AWRRF - A&W Revenue Royalties: Another Dividend Hike Coming For This 5.4% Yielder

2023-07-12 12:36:55 ET

Summary

• A&W delivered a very impressive quarter.
• We calculate that there will be another dividend hike shortly.
• While there is not much wrong in the company's performance, we think that a multiple compression lies ahead.
• We give you our buy point.

All values are in CAD unless noted otherwise.

A&W Revenue Royalties Income Fund (AWRRF)( AW.UN:CA ) earns 3% royalties on gross sales of 1,037 A&W restaurants across Canada. These are "hamburger and root beer" type quick service restaurants and can be seen across the country as standalone locations, adjacent to convenience stores, in urban shopping centres and in malls.

The top line royalty income is used to pay the expenses and refresh the cash reserves (if needed) of the entities within the fund structure. The net available cash then makes its way to the fund on account of it being higher up in the food chain. The fund aims to pay this out in the form of distributions to its unitholders, after ensuring it has reasonable reserves of its own.

The expenses incurred en-route to the final distributions to unitholders of the income fund are few and predicable. They comprise general and administrative expenses, interest expenses and income taxes. Since the royalty is tied to the gross sales of the restaurants, that is where the efforts of the group are focused. To that end, the number of restaurants in the royalty pool has not had a down year since inception of this fund.

And unsurprisingly, barring 2020, the top line number has also grown year after year.

Prior Coverage

While we consider this fund an inflation hedge, we continued to remain on the sidelines the last time we covered it in November 2022. There was nothing wrong with the fund, but its 5.8% yield lost out to the other bargains we saw out there. Pizza Pizza Royalty Corp. (PZRIF) had just snuck under our buy point and we went with that one. We sold it last month when we felt it was overvalued from our standpoint.

Pizza Pizza snuck ahead in total returns during our holding period, but nonetheless even A&W had a good run.

As it trades at a higher price now, A&W yields 5.4% now versus the 5.8% back in November. However, there is potential for yet another dividend hike based on the Q1 results, which we will talk about next.

Q1-2023

The overall top line sales increased by 8.1% year over year, while the increase in terms of the same store sales was lower, it was still an impressive 6.1%.

To put this 6.1% same store sales growth into perspective, it is over 80% of the annual increase for 2022. It is also very respectable when one disregards the covid-19 related volatility in 2020-2021.

While 2022 still had a few restrictions remaining relating to the pandemic, 2023 had none, making room for the restaurants to thrive. Historically, and we are excluding the exigent circumstances of the last couple of years, the first quarter is not the strongest performer. The restaurants typically perform better in the subsequent quarters riding on holiday events like Black Friday and Christmas shopping. Summer travel and back to school sales, along with better weather, propel sales growth in the latter part of the year. So the growth experienced in Q1 bodes well for the rest of the year.

Coming back to the results, at a time when majority of the businesses are suffering the impact of rising interest rates, we have this income fund showing an impressive decline.

There is a $60 million term loan on the books. It's an interest only loan repayable in September 2026 and the rate on it is 1.74% fixed plus 1.15% per annual stamping fee. The 1.74% is fixed via an interest rate swap agreement which also goes to September 2026. The swap agreement that matured in December 2022 had a 2.80% fixed portion. This 106 basis points differential along with earning substantially higher on the cash reserves, cut the next expense by almost half year over year.

Outlook & Verdict

Extrapolating the annual income using Q1 and the 2022 numbers, we come to $2.16 in earnings per unit.

We have ignored the unrealized gains/losses on interest rate swaps for the purposes of this exercise. Being a top line income fund, A&W retains very little of its earnings in reserves and distributes most of it. That can be seen in the payout ratios below.

In light of the anticipated recession, even if they err on the lower side and distribute 92% of the earnings, it still warrants a dividend hike from the current 0.16 cents/month. We expect a hike to 17 cents around Q3 of this year. That would still make it yield under 6% at current prices. That is good but not great in an era of 5.35% 1 year GICs and almost 4% on the 5 year Government of Canada bonds.

We think there is some multiple compression risk as well and that will come into play the moment the markets get off the idea that there will be aggressive rate cutting cycle. It is hard to find any fault with the company except we can bring up our observation that some of the pricing has gone a little out of whack with reality. Fast food is getting incredibly expensive and A&W has so far been enjoying this price increases via its direct leverage to the top line. But somewhere here with housing costs rising so rapidly and Canadians out on a limb on variable rate mortgages , there will likely be some push back. We would only look to buy this at a far lower multiple today and aim for maybe 13-14X earnings. This would get us to the $28-$30 zone.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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