460 stores could close: analyst tips more pain for Donut King owner

RFG's writedowns and banking issues follow Fairfax Media reports that the group was using a business model that had sent hundreds of franchisees within its network to the wall financially. The investigation also uncovered underpayment of staff by store owners.

RFG's shares have been hit hard by the news of its poor results and its new strict borrowing rules from its bankers. Its shares fell 35 per cent on Monday and a further 14 per cent on Tuesday.

RFG's shares recovered slightly on Wednesday, closing up 5.26 per cent to $1.20.

Store closures are part of RFG’s turn-around strategy as is a plan to increase support for franchisees.

The group also intends to take Michel’s Patisserie back to its French café heritage.

UBS analyst Jordan Rogers said RFG's problems were far from over and its balance sheet could be under pressure for an extended period.

"RFG has agreed to new banking covenants that appear difficult to comply with, in our
view," Mr Rogers said.

"RFG flagged another 160-200 outlet closures over the next circa 15 months and has
suspended dividends.

"We now forecast around 460 net outlet closures over the next 2.5 years."

Mr Rogers said this would a "36 per cent closure of current domestic portfolio partially offset by about 100 net openings in the international division".

Mr Rogers also said UBS did not believe the company would return to growth in the first half of 2019.

"RFG's International earnings are likely to grow but the domestic franchised brands are closing outlets, network sales are falling and are struggling to lift foot traffic or deliver transaction growth," he said.

Mr Rogers said RFG was expected to improve its business model to deliver profits to its franchisees but said this could impact the company's earnings.

"We expect RFG’s margins to fall as the value split between RFG and
franchisees is permanently change (there is an initial focus on field support and cost of goods).

Mr Rogers put a price target on RFG's shares of 90 cents, saying the investment bank saw weakness in the company beyond 2018 and 2019.

"We downgrade our earnings per share forecast by 50-60 per cent from full-year 2020 estimates onward and downgrade our rating on RFG to sell," Mr Rogers said.