Diversified Royalty: Another Dividend Hike Takes 8.6%-Yielder Higher (OTCMKTS:BEVFF)

All values are in CAD unless noted otherwise.

Diversified Royalty Corp. (OTCPK:BEVFF, TSX:DIV:CA) earns royalty and management fees from varied businesses across North America. Its royalty roster includes well-known names like Mr. Lube, AIR MILES, Sutton, Mr. Mikes, Nurse Next Door, Oxford Learning Centres, and BarBurrito. The latter was added fairly recently, in October 2023. Being a top-line royalty company, its expenses are few and consist of “salaries and benefits, general and administration, professional fees and interest on credit facilities,” as noted in the MD&A. Its raison d’être is to add quality royalty partners, and increase the sales of those businesses, which in turn aids in their ultimate goal, which is to maximize the distributions to its shareholders. Detailed ins and outs of this royalty company can be consumed from their financial reports.

We have covered this company six times previously on this platform, starting from July 2021. In each of the coverages, we have preferred to remain on the sidelines regarding the common stock. The commons have actually fetched investors more than a pretty penny since mid-2021, but it has probably had them reaching for an anti-emetic more than once during this time.

We have not completely skirted this company, however. We got in on the action via debt, more specifically the convertible debentures.

The discount on par, resulting in around a 9% yield to maturity, matched our risk appetite (we bought it at around $90) and hence was a no-brainer way to play this well run royalty company. We continue holding these 2027 maturing debentures and thought it is an apt time to revisit and update our coverage on this business.

Q4 2023

There are generally few surprises from this company, as the royalty model is fairly predictable. Nonetheless, the same store sales growth did surprise on the upside, especially with Mr. Lube with a 14% year-over-year increase.

It might seem that we are giving it credit for the performance of just one of its multiple royalty streams, but as you can see above, it is the largest by far. Most other metrics like revenues and EBITDA also exceeded analyst expectations. One thing to note here is that this barn burner of a performance still did not increase distributable cash flow per share.

This was the direct result of the big increase in the share count. Mind you, we are not critiquing the equity issuance to add more partners. We are just adding the nuance that per share metrics are important. Investors often label things as positive in a blanket manner, whereas most of the time deals are done at a fair price, and it takes time for per share metrics to reflect the advantages.

Speaking of equity issuances, Diversified completed yet another one, and this was modestly large in relation to the existing market capitalization.

Diversified Royalty Corp. (the “Corporation” or “DIV”) is pleased to announce that it has closed its previously announced bought deal public offering of 20,320,500 common shares from treasury of the Corporation, including 2,650,500 common shares issued pursuant to the full exercise of the over-allotment option, at a price of $2.66 per common share (the “Offering Price”) for total gross proceeds of approximately $54.0 million.

Source: Company Press Release.

This was done to fund the acquisition of BarBurrito trademark, and that transaction was initially put on their credit line.

Acquisition of the trademarks and certain other intellectual property rights used by BarBurrito in Canada for $72 million cash at closing and certain additional consideration, Initial annual royalty revenue from BarBurrito of $8.3 million plus $80,000 of management fees, representing approximately 12% of DIV’s pro-forma adjusted revenue. DIV is acquiring the incremental $8.4 million of revenues from BarBurrito at a royalty acquisition multiple of 8.6x

Additional consideration includes a $36 million promissory note that is repayable as new BarBurrito locations, contributing an additional $4.3M of royalties to DIV, are added to the Royalty Pool, representing an 8.4x royalty acquisition multiple. The royalty grows at a fixed rate of 4% per year for 7-years and thereafter will fluctuate based on gross sales of BarBurrito locations in the Royalty Pool.

Source: Company Press Release.

We are not certain exactly how this will play out, but the terms do seem quite generous for DIV. The transaction was completed in October 2023 and investors might remember that the credit markets were quite tight back then. So this does appear like a good deal, but we will have to monitor it to see how it plays out.

Outlook & Verdict

Having a bunch of different revenue streams does make Diversified Royalty Corp. more resilient. Even its individual royalty lines, while dependent on the economy, are not extremely cyclical. Its exposure has always been just on the top line, so it is not impacted by margin crunches. So the company continues to prosper.

If there was a weak spot here, it was in the AirMiles segment. That area has been suffering since Sobeys hit the exits and Bank of Montreal (BMO) took over the program. But this segment made up only about 6.3% of revenues, so the impact has been muted, with its larger partners doing well.

The leverage here is a tad bit higher, even after the equity issuance. You can see that impact by observing how the interest expenses have been moving higher over time. Another factor here is that a lot of these interest rate hedges run out in about 1 year from now.

That should work out if we are in a rate cutting cycle, but don’t consider it a lock yet. We entered into 2024 with everyone expecting 6 rate cuts from the Bank Of Canada, and the current market expectations have been whittled to just two. All in, we think the shares represent average value here, and we don’t see them as particularly cheap or expensive. The debentures offer an approximate 7.5% yield to maturity, and that maturity is 3 years away. We remain comfortable owning those as the debt to EBITDA is close to 4X here.

The way to look at it is whether we would want to own all those royalty businesses at a 4X (or even 6X) EBITDA multiple, and the answer is, of course, yes. So we see the debt as very low risk here and would happily add to it in a market swoon. The common shares do offer a high yield, but we don’t see it as that attractive considering you can get about 6.6% from businesses like A&W Revenue Royalties Income Fund (AW.UN:CA) and Pizza Pizza Royalty (PZA:CA), both of which use about 1X debt to EBITDA.

We rate the Diversified Royalty Corp. common shares a hold and continue to get income from the bonds.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult a professional who knows their objectives and constraints.

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.