A pull-back at chocolatier Thorntons (THT) could tempt risk-tolerant investors. We expect more earnings upside to come from the £69.7 million cap’s transformation from chocolate retailer to fast moving consumer goods (FMCG) provider.

Derbyshire-based Thorntons is three years into its turnaround under chief executive officer Jonathan Hart, who has rebalanced the business, revitalised the brand and restored profitability.

The closure of ‘Own Stores’ continues, as Hart right-sizes the retail portfolio to a sustainable, profitable estate, although retail will remain a great way to showcase the brand. Thorntons’ ongoing strategic shift towards a higher margin FMCG model should continue to raise earnings before interest and tax (EBIT) margins. Though the division’s emergence as the core business is positive, it does leave Thorntons at the whim of the embattled supermarket chains. The precise timing of large FMCG orders can vary, so quarterly numbers may become less predictable.

Thorntons- store

The good news is Thorntons is diversifying its customer base, growing through the convenience channel and having successes with Superdrug, Debenhams (DEB) and other ‘gifting’ retailers.

Full-year figures (10 Sep) revealed a 60.4% surge in pre-tax profit to £7.5 million on sales up 0.6% to £222.4 million. Thorntons continues to benefit from strong market positions in a resilient confectionery market – its ‘premium’ products represent an ‘affordable treat’ – while any uptick in real wage growth will boost demand further.

Small Caps - Thorntons - Sep 14

Key risks include the potential for further sharp cocoa price hikes, though Thorntons has successfully passed on price increases to customers and proven adept at managing raw material cost inflation through forward buying and canny product engineering.

Thorntons also has opportunities to grow the brand overseas. Australia, South Africa and the UAE remain the key growth drivers, though the huge US market, where it has secured some modest listings, should become its biggest international market in the coming year.

Investec Securities has a ‘buy’ rating and 175p price target for our running key selection (see SharesPlays21 Nov ‘13). For the year to June 2015, the broker forecasts a 25% pre-tax profits rise to £9.4 million for earnings of 9.7p (2014: 8.9p), ahead of £11.8 million and 12.2p respectively by June 2016. On a prospective price to earnings (PE) ratio of 10.5, the shares boast appetising re-rating scope as earnings quality continues to improve.

Issue Date: 24 Sep 2014