Restaurant Royalties: Everything Going as Planned
What you need to know:• Restaurant royalties’ same-store-sales growth continues to outpace food inflation in Canada which we believe to be persistent
• The full-service and limited-service restaurant industries have proven to have resilient growth through all economic conditions
• The group outperformed the TSX by 450 bps since our last note, yet valuations still remain at trough levels
Since publishing our thematic research piece on restaurant royalties on November 29th, the group has performed well, increasing 5% on average compared to the TSX which was flat. BPF.UN was the best performer in the group, being up 9%, and KEG.UN was the worst performer, being down 1%, while BPF.UN and PZA increased their monthly dividends. This report will revisit components from our investment thesis, covering new data and updates from each company.
Revisiting Our Investment Thesis
Inflation Hedge
In our previous note on restaurant royalties, we highlighted that since restaurant royalties take a percentage of system/franchise sales, they benefit from food inflation without the downside of increased input costs. In Q4/22, monthly food inflation in Canada averaged 10.2%, while in Q1/23 it averaged 9.7%. This compared to the 20.4% average SSSG posted by our peer group in Q4 (Figure 1) and 28.0% in Q1 (Figure 2). We again note that this includes the effect of the restaurants not operating at full capacity in their respective comparable periods. However, KEG.UN recently introduced new disclosure for average sales per operating week which was up 15.3% in Q1, removing the effect of pandemic restrictions. This again illustrates that food inflation is a major tailwind for restaurant royalties and guest traffic is incredibly sticky, with all firms outperforming food inflation asides from A&W.
While the food inflation rates in Canada are starting to moderate (8.9% in March 2023, which is still objectively very high), we reiterate our view that 4%+ food inflation will persist for multiple years, providing outsized dividend growth for the restaurant royalty companies as long as volumes remain steady or decline modestly.
A&W Revenue Royalties Income Fund (the Fund) is a limited purpose trust established to invest in A&W Trade Marks Inc., which through its ownership interest in A&W Trade Marks Limited Partnership owns the A&W trade-marks used in the A&W quick service restaurant business in Canada. As of Dec 31 2010, Co.'s number of restaurants in the royalty pool was 700.
The Fund is an open-ended limited purpose trust. The Fund was established to indirectly, through the Boston Pizza Royalties Limited Partnership, acquire the trademarks and trade names owned by Boston Pizza International Inc. ("BPI") and used in connection with the operation of Boston Pizza restaurants in Canada (collectively, the "BP Rights"). The Fund was also established to acquire, directly from a bank, the BPI loan in the principal amount of C$24 million. As of Dec. 31, 2010, BPI operated 334 restaurants in the Royalty Pool, with all but three of the restaurants owned and operated by independent franchisees.
Keg Royalties Income Fund is an unincorporated open-ended limited purpose trust. Through its subsidiaries, Co. is engaged in operating and franchising of casual dining steakhouse restaurants business in Canada and the United States.
Pizza Pizza Royalty is a limited purpose, open-ended trust. Through its interest in Pizza Pizza Holdings Trust (the "Trust"), and in turn through the Trust's interest in Pizza Pizza Royalty Limited Partnership, the Fund acquired the trademarks, trade names, operating procedures and systems and other intellectual property and proprietary rights and all goodwill associated therewith owned by Pizza Pizza Limited ("Pizza Pizza") used in connection with the operation of all restaurants operated by Pizza Pizza, its subsidiaries and its franchisees. As of Jan 1 2011, the Fund had a total 695 restaurants in the pool: 590 were Pizza Pizza restaurants and 81 were Pizza 73 restaurants.
SIR Royalty is established to acquire directly, certain bank debt of SIR Corp. (SIR) and indirectly, through SIR Holdings Trust, all of the Ordinary LP Units of SIR Royalty Limited Partnership ("the Partnership"). The Partnership owns the Canadian trademarks (the "SIR Rights") formerly owned or licensed by SIR or its subsidiaries and used in connection with the operation of the majority of SIR's restaurants in Canada. The Partnership has granted SIR a 99-year license to use the SIR Rights in most of Canada in consideration for a Royalty, payable by SIR to the Partnership, equal to 6% of the revenue of the restaurants included in the Royalty pool.
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