People have developed a taste for what’s on the menu at Hotel Chocolat (LSE: HOTC). Its shares have been gobbled up by investors and they now trade at around 385p, well above the 199p price seen just after the May 2016 IPO.
The recipe for success, refined since the company was formed in 1993, is to make high-quality chocolate with less sugar and more cocoa and sell it directly to customers through physical stores, online, and via selected partners. There is a strong focus on gifting, and ices and drinks have been added recently. With price points between £1 and £500, there is something for everyone, and revenues have grown by 13.05% per year on average from £81m in 2015 to over £132m in 2019.
HOTC owns an estate in St Lucia where it grows special beans, and being in the game enhances its relationships with other suppliers, who receive an informed and fair price. A bespoke facility in Cambridgeshire is responsible for 95% of the manufacturing and doing it in-house allows faster innovation and better quality control. If fair prices and UK manufacturing sound troubling for those who only look at the bottom line, then a reported gross margin of around 67% should soothe any fears.
Operating margins have increased from under 5% in 2015 to around 11% in this year, which is good for a retailer, and investors would have been pleased with the 25% return-on-equity (ROE) revealed in the latest annual report. High returns to equity are possible because of the generous margins, and the absence of substantial interest payments.
However, it is worth noting that the company has significant operating leases in place. These will soon be classified as debt, which will increase HOTC’s financial leverage ratios (but not worryingly) and increase the operating profit (and margin) since lease expenses will no longer be deducted from it in full. The effect on net income and therefore ROE may be positive or negative depending on whether the interest and depreciation charge is smaller or larger than the lease expense it replaces.
Assuming these margins at least stay stable, then generating more sales should see the share price increase. Investors are expecting chocolate to keep flying off HOTC’s shelves as the ratio of the share price-to-EPS is over 40, which is very much growth stock territory. Since HOTC reports that it has just a 0.02% share of a £70bn market, there is lots of room for expansion.
According to market research, the biggest obstacle to capturing more share is a lack of access and so a strategy of increasing its online presence and opening new stores in the UK, US, Japan, and Australia, bringing new members into chocolate clubs, and expanding the range should keep revenues growing. In keeping with a company that is looking forward to its best years, a sound ethical sourcing policy and a commitment to making 100% of packaging compostable, reusable, or recyclable by 2021 should sit well with the growing trend in responsible investing.
You can pick up a dividend yield of under 1% with this stock, but that’s not enough to justify a purchase, even though dividends are increasing. I am more interested in it as a growth stock, watching the price keep pace with earnings assuming, of course, that HOTC continues its impressive revenue growth.
James J. McCombie has no position in any of the shares mentioned. The Motley Fool UK has recommended Hotel Chocolat. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.