Stock Picks | Cake Box - Sweet Enough To Take Away The Taste Of Patisserie Valerie?

23rd Feb '19 by Damian Cannon

10 comments 1846 reads

For the first StockSlam of 2019 I took a quick look at Cake Box Holdings (LON:CBOX). Floated in June last year, at 108p, my hope is that this share might take away my unhappy memories Patisserie Valerie! Within two weeks of listing the shares hit their current level and have stayed there ever since - which makes sense given the lack of news-flow.

So Cake Box Holdings (LON:CBOX) are a specialist retailer. They do fresh cream cakes but with a specific twist; everything is egg-free. This is great for certain religions (such as Hinduism), lacto-vegetarians and anyone with an egg allergy. Browsing their website they have a wide range of cakes mainly based on sponge and cream. That’s attractive to a lot of people it appears although this style is not to my taste.

The reason I know that the cakes are popular is that the company started in 2008, with just one store, and has grown quickly to around 101 profitable franchise stores. The key word there is obviously franchise. They don’t own any stores, and they don’t operate any stores either, which reduces both capital costs and roll-out risk. Their aim is to go from 101 stores to 250. With roughly two new stores opening per month they’ve got a fairly long runway ahead and there's plenty of scope to expand outside the South-East (which is why they are opening a new warehouse facility in the north).

Now the half year results came out recently and the company managed 4.35p in earnings along with increased cash and a 1.2p dividend. With unchanged analyst forecasts sitting at 8.1p (less than twice 4.35p) there's a bit of a disconnect here given plans to open at least another 10 stores. Still with Cake Box Holdings (LON:CBOX) trading on a P/E ~20 you'd expect to see growth and perhaps forecasts being beaten.

At the franchise level the brand is doing well with total turnover up 29% to £14.1 million and online sales materially rising 86% to £1.99 million. Of course there are a number of new stores in there and at a like-for-like level sales growth was a much lower 4.4% (down from 9.0% in the…

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mojomogoz

23rd Feb '19

IMO it’s great franchise structure...but with a product that isn’t great and has limited appeal as I don’t think that there very cream based cakes have a huge broad based appeal in U.K. Note, that they started serving an Indian market and I guess that will still be a big part of their market. Mgt say that they appeal more generally to a ‘working class’ audience and occasional affordable treat.

The margins are real as they make all (or most)their ongoing profit from supplying the sponge for cakes.

There’s a factor to work out about how growth pays as franchisees also pay £150k to get franchise. Most (all?) of other costs to set up are taken by franchisee. So their rapid expansion is probably hitting bottom line decently and margin could reduce decent amount. I guess there’s a low benefit to scale into the margin too.

It might have a decent amount more room to grow so can buy and profit but watch out for those buffers.

I liked mgt and their idea and model but I just don’t think this is a company with real headroom to grow. I think you’ve already got to see the cash return to buy now....and the reality of the market discounting machine is that if they hit high growth limits in next few years you’ll probably get the chance to buy at somewhere near current price with a lot more visibility on outlook for cash return.

Damian Cannon

24th Feb '19

Thanks for the reply - it's good to hear from someone who knows a bit more detail. I didn't quite follow this bit though:

There’s a factor to work out about how growth pays as franchisees also pay £150k to get franchise. Most (all?) of other costs to set up are taken by franchisee. So their rapid expansion is probably hitting bottom line decently and margin could reduce decent amount. I guess there’s a low benefit to scale into the margin too.

Are you saying that growth would hit margins? I would have thought that margins would be fine given that the bulk of income comes from supplying sponge/ingredients and this should just scale up?

Damian

My point wasn’t clear (hasty on smartphone)

1) I don’t think there is much upside to margin through scale effects as they grow

2) they are opening franchises at a decent pace. Each franchisee pays £150k to play and then I think they take on costs (rent, shop set up, etc). So growth brings in cash and little cost to Cake Box.

My knowledge on point 2 is a bit flakey so dyor rather than take my word (I’ll look at notes later and see if I have more detail). But if I’m right then margins could slow a bit to a lot depending on impact pocketing £150k has (or percentage that falls to bottom line).

I’ve not looked at accounts and disclosures in detail so the answers may well be there...and refute my negatives

NB on (2) the franchisee takes on the costs of set-up and running, not Cake Box

Snoo

25th Feb '19

I have mixed feelings on this.

Have visited a store out of interest a while back. On first impressions some of them aren't in great locations, but that doesn't particularly matter.

A view on their website shows something what I believe to be a conflict. Their main USP I believe is that they are egg-free. But this point is barely sold, apart from the domain name. In fact, the real USP appears to have morphed over time, that one can get a personalised cake very quickly in one hour. Competition for this type of thing is very fragmented. Costco offer a far better product and much better value for money, but you have to be a member and you have to order 72 hrs in advance.

So £23.99 for a smaller cake and about 5 minutes of labour seems steep, but obviously great business for them especially if the bases are pre-made and sold to the franchisee. But if people are getting these things for a celebration, they are not going to care on price, and being egg-free is not likely to make any difference either. The taste difference rapidly disappears once a heap of frosting is put on. I don't believe most people buying care too much about the egg-free point, obviously some will.

The business model appears great. Franchising takes away much of the risk. And the website could potentially funnel in a lot of orders for cakes, especially for those that choose their locations correctly.

My main bugbear is governance. Power appears highly concentrated within a couple of people, and the appointment of 2 NEDs on the same day looks like window-dressing to me. Change could be difficult to push through here. Potentially there could be even bigger markets, ie dairy-free cake, gluten-free cake, vegan cake.

Those are some great points Snoo. You're right that the egg-free angle is hardly pushed by the website. What's more they don't even own the cakebox.com or cakebox.co.uk domains which I see as a very amateur move.

As for power concentration the CEO and CFO speak for around 50% of the shares so they absolutely have control of the business. OTOH their interests should be aligned with the minority shareholders.

A final question is whether this is such a great deal for franchisees? I can see the model being popular as an alternative to opening a mini-supermarket, off-licence or restaurant but is it sustainable long term?

Cake Box claim that franchisees typically see quite a short payback period of 18 months.

As I am now at desk with notes I can clarify some points I made above from memory to keep record straight:

£125k to purchase a franchise. £30k payment to CAKE and £95k to shop build to their specifications

£100k pa EBITDA per store

CAKE profit is all in the bake with 70% margin on the sponge (they did not give detail re cream etc they also supply but assume that is part of 'bake' and actually reduces margin from a higher level to 70%)

Thanks for the extra detail - very interesting.

For fun I've spent a few minutes looking for franchisee reviews but couldn't find any. However I did turn up a few gems:

A direct competitor: https://www.egglesscakeshop.com/

How the company market themselves: https://www.what-franchise.com/business-advice/running-a-franchise/could-you-be-a-team-player-with-the-eggfree-cakebox-franchise

How it looks like to a potential franchisee: https://franchiseguidehq.co.uk/cake-box-franchise/

A typical shop location: https://www.barnettross.co.uk/details/201710/2.pdf

There is one opening near me, will check it out soon.

Personally I think it'll do quite well. The product as I see it is personalised cakes, not egg-free ones and there is not going to be anyone that has a faster turnaround, and as long as a minimum standard is met people eating these things are hardly going to be assessing taste/quality too closely. The look counts for more than anything.

The business has very strong Asian roots, from the main people to the location of the first shops. I believe they didn't pick up the domain name because the original strategic focus was on the ingredients, which has changed now to focus on customisation/delivery times and a more broad market including targeting people that do eat eggs.

My concern is, is that in most people's opinion, eggs do make for better cakes. What is going to happen if there is a terrific opportunity or demand (like gluten-free, or dairy-free) that requires egg to keep the quality up? From a shareholder point of view, abandoning the 'egg-free' part of the name would make sense as a much larger variety of products can be offered. The bases come in from outside so it would be entirely possible to avoid cross-contamination. The vegan slant seems to have worked very well for Greggs and gotten them a load of publicity.

My gut feeling is that this would be a red line for the owners, and there isn't sufficient power on the board to challenge them.

Markteign

27th Feb '19

All I can say is that my partner bought a personalised cake for me recently; which I took into work.

Turnaround was very quick indeed - a few hours - the cake itself went down a storm. It was very attractive and a number of people remarked on how light the sponge was.

Obviously experience may vary, but I would definitely use them again.

The location of the store (in an outlying area of Bristol) is probably not ideal. The display of cakes in the store is very attractive and noticeable and it appears very hygienic. Again, whether this applies to all their stores, I wouldn't know.

Cake Box - Sweet enough to take away the taste of Patisserie Valerie?

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Damian Cannon

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