The Keg Royalties Income Fund

I do not own this stock (TSX-KEG.UN, ). It was a stock suggested by one of my readers. I like dinning at The Keg. I find the food very good. At stock forums I viewed, investors liked this company as it is guaranteed 4% of the sales at Keg restaurants as income to the fund. So I decided to take a look at it.

I will be upfront. I would not invest in this stock. If I understand the accounting records, I would be deeply concerned about two things, just as far as income is concerned. One, money is flowing into this fund from Keg Restaurants Ltd. (KRL) and this company, after a disastrous year in 2009, stopped publishing their accounting statements. The restaurant business is a tough business. If KRL is not making money how will they be able to pay money into this fund?

The second concern I have is that interest income makes up a large portion of the income of this fund. If I am reading the statements correctly, the fund loaned KRL $57M and is collecting 7.5% interest on this loan. This is a high interest rate under the current circumstances. And, we go back to the thought of if KRL is not making money how will they be able to pay this interest?

Also, if I am reading the financial statements correctly, this fund pays a distribution to Class C shares held by KRL of $.0625 per share. In 2011 $4.275M was paid on Class C shares and fund got paid interest of $4.281M on KRL's loan. The notes say that this distribution is due to KRL as long as the note is outstanding.

I know that this income fund is due 4% of revenue for Keg restaurants. I understand that people think this is great, because no matter what, the fund is due this 4%. However, I would be very concerned about the ability of the restaurants to make money and paid this royalty.

So, let's now go on to look at distributions. The 5 and 10 year drop in distributions is at 2.6% and 1.1% per year, respectively. Distributions were growing until 2011 when they were decreased by 24.9%. The current dividend yield is still a healthy 6.53%. The 5 year median dividend is a lot higher at 11.08%.

I get 5 year median Dividend Payout Ratios of 103% for earnings and 99% for cash flow. There is no analysts quoting estimates, but looking at the past 12 months to June 30, 2012, the DPRs would be 139% for earnings and 63.8% for cash flow. However, since there is a big difference in CFPS and Adjusted CFPS, we might want to use the Adjust CFPS and that gives us a DPR for CFPS of 80%.

Total return on this stock has been 11.47% and 12.01% per year over the past 5 and 10 years. The dividend portion of this return was 9.98% and 9.59%. Income is 87% and 80% of the total return. The capital gain on this stock over the past 5 and 10 years was 1.48% and 2.42% per year, respectively.

KRL hold a number of classes of shares from A to D. All these, except for Class C are exchangeable into fund units. Class C shares are a liability. All these shares get distributions. As I read the notes, they are paid their distributions before fund units are.

The ROE for the KEG looks good with a 5 year median of 11.7% with the ROE for the end of 2011 at 10.8%. The ROE on the comprehensive income was the same as the ROE on net income. For the first 12 months of this year the ROE is lower at 8.6%. I cannot get a ROE on KRL because it had a negative book value.

The debt ratios for the KEG look great with the current Liquidity Ratio at 2.17 and the current Debt Ratio at 1.88. The current Leverage and Debt/Equity Ratio are also fine at 2.13 and 1.13. The last debt ratios I got from KRL are very low. They were always below 1.00 with the Liquidity Ratio in 2009 at 0.46 and the Debt Ratio at 0.69. (This means that current assets could not cover current liabilities and assets cannot cover liabilities.)

I would not buy. All their income depends on one company that no longer publishes their financial statements. When that company did publish their statements, they did not seem to be able to make any money and their debt ratios were awful. I would worry about their ability to pay the royalties promised.

Vancouver-based Keg Restaurants Ltd. is the leading operator and franchisor of steakhouse restaurants in Canada and has a substantial presence in select regional markets in the United States. KRL continues to operate The Keg restaurant system and expand that system through the addition of both corporate and franchised Keg steakhouses. Its web site is here Keg. See my spreadsheet at keg.htm.

This blog is meant for educational purposes only, and is not to provide investment advice. Before making any investment decision, you should always do your own research or consult an investment professional. See my website for stocks followed and investment notes. Follow me on Twitter or StockTwits.