 2007 Americans bought $16.3 billion worth of chocolate, according to the National Confectioners Association. It's definitely not a product prone to recessions, yet chocolate, like most non-essentials, is taking it a hit these days. Several of the big names have lost value, but there could still be investment potential in one of the industry's lesser-known companies.

Rocky Mountain Holding Its Own
Specialty chocolate shop Rocky Mountain Chocolate Factory (Nasdaq:RMCF) is based out of the Durango, Colorado, and has 329 stores (all but four are franchised). It has seen sales slow in recent quarters knocking its stock down 43% in the last 52-weeks alone. Twice in the past three quarters, its stock dropped more than 5% in just one day in reaction to its earnings announcements (13.8% after releasing third quarter earnings in January and another 8.6% when delivering year-end results in May).

It moved down 5% in early July after announcing first-quarter results. Its stock hasn't been this low since late 2004, but it is up significantly since 2003. In fact, a $100 investment in February 2003 was worth about $500 in February 2008. This compares very favorably to its peer group, which includes Hershey (NYSE:HSY), Tootsie Roll (NYSE:TR) and Wrigley (NYSE:WWY).

I see this drop as a complete overreaction to results that really weren't that bad. (To learn more, read The Madness Of Crowds.)

Recent Results
The third quarter ended November 30, 2007, for Rocky Mountain Chocolate showed revenues declining 3.6% to $8.8 million from $9.1 million the year prior. Its same-store sales at franchised locations were 2.5% lower with income from operations down slightly to $2.05 million. Its operating margin was 23.3%, down just 20 basis points from the same quarter in 2006.

Revenue for fiscal 2008 was up 1% to $31.9 million. Its total sales system-wide including both company-owned and franchised stores were $113.3 million, an increase of 4% while net income rose 5% to $5 million. Finally, first quarter revenue for fiscal 2009 was $7.1 million, down from $7.3 million last year with same-store sales off 2.5% year-over-year. Income from operations was down slightly to $1.62 million from $1.63 million the year before. Given its system-wide same-store sales averaged quarterly growth of 1.2% in the last five fiscal years, it seems penal to drop the stock 43% in two-thirds of a year for results that weren't too far off its historical average. (To learn how to break down these numbers quickly, read our Advanced Financial Statement Analysis Tutorial.)

Franchise Support Critical
The company generates revenue from three sources:




  1. Sales of factory-made chocolate to franchisees;
  2. Sales from company-owned retail stores; and
  3. Royalties and franchise fees.


Chocolate sales represent 75% of sales, company-owned stores produce another 5%, and royalties and franchise fees contribute the remaining 20%. Providing support to franchisees is critical, especially in these trying times. The company is working hard to help them raise their store's average transaction amount, keeping expenses low and increasing the number of customers it serves on a daily basis. While difficult, these are all achievable tasks for franchisees.

The relationship is not one-sided, and management is doing its part to hold the line on prices despite increased costs. Factory margins were off 420 basis points from 34% to 30% in the first quarter, yet it managed to cut operating expenses by 6.3%, primarily through job reductions at its plant totaling 55 people or 25% of the workforce. Unfortunately, passing costs on to franchisees all at once is not a solution. Call it short-term pain for long-term gain.

Bottom Line
Slow and steady wins the race. Sales have grown to $31.9 million in 2008 from $21.1 million in 2004 and operating income to $7.9 million from $3.8 million over the same four years. At the same time, the dividend has risen every year from 10 cents to 40 cents and is currently yielding 4.5%. Rocky Mountain Chocolate Factory is 135th in Entrepreneur Magazine's Franchise 500 ranking, and its directors and officers own 20.83% of the stock. That's always a good sign. More importantly, it's not just the founder (who has 11.56%); the others hold an additional 9.27%.

With zero debt, I don't see why it can't ride out this economic storm and come back even stronger when the next boom comes along. In the meantime, I see little downside in its stock price. Who can resist a little chocolate?



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Tickers in this Article: RMCF, HSY, TR, WWY

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