Published on April 3rd, 2023 by Nikolaos Sismanis
The Keg Royalties Income Fund (KRIUF) has two appealing investment characteristics:
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The combination of a high dividend yield and a monthly dividend render The Keg Royalties Income Fund appealing to income-oriented investors.
But there’s more to the company than just these factors. Keep reading this article to learn more about The Keg Royalties Income Fund.
The Keg Royalties Income Fund is a limited-purpose fund that owns the Keg trademarks and related property that were purchased from Keg Restaurants Ltd (KRL). The Keg Restaurants have built a premier steakhouse brand in Canada, with an established presence in the United States.
With the fund owning the rights to the brand, it has granted KRL an exclusive license to use the Keg Rights in exchange for a monthly royalty payment equal to 4% of the gross sales of Keg restaurants.
In return for adding restaurants to the fund’s royalty pool, KRL receives the right to acquire units in the fund. KRL’s effective ownership of the fund has grown from 10.00% at the time of the IPO in 2002 to 32.43%% as of the end of 2022. Hence, the interests of the two entities are well-aligned.
The Keg Royalties Income Fund stands out as a “top-line” fund, with its revenue stemming predominantly from KRL’s restaurant sales and only minor operating and financing expenses curbing its net income. Additionally, the fund benefits from a secondary source of income – a $57.0 million Keg Loan, which generates interest income at a rate of 7.5% per annum, paid monthly.
This unique structure shields the fund from the fluctuating earnings and expenses associated with actually running the restaurants. As a result, the fund enjoys protection from inflation and a relatively predictable stream of royalties and interest, among other benefits.
Similar to other royalty funds of its type that we have analyzed, like the Boston Pizza Royalty Income Fund and the A&W Revenue Royalties Income Fund, the fund’s growth prospects and overall performance hinge on just two key factors. The first is the number of franchised restaurants in its royalty pool, while the second is the rate of growth in same-restaurant sales.
For context, at the start 0f 2004, the fund had 86 Keg restaurants in its royalty pool. By the end of 2007 and 2013, this number had grown to 95 and 102, respectively. Since then, activity in the royalty pool has been rather stagnant. At the end of 2020 and 2021, the fund had 106 restaurants in its pool, while by the end of 2022, it had added one more to its count of 107.
We expect very few annual additions to the fund’s royalty pool, as it appears the brand has reached peak scaling potential. In comparison to the Boston Pizza and A&W Royalty Funds, which primarily focus on fast-food brands and offer more significant growth potential, Keg’s high-end dining experience is more tailored to a smaller and more specialized demographic, resulting in a more contained expansion capability.
That said, growing same-restaurant sales still poses a growth catalyst for the fund. In 2019, before the COVID-19 pandemic, there were 105 Keg restaurants in the fund’s royalty pool, generating about C$623.7 million in gross sales, or C$5.94 million per restaurant. In 2022, the company had 107 restaurants in its royalty pool, generating about C$676.4 million, or C$6.32 million per restaurant.
As a result, last year, the fund recorded about C$27.06 million (red box) in royalty, which is exactly 4% of the underlying gross restaurant sales in the royalty pool. It also recorded an additional $4.3 million in interest income from its 7.5%-yielding loan, as mentioned earlier. You can also see the distributions paid to KRL corresponding to its ownership in the fund and other advancements paid for upcoming restaurant openings.
Source: Annual Report
Future price increases in line with inflation should slowly but gradually add to the fund’s royalty-eligible gross sales generated by KRL. Of course, foot traffic in the company’s restaurants and/or restaurant openings and closings could sway results either.
Aligned with the fund’s aim to distribute all its profits to unitholders, the payout ratio has consistently hovered around the 100% mark. In 2022, it stood at 104.7%, while in 2021, it was 121.5% owing to the fund’s decision to disburse extra cash that had been held back in 2020 due to the pandemic, which had resulted in a payout ratio of just 85.9% at the time. Still, since its inception, management estimates that 99.78% of distributable cash has been distributed.
Investors should not expect distribution increases or distribution “cuts”, but instead expect that each year’s total distributions per unit will vary based on the underlying gross sales of Keg-licensed restaurants.
We see limited distribution growth prospects moving forward, in line with our rationale regarding the fund’s overall growth. Apart from higher pricing over the years, we can see the fund generating more or less stagnant earnings and thus paying out rather stagnant distributions.
The current monthly distribution of C$0.16 translates to an annualized rate of C$1.14 (or US$0.85), implying a yield of 7.2%. It is a rather substantial yield, but at the same time, however, it reflects investors’ expectation for limited dividend growth prospects.
It’s worth highlighting that the management’s approach appears to involve dividing the quarterly or yearly distributions into equal sums by forecasting the forthcoming cash flows, thereby creating a uniform distribution rate and ensuring consistency in payouts month after month.
The Keg Royalties Income Fund offers a hefty dividend yield, which along with the highly attractive frequency of its monthly payouts, make it a highly compelling pick for income-oriented investors.
Its frictionless revenue model, which is directly tied to the gross sales of the restaurant in its royalty pool, offers protection from inflation, and a dependable stream of profits, regardless of the profitability of each individual restaurant.
Provided that there are no significant changes to the Keg brand, we anticipate the company will continue to generate a stable stream of monthly distributions through reliable royalty and interest income.
However, compared to other trusts of this type we have analyzed, we anticipate that the scope for distribution growth is relatively restricted due to the paucity of new restaurant openings and the possible saturation of the brand.
Consequently, investors should prepare for the bulk of their returns to come from the dividend. Taking this into account, we believe the fund will not achieve annualized returns exceeding the mid-to-high single digits, in line with its current dividend yield.
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