Why it doesn’t pay to buck the trend

Monday, 12 March 2018
Melbourne, Australia
By Terence Duffy

  • Falling prices warn of bad news to come
  • Business partnerships need to be win-win
  • The power of the press

Editor’s note: Port Phillip Publishing’s office is closed today for the Labour Day Holiday in Victoria. We’ll be back tomorrow with a new Port Phillip Insider.

Today we’re bringing you a complimentary issue of Money Morning Trader, originally published last week on Thursday, 8 March.

Money Morning Trader is a daily paid service (Monday–Friday), brought to you charting guru, Terence Duffy. Terence details how the day’s charts tell you everything you need to know about the economy and the stocks about to move. And they do it long before the mainstream financial media gets onto the story.

Terence looks for stocks about to break higher, and to get on board for the run. As he says, the stock market itself tells you which stocks to buy! To understand what he means by that, you can find out more about Money Morning Trader here.

A falling share price tells you a lot about the health of a company.

It tells you that something in the business is not quite going to plan.

The market has an uncanny knack for figuring this out before the reasons are widely known.

The collective wisdom of the market seeks out success and follows it while business is growing. The smart money is very quick to find signs of trouble. This shows up in the charts.

Shares in Retail Food Group Ltd [ASX:RFG] have fallen a long way in the last eighteen months. The company owns Michel’s Patisseries, Donut King, Gloria Jeans and Brumbies Bakeries.

From a high of $7.37 in September 2016, RFG is down to $1.20, where it closed yesterday. That’s a whopping fall of 83.7%. It’s getting close to losses in the 1929 stock market crash when the Dow Jones index fell by 90%.

After listing on the ASX in 2006, RFG sought growth by acquisition. They spent more than $500 million in the next decade on acquisitions in the food franchise industry. The company was achieving record profits, double-digit returns on equity and big dividend payouts for shareholders.

Where did it go wrong?

Successful business relationships last for a long time when everybody wins. If every party in a transaction is doing well, there’s an incentive to keep doing business. If one side is losing, the relationship usually comes to an end.

RFG operates most of its stores in a franchise model. The phenomenal growth in its business model put pressure on business relationships. Many franchisees have been pushed to the wall.

The share price was already in a downtrend after the high of $7.37 in September 2016. It hit a low of $4.20 in July 2017 and struggled to bounce off this level for the next five months.

Then they got hit by a bombshell.

Fairfax Media published a three-part investigation that uncovered a brutal business model.

Franchisees suffered from crippling fees, rising labour costs, higher rent and expensive food costs. They claimed little support from head office as the company sought to cut costs and keep margins healthy.

Many people had given up their nest egg or borrowed hundreds of thousands of dollars to buy a store. Unable to make a profit, operators then struggled to find a buyer. Some have closed the doors and simply walked away.

Here’s the daily chart of RFG:

chart image

Source: Optuma
Click to enlarge

You can see that the stock was already in a downtrend long before the Fairfax report was published.

The big down day in February 2017 was an early warning sign of bad news to come. The company broke below support at $6.00 that had held for six months. Then came a series of lower highs marked by the arrows in the chart.

On Friday, 8 December 2017 the market closed at $4.40. The Fairfax Media report was published over the weekend. On the following Monday, the stock fell 26.1% and closed at $3.25.

The share price fell further before RFG went into a trading halt. The ASX suspended RFG from trading following its failure to lodge its half-year report and accounts. This failure breached ASX listing rules.

When trading resumed, there was another gap lower. RFG reported a net loss after tax of $87.8 million for the first half. This compared to a restated $32.7 million for the similar period a year earlier.

The market was down by 50% at the low of $1.03 before a slight recovery.

The chart had already given plenty of warning that something was amiss.

Let’s take a look at another technique. Here’s the weekly chart:

chart image

Source: Optuma
Click to enlarge

This chart is overlayed with the weekly swings. It’s quite a useful tool in the powerful Optuma software. Use it to your advantage.

When the weekly bar makes a higher high and a higher low, the swing chart moves up. When it makes a lower high and a lower low, the swing chart moves down.

This enables you to see the swing highs and lows at a glance. It clarifies the important turning points and takes out some of the noise in the chart.

From January 2017, RFG was never able to break above a weekly swing high. Not once. Every single high in the weekly swing chart was lower than the one prior.

This shows a decided lack of strength. It gives you no reason to hold the stock.

Good trading,
Terence Duffy