Restaurant stocks have been sold off heavily in Canada this year, as consumer debt becomes an important factor for many people to take care of, and as the economy naturally slows its growth.
Although Restaurant Canada has predicted a 1.2% annual increase to restaurant sales through 2021, the data that is being seen from numerous restaurants shows a large reduction in same-store sales, with some restaurants reporting up to a 5% decrease.
This has affected a lot of the royalty stocks, especially the ones that aim to pay out close to 100% of their profits, which has led to their payout ratios climbing over 100% as a result of the decrease to their business.
While a lot of restaurant royalty stocks have been sold off heavily this year due to that fear, one stock that has held up well for the most part is Keg Royalties Income Fund (TSX: KEG.UN).
Its stock has been mostly rangebound this year after a decline of roughly 20% in 2018, which is pretty substantial for a royalty company.
The Keg operates restaurants in Canada and the United States, with 106 total restaurants in the royalty pool at the end of the third quarter.
It receives a 4% top-line royalty of all system sales, which in the third quarter equated to roughly $6.2 million and approximately $19 million for the nine months ended September 30, 2019.
On the total revenue, its operating costs are very minor, so it reports an operating margin of more than 95%. From there it pays out nearly 40% of its operating income to the Keg Royalties Limited, which leaves it with an income before tax margin of roughly 60%.
Depending on some fair-value adjustments and the amount of tax it pays, its net income can vary from quarter to quarter, so looking at its distributable income is a better measure of its operations.
The Keg, although it doesn’t completely compete with many of the other restaurant royalty stocks, such as Boston Pizza, because the Keg is more of a luxury brand; it still hasn’t been immune from declining same-store sales growth (SSSG).
For the nine months ended September 30, the Keg has seen its consolidated SSSG decline by roughly 1%, and in the third quarter alone, the decline was closer to 3.5%.
These numbers are higher in the Canadian portion of its business and shows that its expansion into the U.S. has helped to diversify its revenue growth, or lack thereof, especially because the American consumer and Canadian consumer aren’t quite in the same boat in terms of consumer debt levels.
The decline in the quarter caused the fund to only report roughly $0.27 of distributable income, which resulted in a 106.1% payout ratio.
The numbers are slightly more stable when considering the nine months ended September 30, as the company generated distributable cash in the $0.89 region, which resulted in a 96.7% payout ratio.
In total, the fund pays a dividend that equals roughly $1.14 per year, which, at today’s price, gives it a yield of approximately 7.1%.
Going forward, it knows it can’t control consumer spending, but it can do everything in its power to capture more market share and try and drive as much traffic as possible. The Keg is a Canadian favourite, after all, and a high-quality brand that has tonnes of recognition.
It’s the go-to place for fine dining for the average consumer in Canada and a place that never gets old, so going forward over the long term, it should be a top income-generating stock.
