Last year, when we lived in Vancouver, I organized the Vancouver Value Investors meetup. We held our monthly meetings at the Keg Restaurant downtown. “Steak and Stocks” was our slogan and I enjoyed savoring a slab of prime rib and garlic mashed potatoes while we discussed investments. Little did we know that sitting under our noses was an interesting investment opportunity: the Keg Royalties Income Fund.
The Keg was started by Albertan and Harvard MBA graduate George Tidball. Tidball was the entrepreneur responsible for introducing McDonald’s restaurants into Canada in the 1960s. Having made a success of that, he started what was to become the Keg in 1971. His goal was to have a chain of casual dining outlets that were lively and fun.
Today the Keg has carved out a niche for itself as a place to enjoy top quality steak and prime rib at reasonable prices and in a fun and relaxed environment. It is the name for steakhouses in Canada and it is starting to make inroads into the much larger U.S. market. It is now run by the experienced and capable restaurateur David Aisenstat.
The Keg Royalties Income Fund (KRIF) trades on the Toronto Stock Exchange under the symbol KEG.UN. The entity is an income trust unit that pays a whopping 13%+ dividend (based on the current unit price of $9.70).
Unlike many income funds that may not be able to sustain their payouts, KEG.UN is different. It is a unique security that earns its income from two sources:
- A 4% royalty on the sales of all Keg restaurants in the royalty pool.
- Interest on a loan to Keg Restaurants Limited (KRL), the private company that owns and operates the actual restaurants.
KEG.UN has no direct exposure to the operating profit and loss from the operation of the restaurants. This exposure plus most of the benefits from opening new locations goes to KRL. As well, KEG.UN has no responsibility for capital expenditures or working capital needs of the restaurants. Thus it can continue to pay out 100% of its earnings without any issues.
As an income trust, KEG.UN currently pays no corporate tax. Due to changes in Canadian tax law, income trusts will be required to pay taxes on their distributions beginning in 2011. The tax rate will be about 30%. So this will reduce payouts by the same amount.
However, despite this tax increase, I believe that KEG.UN deserves closer inspection. This is because its earnings and dividends will grow with increases in sales at its restaurants. For KEG.UN this benefit will come from year over year increases at existing restaurants.
Based on my math, at a price of $9.70 the units offer a compounded annual rate of return of a little over 13% based on discounting the expected dividends to present value. This valuation assumes the current annual dividend of $1.28 will grow at 2.5% annually and taxes of 30% will begin in 2011.
For investors looking for a respectable return with most of that in the form of income, take a look at KEG.UN
Related links:
Value Beacon 