Deep Dive #1 - Cake Box Holdings PLC (#CBOX)

The sweetest investment you will ever make!


Investment Thesis - Sweeeeet!

CBOX is an asset light franchise business model with >40% ROCE and no direct national competitors. The company has grown revenues at a 5yr CAGR of >30% and we expect growth to remain strong due to 1) new kiosk format in shopping centres and supermarkets (Asda); 2) new delivery service; and; 3) product innovation (vegan, gluten-free). The business has proven to be pandemic resistant, with revenue +17% and adj. EBITDA +26% FY21A (March year end). CBOX boasts gross/EBITDA margins of 50%/25% and we expect these margins to expand as 1) sponge sales become a larger slice of the pie (70% gross margin); 2) CBOX benefits from bulk buying; and; 3) online sales increase. CBOX also benefits from a robust balance sheet which is net cash. This is a founder-led company with the management team owning 49% of the company and with LTIP awards well aligned with shareholders’ interests. The company has a strong institutional shareholder base with the likes of Fidelity, AXA, and Ennismore on the list and it has a limited broker coverage (2 + paid marketing). CBOX trades on a reasonable valuation of 22.6x EBITDA FY21A (rapidly falling thereafter). As per all the high quality cash compounders, we expect most of the returns to come from the growth and compounding of earnings and not from the re-rating of the stock. This is the first micro-cap that makes the cut and we are long term holders of the stock. Stay tuned for our next deep dive due in September.

Let’s dive in!


ROCE - Historically 40-60%

CBOX operates an asset light franchise business model which has historically generated ROCE of 40-60%. A third of the companies sales are generated through the selling of sponge, to make the cakes, to franchisees and this is done at a 70% gross margin. Gross margins are high and have historically been between 40-50%. EBITDA margins are also robust at 25% FY21A. ROCE has decreased over the last couple of years despite margins being relatively stable as the capital employed has increased and the asset turnover has decreased. This has been driven by the two new warehouses/distribution centres (Bradford/Coventry) and the additional inventory required when operating three facilities vs one (Enfield). We expect ROCE will increase as sponge sales becomes a larger slice of the pie and the company benefits from bulk buying. Management have also said that the current set up is enough to achieve 250 stores and more and therefore we expect capital employed to grow at a slower rate than returns.


Moat - No direct national competitors

A cake shop is not a hard to replicate business however a cake shop franchise with 157 stores is. It has taken CBOX 12 years to reach 157 stores and there are no direct national competitors. There is strong demand from franchisees, with 52 deposits held from potential franchisees (all time high). The franchisee proposition is attractive with a low initial investment required and a 20 month payback on average. We expect the moat to widen as the company increases its footprint. We see the competition falling into three baskets: large supermarkets; coffee chains; and; independent bakeries. The large supermarkets tend to have limited choice and use artificial ingredients (vs CBOX’s fresh cream and locally sourced fruit). The coffee chains have limited choice and can’t cater for large events. The independent bakeries usually sell at a higher price point.

CBOX’s offering has several unique features:

  • All cakes are egg-free and therefore suitable for people who are unable to eat eggs for dietary or religious reasons

  • CBOX is a one stop shop offering a wide range of cakes of all sizes suitable for a variety of celebrations

  • The cakes can be personalised/customised (check out the Dark Horse Research cake below!) and ordered and collected within the hour

  • Cakes can be ordered for delivery via CBOX’s website/Uber Eats/Just Eat/Deliveroo

We believe that the lack of competition and CBOX’s unique features will result in a high ROCE for years to come.


Growth - >250 stores

According to the IPO document, the UK market for cakes, cake bars and sweet baked goods was estimated to be worth £2.2bn in 2017. CBOX’s market, celebration cakes and large cakes is estimated to be worth £715m. Using FY21 franchisees sales, CBOX has approximately 6% of the market and we believe there is still plenty of room for growth.

Sales and EBITDA growth has been impressive achieving a 5yr CAGR of 31%. Sales growth has been driven by a mix of new stores and LFLs. EBITDA growth has been driven from the top-line as EBITDA margins are unchanged vs FY16.

Future growth will be a combination of number of new stores, LFLs, and EBITDA margins. We have visibility on the number of new stores. As at FY21, CBOX had 157 stores and 21 kiosks. At the IPO the company was targeting 250 stores. We believe that given the new kiosk format in shopping centres/supermarkets, that the number of potential stores could be meaningfully higher. Management expect to open 18-24 new franchise stores in FY22, with already nine new stores opened in the first three months. If we assume they open 21 stores a year, they have 4.5yrs of visible growth (to reach 250 stores). Adding 21 stores a year increases sales by c.9-13% p.a. 250 stores could possibly be reached by FY25 with sales at approximately £35m assuming everything else is constant.

We believe 250 stores is more than achievable given the location of the 157 stores. There are clear gaps in Scotland, South Wales, and South West England where there is plenty of scope. Two more avenues of growth have recently been thrown into the mix: 1) kiosks; and; 2) deliveries.

We believe that the introduction of kiosks means that the original target for 250 stores can be surpassed. In FY20 CBOX experimented with 12 shopping centre kiosks. In FY21 it trialled five kiosks at a national supermarket (name not disclosed but our analysis points to Asda - see below). As at FY21, CBOX has 21 kiosks and post period end the company has opened one supermarket kiosk and has six new supermarket sites confirmed (28 kiosks in total). The kiosks are typically operated by a franchisee who operates a nearby shop and delivers twice a day to the kiosk. The kiosks have similar revenue/profit to the stores, are smaller in size, but benefit from higher footfall and take less time to reach maturity. We believe this adds a new angle to the growth story. A simple google maps search returns this:

Asda has more than 600 stores in the UK. We think that given the price point, Asda is the best suited supermarket partner for CBOX, and that given the footfall and national reach, offers significant opportunities for CBOX’s growth strategy.

Deliveries is also an area which has significant potential in our opinion. Prior to lockdown CBOX had an option to order online and collect. This has been growing steadily, accounting for 15% of franchisees’ sales in FY20. CBOX was already experimenting with home delivery when Covid hit, but the lockdown fast tracked plans with CBOX finalising the custom made delivery package (pic below - important given the delicate nature of fresh cream cakes) and signing up with Uber Eats, Just Eat, and Deliveroo. The launch was successful and online sales were up 71% in FY21 (22% of franchisees’ sales). Later in the year CBOX launched its own delivery service. Home delivery not only adds incremental growth opportunities but also sets CBOX apart from the competition.

Now let’s look at CBOX’s LFLs. The online sales are obviously a large tailwind here. Innovation such as egg-free custard, vegan, and gluten-free options should support LFLs. The reading for FY20A and FY21A have been adjusted for Covid and therefore are probably not as reliable. FY20A LFLs includes 49 weeks to 8 March, FY21A LFLs include 1 June 2020-7 March 2021. We would expect LFLs to remain positive in the medium term.


Management - Skin in the game

This is a founder-led company with the CEO/CFO still owning 41.7% of the share capital. The CEO, Sukh Chamdal, founded the company in 2008. He is the largest share owner and owns 32% of the company. He has over 35 years’ experience in food manufacturing and the retail industry. He started his career in the family business selling Indian sweets and savouries. He was joined in 2009 by Pardip Dass, the current CFO, who co-founded the franchise arm of the business. He owns 9.7% of the company. He has over 15yrs experience in the F&B industry working for companies such as Masala Zone, Group Chez Gerard Restaurants, and Real Pubs. He qualified as an accountant whilst working for Starbucks. The COO, Dr Jaswir Singh, joined in 2010. He owns 1.4% of the business. He originally qualified as a medical doctor and then joined the family textile business which he ran through the 90s. He ran his own restaurants business in the 2000s before joining CBOX. All three senior managers also have some exposure to the actual stores. The CEO’s daughter owns four stores, the CFO partly owns one store and the COO partly owns seven stores. This provides the leadership team with valuable insight into franchise store operations and the team often trials new products and initiatives in these stores.

Senior management is supported by a highly experienced Non-Executive Chairman, Nileshbhai Sachdev, who was appointed in 2018. He owns 0.05% of the company. He was previously Chairman of Sirius Real Estate Ltd, of Market Tech Holdings Ltd, and a Non-Executive Director at Intu Properties PLC. He worked as Group property Director of J Sainsbury and prior to that spent 28 years at Tesco. The three other Non-Executive Directors have backgrounds in accountancy, corporate law, and marketing/communication.

The remuneration policy appears to be well aligned with shareholders’ interests. The base salaries, which were historically below the mid-market rate, were increased in order to be able to attract/retain top talent and execute the company’s strategy. The annual bonus is capped to 75% and the majority of the bonus is linked to financial targets such as adj. EBITDA (details not disclosed). In terms of long-term incentives, the Group operates two equity-settled share-based remuneration schemes. The main vesting condition for senior managers is EBITDA reaching £19m (FY21 EBITDA £5.4m) by the third anniversary of the date of the grant. The main vesting condition for the Executive Directors is EPS reaching a minimum of 36.4p by the third anniversary on which 30% will be exercisable. The options have a three year vesting period and a two-year holding period ensuring a five year gap between grant and the first available opportunity to benefit from a vested LTIP award.


Valuation - Focus on the compounding

Historically, CBOX has traded between 15x-20x TTM EBITDA. The stock currently trades at 22.6x FY21 EBITDA which is above the range, however our analysis shows that when you look at the long-term growth, the valuation falls back into the historical range on FY22E numbers and beyond. What is important to note is that we expect most of the returns to come from the growth and compounding of earnings and not from the re-rating of the stock. We are quite happy for the multiple to stay within the historical range. We believe our assumptions in the scenario analysis below are conservative. We expect CBOX to grow number of stores by at least mid-guidance (21 p.a.) given the new format and franchisee waiting list. We expect LFL franchisee sales to continue to be positive in the midterm as the company innovates and online sales increase. We expects margins to improve as number of stores increases, sponge sales become a bigger slice of the pie, and CBOX benefits from bulk buying.


Balance sheet - Net cash/asset light

Due to the franchise business model, CBOX has an asset light balance sheet. The business is net cash (£3.6m), generated CFO of £5.2m and paid a dividend of £2m (1.5% div yield) in FY21A. The group’s only debt is a mortgage of £1.5m secured by its freehold properties in Enfield, Bradford, and Coventry. The freehold properties are worth £4.6m (Feb 2021 - independent valuation, historic cost £2.8m). The business generates a 20% FCF margin and is trading on a 3.5% FCF yield (vs 1.5% div yield) suggesting plenty of room for dividend increases.


Business model - Franchise

CBOX operates a franchise business model. It does not own or manage any stores directly. This means that it has an asset light balance sheet and does not require significant capital to expand. Unlike other franchises which charge a percentage of revenues, CBOX makes most of its money from selling to franchisees the sponge used in the cake and cake supplies. The sponge is sold at a juicy 70% gross margin. CBOX’s manufacturing does mean that there is an element of capex related to the production sites, however the three sites it currently operates, Enfield (main site), Bradford, and Coventry can support the company’s original target of 250 stores and more. The company makes money from the store fit out which are paid for by the franchisees and which the group manages using 3rd party contractors. CBOX also charges an initial franchise fee.

The franchisees invest c.£145k per store which the group recommends to fund 50/50 cash/bank debt. The Group has arrangements with the bank to provide franchisees with debt funding subject to credit approval. The investment is used to pay the £40k initial franchise fee, the store fit out, and working capital for the business. The franchisee enters into a 5yr franchise agreement with the Group with the right to renew at the end of the agreement. The franchisee can expect to earn on average £87k EBITDA p.a. based on mature stores (opened 12 months or longer) and average payback time is 20 months. A franchisee receives significant support/training from the group and does not require previous food/cake knowledge. The franchisor creates/delivers the sponge and therefore there is no baking done at the stores. The franchisees are trained to decorate the cakes using fresh cream and this is done at the store.

Cake Box sells a wide range of fresh cream cakes in different sizes, many of which can be personalised and collected/delivered within one hour. All the cakes are egg free which makes them suitable for people who are unable to eat eggs for dietary or religious reasons. The price point is good value for money and towards the lower end of the range with a typical cake that serves 8 costing £25-35. The personalised cake that we ordered, which serves 8, cost £30.

In 2020, CBOX adapted to Covid/lockdown by providing home delivery via Uber Eats, Just Eat, and Deliveroo. Later in the year, the company launched its own delivery service. The Group takes a 7.5% royalty fee on online orders. Getting the packaging correct was crucial due to the delicate nature of the cakes.


History -Founded in 2008

CBOX was founded in East London in 2008 by Sukh Chamdal (CEO). In 2009, Pardip Dass (CFO) joined Sukh Chamdal and co-founded the franchise arm of the business. The Group grew through franchise expansion and does not own/operate any stores. CBOX IPO’d on 27 June 2018 at 108p (mkt cap:£43.2m) on AIM. The founders placed 38.2% of the share capital. On 8 Sep 2020, Sukh Chamdal placed 9.4% of the share capital at 170p (£6.4m) in response to demand from investors and to increase liquidity. The CFO bought £382k. The free float is now 51%.


Shareholder Register - Institutional

CBOX has an impressive institutional shareholder register with some well known names such as Fidelity, AXA, Ennismore, and more.

Shareholder register as at 31/05/21:

  • 31.97% Sukh Chamdal (CEO/co-founder)

  • 10.59% Canaccord Genuity Wealth Management

  • 10.57% Amati Global Investors Ltd

  • 9.74% Pardip Dass (CFO/co-founder)

  • 5.65% AXA Investment Managers UK Ltd

  • 3.88% Fidelity Management & Research Company LLC

  • 3.41% Ennismore Fund Management Ltd

Most recent trades:

21/05/21 - AXA increased position from 4.98% to 5.65%

01/03/21 - AXA decreased position from 7.88% to 4.98%

04/12/20 - Canaccord decreased position from 11.11% to 10.99%

09/09/20 - Canaccord increased position from 5.04% to 1.11% (from placing)

09/09/20 - MI Chelverton UK Equity Growth Fund - New position 5.34% (from placing - but not sure why not on shareholder register)


Broker coverage - Limited

  • Shore Capital - NOMAD/Corporate Broker

  • Liberum - Initiated on 03/03/20

  • Equity Development - Non-independent/marketing material


Key dates - 1H22 trading update

  • March year end (Sep 1H)

  • Trading update post 1H22 close (last year on 12/10)

  • 1H22 results (last year on 23/11)

  • Ex-div date 15/07


If you have reached this point, well done and thank you for reading!

Dark Horse Research