The restaurant industry has been under a lot of pressure the past few quarters, understandably so given Canadian consumer debt levels.
Most Canadians will have to cut back their spending over the next few years in order to pay down some debt.
This means that many discretionary items will be cut from budgets; one of the easiest things to cut from budgets is eating out at restaurants.
The scare that restaurants may be impacted in a major way is a bit overblown, however, leaving some restaurant stocks extremely undervalued — and presenting an attractive long-term opportunity.
Keg Royalties Income Fund (TSX: KEG.UN) is one of those stocks.
The Keg Royalties Income Fund receives a royalty from all the Keg restaurants in its royalty pool. The Keg is unique in that there isn’t much competition from restaurant chains in the steakhouse industry, giving it a slight moat.
Its brand is also highly recognizable — and it’s a favourite among Canadians wanting to go out and enjoy a luxury dinner at an affordable price.
The situation
Although Restaurants Canada has said that it expects growth for the next few years, so too has the National Restaurant Association in the United States.
Companies like Boston Pizza are seeing major negative growth that’s has been clearly impacting business and affecting the dividend. Up until the end of the third quarter in 2019, on an annual basis, its same-store sales were down 2.3%. In the third quarter alone, same-store sales were down 4.2%.
That is significant negative growth that wouldn’t warrant a sell-off in the stocks, but for the Keg, its slowdown in sales growth has been a lot less dramatic.
The Keg has also seen some slight negative growth, but compared to a lot of its peers, it’s still largely outperforming and it looks like its business is remaining robust.
Most important for investors is that unlike some of its peers, its dividend is not in danger.
Restaurant royalty companies traditionally aim to payout 100% of their earnings, which is great for investors while income is growing; the dividend increases every year.
It can however, become a problem when sales begin to decline, as most companies will be paying out more than they are earning, and if they can’t turn it around fast enough, will have no choice but to trim the dividend.
That’s the major concern for investors, which has caused a sell-off of many of these stocks.
The numbers
Currently, the Keg has 105 restaurants in its royalty pool, operating in Canada and the United States. Each individual restaurant pays a roughly 4% royalty on sales, which has combined to give the fund revenue of $29.9 million over the last 12 months, up roughly 9% over the past three years from its 2016 revenue of $27.4 million.
That’s pretty strong growth in its system-wide sales. What makes it even more attractive is that the growth has consistently increased every year.
Because it’s a royalty company and there aren’t many costs to run the fund, the growth in its revenue is crucial to the growth of its dividend.
The dividend yields roughly 7.3% today, has been increased regularly and is consistently paying out nearly 100% of earnings.
The dividend makes the stock highly attractive, plus you can gain exposure today at pretty fair value, at a p/e of just 13.7 times, while the shares trade just off its 52-week low.
The bottom line
As the stocks have been sold off due to fears over negative sales growth — and as the Keg’s numbers show — its business is still not in any danger. Indeed, the company’s sell-off in its share price has created an attractive entry point for investors.
It’s an ideal income stock that will pay you every month. Over the long term, investors can expect continued growth.
