Cake Box (CBOX) – A slice of franchise growth

Cake Box (CBOX) – A slice of franchise growth

Cake Box (CBOX) opened its 100th store in September 2018 and is continuing to roll out its egg-free cake shops across the UK. The listed business is a highly profitable and cash generative franchisor. Competition is a threat but Cake Box has a distinctive brand and a differentiated product offering.

I recently visited a new Cake Box (latest share price 166 pence, market cap £66 million) store in Holloway road, North London. My overall impression was positive and it is therefore worthwhile examining the investment case.

The most attractive equity investments generate high returns and have meaningful long-term growth potential (i.e. AJB – Quality and growth). To quote the Sage of Omaha, Warren Buffett:

“The ideal business is one that earns very high returns on capital and that keeps using lots of capital at those high returns. That becomes a compounding machine.”

Is Cake Box a compounding machine?

(Source: Cake Box)

Cake Box appears to be a quality business with long-term growth potential. However, it also a niche business (celebration cakes) and may be vulnerable to new competition.

When seeking to identify a “compounding machine” there are number of useful questions to ask:

Does Cake Box generate attractive returns?

Cake Box’s fiscal 2018 (year to March) return on capital employed (ROCE) was 58% and the operating profit margin was 26%. Free cash flow conversion was 95.6% and the cash flow return on capital employed (CROCI) was 46.2%.

Net cash was £0.8 million at September 2018 and the group paid a 1.2 pence dividend in the first half (six months to September 2018).  Store leases are in the name of the franchisees with Cake Box having no liability.

Cake Box generates attractive returns (year to March)

(Source: SharePad)

Cake Box had an EBIT profit margin of 26% in fiscal 2018 (year to March) versus 22% in fiscal 2016. A high profit margin indicates financial resilience while an improving profit margin indicates competitive barriers to entry.

Cake Box EBIT profit margin (year to March)

Source: SharePad

Does the business have scope to grow?

The number of stores has increased from 3 at March 2010 to 101 at September 2018.  With six out of ten stores in London and the South East there is scope for expansion across the UK.

Like-for-like sales increased 15% in the year to March 2018 and there was a 4.4% increase in the six months to September 2018. The strong performance in the first half of fiscal 2019 was despite the hot summer weather in the UK.

Cake Box’s rapid growth to date

(Source: Cake Box)

Are franchisees doing well?

Cake Box can only grow if it is able to attract new franchisees.  This shouldn’t be a problem with 99% of mature stores (open for more than 12 months) profitable. The average franchised store earns an average of £97k EBITDA profit per annum.

This has been on an improving trend with the corresponding figure at £52k back in 2013. The group recently stated that it has a “strong pipeline of new franchisees and existing ones looking for additional stores.”

The pitch to attract new franchisees

(Source: Cake Box)

Cake Box net average weekly store sales (£)

 

(Source: Cake Box)

Average annual store profitability (EBITDA £’000s)

(Source: Cake Box)

Can it keep the competition at bay?

Cake Box says that it has “no direct competitor for egg-free, fresh cream, personalised cakes.” It offers a 1-hour click and collect service, photo cakes and instant personalised messages (Prospectus page 8 and 9).

Personalisation is a big selling point given that it helps make a gift or present “special.”  Moonpig.com, whose founder Nick Jenkins was on Dragons Den, has done well by offering personalised greeting cards and gifts.

Cake Box offers a rapid turnaround for personalised cakes

(Source: Cake Box)

The company’s IPO prospectus notes that supermarkets don’t offer egg-free cake or personalised cakes. A quick look online, however, shows that Intercake offers personalised cakes “at participating Asda and Morrisons UK stores.”

Fresh cream is a strong selling point for Cake Box and the only competition here is from national café operators. However, cafés generally don’t offer personalised cakes or same-day ordering.

It appears unlikely that supermarkets or cafés will move onto Cake Box’s turf.  Supermarkets focus on large-scale food production while cafés focus on sit-down customers.

The collapse of Patisserie Valerie (CAKE) has taken out a competitor that had 206 stores at March 2018 (70 stores have closed).  Patisserie Valerie offered a modest level of personalisation on some of its cakes.

Cake Box and the competition: ticking all the boxes

(Source: Cake Box)

What is the market backdrop?

Cake Box focuses on celebration cakes, which makes up 19% of the UK retail cake market while large cakes account for 11% of the market.  The UK retail value of both of these categories together was £715 million in 2017.

Cake Box does appear to stand out as a maker of personalised cakes with fresh cream. I have been force-fed my fair share of low quality cakes (high-sugar content and without fresh cream) at family events.

(Source: Cake Box)

How does the management stack up?

CEO Sukh Chamdal has over 35 years’ experience in food manufacturing and retail. CFO Pardip Dass is a qualified accountant and has over 15 years’ experience in the food and beverage industry.

According to the prospectus, CEO Sukh Chamdal and his spouse own 41% while CFO Pardip Dass and his spouse jointly own 8.8%. Significant skin in the game is an encouraging sign.

An experienced team

(Source: Cake Box)

What are the key risks?

In my view, Patisserie Valerie’s collapse doesn’t have a negative read across for Cake Box.  The group has no trouble attracting franchisees suggesting that the majority of stores are profitable.

Cake Box generates the bulk of its revenue from supplying cake products to its franchisees. Sponge sales and cake supplies make up 77% of revenue in fiscal 2018 while the franchisee fee was only 5% of revenue.

The company is not exposed to leases on stores that are no longer profitable – franchisees take on the leases for their stores. Successful franchisors like McDonald’s and Domino’s Pizza have tended to be resilient and profitable businesses.

Patisserie Valerie had a large store footprint and high staffing costs given that the chain caters to sit-down customers. Cake Box, on the other hand, sells cakes to go and the stores are therefore small and only require a few employees.

Cake Box revenue mix (year to March 2018)

 

(Source: Cake Box)

General risk factors for Cake Box our outlined in its IPO prospectus (P23).  The group needs to keep franchisees on side as its executes its expansion plans.  A second warehouse and distribution centre is scheduled to open in the north of England in the first half of 2019.

Summary and valuation

According to SharePad, Cake Box’s historic P/E for the financial year to March 2018 is 24X (no new shares were issued in the IPO). Adjusted EPS (before IPO costs) jumped 36% in H1.  If this pace of earnings growth continues in the second half the P/E will decline to 17.6X (fiscal year to March 2019).

The business generates attractive returns and there is scope for a meaningful increase in the store count.  Founder-run companies, with significant skin in the game, tend to perform well over the long-term.

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    A silly comedy video yes. But from 2 minutes 40 seconds it illustrates neatly the investment case for Cake Box:

    https://www.youtube.com/watch?v=RK78IKPzeNc&t=190s

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