Boston Pizza: Alberta Down, Everywhere Else Is Up

| About: Boston Pizza (BPZZF)

Summary

As a result of distribution increases, the current yield is 8%.

Alberta seeing same-store sales declines as a result of oil-related weakness.

The rest of Canada was positive; management is optimistic they can continue to offset Alberta's weakness.

On February 10th, Boston Pizza Royalty Income Fund (OTC:BPZZF) reported good same-store sales results and an increase to the 2016 distribution. The stock, however, remains range-bound reflecting worries over the state of Alberta's economy - home to 30% of stores. The share price is down nearly 30% from an all-time high of $24 and currently yielding 8%.

At more than $1 billion in system-wide sales, Boston Pizza is one of Canada's largest casual restaurants. The fund earns a royalty on sales (excluding liquor and select promotions) at more than 350 Boston Pizza restaurants across Canada and pays substantially all its cash flow out as a distribution.

The brand has begun to mature with same-store sales moderating in recent years as new store openings slowed and customer behavior shifted to fast casual options.

Q4 2015 results

In the quarter, revenue increased 3.8% as a result of a 2.1% increase in same-store sales and an additional 8 new stores. In the same period last year, the fund reported a 1.7% decline in same-store sales.

While Boston Pizza's history is as a Western Canadian based chain, in the past 10 years, the business has expanded across the country and Ontario is now the largest market. Approximately 65% of stores are outside Canada's primary oil-producing provinces, Saskatchewan and Alberta, allowing the business to thus far overcome Canada's oil-related malaise.

On the conference call, management provided some interesting insight:

- Same-store sales in Alberta are down, everywhere else is positive

- In Q4 average cheque was up ~2% while traffic is flat to up slightly

- If no Canadian hockey teams made the playoffs, it would represent a modest traffic headwind. If the Raptors basketball team made the playoffs and had a good run, national interest could offset hockey related headwinds.

- Q4 was buoyed by the Toronto Blue Jays playoff run, which increased traffic across Canada

- Restaurant operators are seeing moderate inflation, particularly in produce and protein, as a result of the declining Canadian dollar.

The bifurcation in sales between oil-based provinces and the rest of Canada is similar to Pizza Pizza (OTC:PZRIF) - YTD same-store sales at their Western Canada operations were 0.8% while the rest of Canada (mainly Ontario) delivered 7.5%

An 8% Yield?!

The purpose of the fund is to pay all excess cash flow to shareholders. With modest operating expenses, same-store sales and distribution growth should track each other.

However, in 2015, the company purchased an additional interest in the restaurant royalty - now 6.5% of sales (from 5% previously). As a result, the payout ratio was 94% in 2015 and we continue to see the distribution catch-up to sales.

For Q1 2016, management increased the distribution by another 6.2% for an annual distribution of $1.38 (from $1.30) or approximately an 8% yield.

Why is the yield so high?

These royalty corporations typically have higher yields but Boston Pizza does stand out - the yield is ~2% higher than The Keg (6.1%) and A&W (5.5%), for example.

To start, their is general aversion to companies with exposure to the oil industry and, to be fair, same-store sales are lagging other chains. In times of economic weakness, customers likely trade-down from restaurants like Boston Pizza.

Further, the high-yield may also reflect investor worry that same-store sales go negative. A sustained period of negative same-store sales (2-3 years) could use up any reserve cash and the payout ratio buffer, putting management in a position where they would have to re-evaluate the distribution.

That said, these conclusions seem unfounded thus far - growth is actually modestly accelerating and the company is managing through economic weakness reasonably well. 2016 may bring more challenges but as long as same-store sales are positive, the 8% yield is safe in my view.

A&W's Success

I'll extend this article with brief focus on A&W's unique success. A&W is the second largest burger chain in Canada with just over $1 billion in sales. McDonald's remains the market leader with nearly $4 billion in sales and 65% of the burger market. In recent years, an aggressive expansion plan into Ontario and Quebec, restaurant re-imaging and a unique marketing campaign have fueled market share gains.

While Western Canada represents 50% of the store base, more than 70% of new unit growth is in Ontario and Quebec where the brand less penetrated. The store base is now more than 50% re-imaged. Perhaps most unique is their marketing campaign, which promotes the use of hormone-free beef and organic coffee.

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Not only were they one of the early "better ingredients" adopters among burger chains, the marketing has been on point serving to differentiate the brand in a crowded market. The result has been a substantial rise in same-store sales since the initial push in 2013.

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Looking forward, the brand will begin to lap some tough same-store sales comparables in 2016 and undoubtedly feel some of the pinch in Alberta. Like with Boston Pizza, I think investors are simply hoping growth in the rest of Canada continues to offset the effects of a low oil price.

Disclosure: I am/we are long PZRIF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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