The Motley Fool

Forget Bombardier, Inc.: Buy This $2 Stock Instead

Bombardier, Inc. (TSX:BBD.B) announced Tuesday that it was cutting its CSeries delivery forecast for 2016 from 15 to seven planes. That’s not good news for a company that’s been having delivery issues in other parts of its business. While investors inexplicably seem to love this $2 stock, you don’t have to be one of those caught up in the propaganda.

I say forget Bombardier and buy Diversified Royalty Corp. (TSX:DIV) instead. Here’s why.

When you buy Bombardier, you’re getting the political interference of the Quebec government directly through its 49.5% ownership in the CSeries program and indirectly through the Caisse de dépôt et placement du Québec 30% interest in the rail car division.

You couldn’t get a less independent company if you tried. Add to that the dual-class share structure, which gives the Beaudoin/Bombardier families control over its business, and you’re basically supporting corporate welfare.

This is a company valued at almost $5 billion, despite the fact it’s essentially broken. Buying its stock is nothing more than pure unadulterated speculation.

Diversified Royalty, on the other hand, is a small-cap worth $275 million that you’ve probably never heard of–at least until recently, when Cara Operations Ltd. (TSX:CAO), the owners of restaurant brands such as Swiss Chalet, Milestones, Harvey’s, and many others, announced that it was paying $93 million to acquire a majority interest in Original Joe’s Franchise Group, Inc., the Calgary-based group behind the Original Joe’s, State & Main Kitchen Bar, and Elephant & Castle restaurant concepts.

What does this have to do with Diversified Royalty? It owned the trademarks and royalty rights to those restaurants. Cara is paying Diversified Royalty $90 million to re-acquire those rights. Diversified Royalty intends to use $15 million of the proceeds to pay down term debt with the remainder added to existing cash.

This was a win/win deal for both Cara and Diversified Royalty.

Cara benefits because it gains 99 locations, $250 million in system-wide sales, and $14.7 million in normalized operating EBITDA. More importantly, it gives Cara a bigger footprint in western Canada, where it’s currently under-represented, while also creating potential synergies with its existing 1,120 restaurants in its network.

Diversified Royalty benefits because its royalty stream was feeling the heat of a faltering Alberta economy, where most of Original Joe’s restaurants are located. By completing this deal, Diversified Royalty’s exposure to Alberta goes from 30.1% of revenue down to 16.7%–a more manageable number.

What’s left after the Original Joe’s sale are royalty streams from two franchise operators: Mr. Lube and Sutton Realty Group. In the first six months of 2016, they generated a combined $8.2 million in royalty income. Because both royalty pools were acquired in the summer of 2015, there’s little history available from either.

However, we do know in the case of Mr. Lube that the 117 locations in the royalty pool achieved same-store sales growth of 6.1% in the first six months of 2016. Diversified Royalty gets paid 6.95% of those top-line sales. In Q2 2016 that came to $3.3 million.

In the case of Sutton Realty Group, Diversified Royalty gets paid $57.38 per agent, per month by the company with that rate increasing by 2% annually. In Q2 2016 it received $875,000 in royalties from Sutton Group. On July 4, 2015, new agents were added to the royalty pool–an increase of approximately $37,000 per quarter.

Here’s where the rubber meets the road.

Diversified Royalty paid $88.1 million in cash along with nine million of its shares for an annual royalty stream of $12 million from Original Joe’s Franchise Group. Cara will pay Diversified Royalty $90 million in cash plus the surrender of those nine million shares. Diversified Royalty got $25.4 million in royalty payments over 23 months of through August 31, 2016.

That’s an internal rate of return of 14.8%. Considering the company signed the Original Joe’s deal in 2014 when a barrel of oil was $112, management has done well for its shareholders.

Moving forward, Diversified Royalty provides investors with a 9.1% dividend yield along with a strong balance sheet that includes $80 million in cash and just $45 million in debt.

Essentially, you’re getting paid handsomely to wait for its next acquisition. What’s Bombardier paying you?

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Will Ashworth has no position in any stocks mentioned.

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