“Retro burger dynamo soars next to McDonald’s with ‘50s flair and modern wi-fi.”

Sleuthing out the "Stable, quiet, prosperous" pick teased by Roger Conrad's Canadian Edge

By Travis Johnson, Stock Gumshoe, November 29, 2011

Roger Conrad has been a well known fan of relatively stodgy income stocks for a long time, with his Canadian Edge and Utility Forecaster both ranking among the top income-focused newsletters according to Stock Gumshoe reviewers for most of the past several years.

And today’s he’s teasing us with yet another somewhat unusual income investment, again North of the border, with the hopes that you’ll be excited enough about learning about this pick that you’ll sign up for Canadian Edge in order to get the name and ticker.

But of course, we like to do things a little bit differently over here at Stock Gumshoe — we like our stock ideas to be, shall we say, a bit more free-ish. So what clues does he give about his top-secret income pick?

“I’m not trying to sell you on McDonald’s.

“Without question, the Golden Arches has been a big, safe cash-maker for a long time.

“But there’s a far cheaper ‘blast from the past’ that can help you build this kind of wealth in a shorter period of time—and with much less risk.

“You won’t find it listed on Wall Street… yet a select group of investors has found a special way to profit from it enormously, some more than doubling their wealth in a few short years—safely and quietly.”

OK, so cheaper, faster growing than McDonald’s, retro-styled, and safe? That sounds pretty attractive, but let’s let Conrad paint a bit more of the picture for us …

“There’s no question that ‘retro’ has been a hot sell for some time now.

“Whether it’s movies, music, food, fashion or art, anything that breathes new life into the best of pop culture’s past seems destined to be a sure-fire hit.

“One company has taken this approach to the max and, by doing so, grown leaps and bounds at a time when many chains are closing shop faster than a hot rod in a drag race.

“With its sleek, mid-century design, vintage artwork and non-stop hit parade of classic tunes, this restaurant chain lures customers back to an era when the burger was truly king.

“Imagine soda machines right out of It’s a Wonderful Life… ice-cream floats in frosty mugs chilled just for you—a signature drink so popular here it’s sold in numerous grocery and convenience stores around the country.

“No doubt about it, this burger chain takes retro seriously—so seriously it even holds ‘cruise nights’ all summer long where classic- and antique-car owners can show off their vintage treasures.”

We get a few more clues about this fabulous burger chain, too …

“… sales have doubled in the last decade, placing it right behind McDonald’s as the second-largest burger chain in this North American market.

“In fact, it’s such a hit that it has already opened over 80 new locations in just the last four years… and now has paid deposits for well over 100 new franchises.

“And it’s so well-run that it has won top honors as part of Canada’s 50 Best Managed Companies program six years in a row.

“Now, while all of this would be more than enough to enrich anyone with a stake in this company, the only problem is that it is still private.”

Private? Aha, so there’s a bit of a catch — it’s not that Conrad is teasing us to buy the stock of this company, it’s something a little different … here’s how he describes it:

“there’s a special type of fund that allows them to ‘own’ this company’s trademark—which is licensed to restaurants in exchange for a percent of their huge sales take.

“With over 700 restaurants already using its trademark, this means a lot of income coming in through the door—so much income that this little-known ‘trademark’ fund has seen quarterly revenue growth soar 183% over the past year… and now has operating and profit margins near 100%!”

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Well, I should hope the operating and profit margins would be up around 100% — it’s not all that expensive, after all, to tally up the sales, ask for the cash, and write a check to your shareholders when it comes in.

In case you’re wondering, yes, this sounds like some kind of pass-through entity, an income trust or a MLP — and since the Income Funds in Canada (also called Canadian Royalty Trusts, or CanRoys) have mostly gone the way of the dodo, it’s apparently some kind of publicly traded partnership.

“The thing is, this fund belongs to a special class of equities, hailing from a land very much like us in the 1950s: stable… quiet… prosperous.

“This royalty income fund is organized as a limited partnership and hands over the lion’s share of all profits to its investors—meaning you.

“Think of it this way: If you parked $10,000 into a reliable dividend payer like McDonald’s three years ago, you’d now have at least $1,160 in extra income.

“Not bad, right?

“Yet if you did the exact same with the ‘trademark’ fund mentioned above, you could be sitting on up to $4,400 in income.”

So which trust is Conrad teasing now?

Thinkolator sez: this is A&W Revenue Royalties Income Fund (AW-UN or AW.UN in Toronto, AWRRF on the pink sheets)

And yes, this is a relatively easy and stable way to get a piece of the top line revenues from the A&W burger chain in Canada — the corporate structure is slightly complicated with partnership interests going back and forth, but they explain it pretty well here. Essentially, this income fund owns the trademarks of A&W in Canada, and they license those trademarks to the company that owns, franchises and operates the actual restaurants. In return, the fund gets a 3% top-line royalty on all sales at all those restaurants.

And yes, the margins are very high — they have a minor amount of office expense, but most of the cost is taxes and interest expense, so most of that royalty goes to the bottom line and is paid out to shareholders/unitholders as a dividend/distribution.

Currently, the yield is in the neighborhood of 7% — they set the royalty payment each year and apparently don’t adjust it during the year, and they appear to place a premium on keeping the distribution stable (as evidenced by the effort they made to keep up the distribution despite the big cost increase from taxes this year). The distribution is paid monthly, FYI, at 11.7 cents per unit (Canadian).

You can get a brief picture of their financial health from the latest quarterly report press release here — their distributable cash is down slightly from last year, which appears to be largely due to the fact that they had to start paying taxes at 18% in 2011 after the pass-through trust structure was killed by Ottawa. That was offset somewhat by the fact that they borrowed a bit of money to buy back shares, so they kept the per-share distribution similar to last year’s.

It’s an interesting income play, and it seems likely that if we see inflation in both the US and Canada and the Canadian dollar remains relatively strong, the revenue ought to rise slowly as sales rise with inflation. I don’t know of any reason to expect A&W to suddenly become more popular or substantially boost prices, though it’s certainly a plus that this revenue-based top-line cut means you don’t have to worry about input costs — an overall plus, inflation-wise, since you’d get the benefit of rising product prices without the pain of rising input costs (assuming, of course, that rising prices don’t deter the consumers from buying).

I’m afraid I’ve never been to an A&W in Canada and have no idea how popular they are or whether they’re rising or declining — they have increased the number of stores, which must be a good thing, though the income trust doesn’t get those increases for free (they effectively pay the operator for the royalties from new stores by issuing new shares of the fund to the operator, as far as I can understand it … the real key is same store sales growth for them in terms of per-unit cash flow and potential dividends). They have no claim to the A&W name or trademarks elsewhere, so this is really not a big growth story — probably not surprising, since it’s pitched as a safe income play.

So what do you think? Is Conrad’s 7% yielding hamburger trademark income trust the kind of thing you’re interested in? Or would you prefer one of the big operators like McDonald’s or Yum Brands or someone else that has dividend growth but a far lower current yield? The only fast food chain I own shares of pays no dividend at all, I’m afraid, so it takes all kinds … let us know what you think with a comment below.


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