A&W: We Like This Juicy 6.7% Yield (TSX:AW.UN:CA)

Note: All amounts referenced are in Canadian dollars. Stock price referenced is from TSX and not the USD OTC price.

A&W Revenue Royalties Income Fund (TSX:AW.UN:CA) proudly states the raison d’etre, A.K.A. mission, on its webpage.

Together, to excite Canada’s most avid burger lovers, wherever they are, with the best tasting burgers they crave, earning even more of their visits and making A&W restaurants even more successful.

Yes, this fund is in the burger business, and is a highly successful quick service restaurant franchise in Canada.

We have covered this fund several times on this platform and have described its revenue/expense/dividend setup more than once. Rather than repeating ourselves in this article, we will let our readers consume this information from the fund’s recently released Q1 financial report or review one of our prior pieces that has more detail.

Prior Coverage

We covered this ticker earlier this year, in March. It was yielding around 6.21% then and was trading at a reasonable valuation. On the flip side, the yield spread to what the 5-year Government of Canada bond was paying at the time was only around 2.58%. So while the valuation was compelling, it was still not exactly cheap in relation to the risk-free investment. The Q4 results and the overall setup still saw us slapping a buy on it.

While rapid price increases of 2020-2023 won’t be happening, we think A&W can price close to inflation rates in its annual price changes. The company has a built-in offset and the highest absolute dividend yield of the last decade is good enough to start getting in. We will also note here that if it paid out everything it earned, the dividend yield would have been 6.77%. All things considered, we think this is a good point to start nibbling on this one as valuation compression has taken enough of a toll.

Source: A&W: 6.2% Royalty Play Grows Into Valuation

Unitholders of this income fund have lost around 6.5% since then, taking into account the dividends that have been paid during this time.

We averaged into this after our last piece and have cost basis of $29.20. With skin in the game (albeit a small amount currently), we shall review the aforementioned Q1 results and update our thesis on this royalty play.

Q1-2024

On the key top-line metrics, A&W managed to eke out small gains. Same store sales were up 0.6% and total sales were up about 1%.

We could say the same for the total royalty income as well. While not exactly a resounding endorsement for the model, the numbers are an improvement over what we saw for Boston Pizza Royalties Income Fund (BPF.UN:CA) just recently. There, the sales actually dropped by 1%. Of course, like Boston Pizza, A&W is also raising prices. Exact amounts are not easy to figure out for either of these two, but we estimate it is about 4% for both these companies. Of course, that gets us to the main conclusion that traffic is declining.

The Q1 2024 Royalty Pool Same Store Sales Growth(i) of +0.6% was a product of an increase in average check size due to industry-wide inflation on goods, services, and labour, partially offset by a decline in guest traffic. Food Services believes that the decline in guest traffic is primarily attributable to increased interest rates and inflation, which have impacted consumer discretionary spending. In response to these economic conditions, Food Services continues to seek new and innovative ways to offer A&W’s guests a delicious and affordable experience and in turn increase guest traffic.

Source: Q1-2024 Financials

With a slightly higher unit count (for those increased restaurants), the distributable cash per unit fell slightly. Below that number, you can see two different distribution amounts.

The numbers can be a bit confusing as A&W pays its 12 distributions a bit differently than many monthly payers. There are 2 record dates/ex-distribution dates in December of each year and none in January.

The high payout ratio is expected with this company, as A&W does not retain cash and aims to pay everything back. There is no capex to be conducted as a royalty company, and debt levels are kept fairly modest.

Outlook

There is no doubt that customers are done with the higher prices for eating out. You can see it in the royalty pool same store sales growth.

It is not just A&W, though. Fast food as a whole is now under assault as customers brace for weaker economy and the impact of rate hikes flowing through via resetting mortgage rates. The one advantage that A&W has is that the exhaustion on “tips” is not relevant at the drive through windows (or inside restaurants) for this company. Still, we are entering a consolidation phase where we can expect flattish the distributable cash flow per share for 2-3 years. The company knows this as well.

Marco Tang

I was just wondering if I could hear any comments you have on traffic and what the promotional landscape looks like from competition perspective?

Susan Senecal

I think everyone is under pressure in terms of traffic and visits just because of affordability is probably the key reason. And that creates an environment where people are looking for value, they’re finding value, and I think our primary area right now that we’re working on is making sure that there’s always that type of value available at A&W from an affordability perspective which tends to get more visits, more traffic, and that’s how we’ve sort of positioned our promotions for the next little while is to keep on ensuring that when people come in, they feel like they can afford it, they feel like they want to come back.

Source: Q1-2024 Conference Call Transcript

We observe the menu prices and promotions locally and they all (not just A&W) are getting the message. Pricing is flat lining and promotions are escalating. This is not a big deal for the royalty company, as it is a top-line play. The underlying restaurants though will have a tough time negating the margin pressures. What we have on our side is a modestly attractive valuation, with the highest dividend yield outside the COVID-19 era. That dividend yield was actually an illusion as well as it got cut almost instantly.

So we do have an attractive valuation and the question is whether you are ok with a 6.7% stream that does not grow for 2-3 years. There is some upside possible if the Pret A brand is successful nationwide.

A&W Revenue Royalties Income Fund (the “Fund”) and A&W Food Services of Canada Inc. (“Food Services”) announce that Food Services and Pret A Manger (Europe) Limited (“Pret”) have agreed on a development plan to expand the Pret brand across Canada following the completion of a successful two year trial period first announced on June 2, 2022. Food Services has exclusive master franchisor rights to Canada for the Pret brand and will introduce Pret’s products to Canadian consumers in a variety of carefully selected formats, beginning with a national roll out of Pret coffee in A&W restaurants this fall.

The Pret brand was first offered in a trial pop-up format in certain A&W restaurants in 2022, and expanded to a first standalone Pret location in downtown Toronto in 2024. The development plan calls for Food Services continuing to increase the number of physical locations offering Pret products across Canada over an initial ten-year development term. Sales of Pret products within A&W restaurants in the Royalty Pool will be subject to the 3% royalty paid by Food Services to the Fund.

Source: Seeking Alpha

But we are modeling flat sales for the next 3 years and still like the stock. We will continue to add on the way down to reach a full position around $25.00 (assuming it gets there). We rate this a Buy and would upgrade to a Strong Buy under $25.00.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.