RFG - When vertical integration fails

One of the curious things to note when looking again over the HY18 Annual Report for RFG is the segment information attached to the consolidated financial statements.

In brief the following underlying segment EDITDA figures are illuminating:

Bakery cafe fell by 38%
QSR systems fell by 19%
Coffee retail systems fell by 68%
Coffee and allied beverage fell by 60%

And finally the commercial food services segment saw 92% growth.

Some of the qualitative issues that have surfaced in the media recently from franchisees are inventory quality concerns and excessive inventory cost from the brands distribution system. Both of these issues seem directly linked to the firms engagement in vertical integration and the attempt to incorporate Hudson Pacific into the corporate structure.

The Hudson Pacific acquisition and the establishment of the commercial food services division has created an agency issue as the franchisees became a customer of one of the largest growing business segments. The growing value of the commercial food services EBITDA to consolidated earnings is a direct conflict of interest with the firms external revenue streams from the four retail segments and indeed the maintenance of quality products to the ultimate consumer.

The commercial segment was purchased in 2016 for 88m and the firm has spent close to another 12.4m on acquisition, integration and restructuring costs that are likely to be mostly attributable to the effort to vertically integrate the RFG brands into the "full service food and beverage company".

To date, I would suggest that the current corporate strategy to vertically integrate the RFG brands has been the primary destructive influence on the retail brands and that a complete rollback of the strategy is required. The first step should be to divest the commercial food services segment and use the proceeds to pay down debt. The segment should be replaced with a procurement division whose sole purpose is to source quality inventory from a range of suppliers and use the large expected supply volumes to ensure the lowest possible input costs for the franchisees.