One business model that can work very well for growth investors is franchising. Companies with a strong business that can be franchised widely can enjoy rapid profit growth without needing to invest heavily in expansion.
It’s a model that’s worked stunningly for Domino’s Pizza Group (LSE: DOM). Domino’s shares have risen by 365% plus dividends over the last 10 years.
I’ll take a fresh look at the pizza takeaway specialist in a moment, but first I want to consider a small-cap I reckon could be a millionaire-maker stock.
Recyling profits
Shares of Filta Group Holdings (LSE: FLTA) have doubled in value since the firm floated in November 2016. The firm’s main business is providing fryer maintenance and oil recycling services for deep fat fryers in commercial kitchens.
It’s a clever idea as this is job can’t be avoided, but isn’t always easy for kitchen staff to do themselves. Having a specialist contractor to provide this service can really make sense.
Fryer maintenance has proven to be a good business to franchise. Recurring revenue from the group’s Fryer Management business rose by 36% to £8.4m last year, and provided 62% of total revenue of £13.5m.
Although Filta Group operates in the UK and Germany, the majority of the business is in the USA, where the highest grossing franchise owner made over $2m in revenue last year. This kind of earning potential should make it easy for the group to attract new franchise owners as it expands across the USA and into Canada.
Is now the time to buy?
Revenue from continuing operations rose by 36% to £11.5m last year. The group moved from an operating loss of £0.25m to an operating profit of £1.7m, giving an operating margin of 14.7% and a return on capital employed (ROCE) of 22%.
A high ROCE is often a characteristic of franchised businesses. I suspect Filta Group’s ROCE may rise further. By way of comparison, Domino’s average ROCE over the last five years was 47%.
Filta stock currently trades on a 2018 forecast P/E of 27, with a prospective yield of 1.1%. That’s quite pricey. But if growth continues at the current rate, I think that today’s price could seem cheap in a few years.
More pizza outlets planned
Domino’s has been a tremendous growth investment. But the share price hasn’t really gone anywhere over the last few years. The shares first hit 350p at the start of 2016. That’s still where they are today.
I think there’s a risk that the business is reaching saturation point in the UK.
Management has increased the target store count for the UK to 1,600, from a current store count of 1,045. Achieving this means splitting existing franchises into two or more parts. Franchisees then run several stores in areas previously covered by just one outlet. This means there’s a risk of ‘cannibalisation’ — new branches taking sales from the old ones.
Profit growth may be slower
Analysts expect Domino’s to report adjusted earnings of 16.2p per share this year. That’s only a tiny improvement on last year’s figure of 16.0p per share.
The picture is expected to improve in 2019, when earnings are expected to climb 10% to 17.9p. But with the shares trading on 21 times 2018 earnings, I think the good news is already in the price. I’m not tempted at current levels.
