Pizza Pizza Royalty Corp. ($PZA.to)

I intentionally included the share price after the change in tax requirements for income trusts took hold

Chart from TIKR, referral code https://app.tikr.com/register?ref=smob7c

  • Ticker: PZA
  • Market Cap: 312 mil (CAD)
  • Current Yield: 6.8%

This is a fairly straightforward idea for those looking for income (and maybe a bit of capital appreciation), though the structure is a little complex. This slide from the most recent AGM presentation will explain it better than I can.

The public shares (Pizza Pizza Royalty Corp) give you access to 76.5% of the Royalty Limited Partnership, the remaining 23.5% is owned by PPL.

PPL, a private operating company, was amalgamated with Pizza 73 Inc. under the OBCA pursuant to articles of amalgamation dated July 24, 2007. The registered and head office of PPL is located at 500 Kipling Avenue, Toronto, Ontario, M8Z 5E5. PPL is the successor to a corporation initially incorporated in 1967. PPL operates the Pizza Pizza and Pizza 73 quick service restaurant systems using the Pizza Pizza Rights and the Pizza 73 Rights as permitted under the Licence and Royalty Agreements. PPL owns Class B and Class D Units representing an effective 23.0% interest in the Partnership at December 31, 2019.

From the most recent MD&A and AIF:

As of September 30, 2020, PPL indirectly held an effective 23.5% interest in the Company (December 31, 2019 – 23.0%) by holding all Class B and Class D Units of the Partnership. PPL has the right to exchange one Class B or Class D Unit indirectly for that number of Shares equal to the Class B Exchange Multiplier or Class D Exchange Multiplier, respectively, applicable at the date of such exchange, as described under “Royalty Pool Adjustments”.
The Class B and Class D Units are entitled to receive monthly distributions established by PPRC’s board of directors. A monthly distribution is paid to both PPL and PPRC on a pro rata ownership basis, with PPRC’s ownership held through its Class A and Class C limited partnership units of the Partnership.

When I calculate earnings to shareholders and payout ratio, I am including the distribution to PPL from the Partnership on Class B and D shares. I am using fully diluted shares in my per share calculations.

The multiplier is reviewed annually based on the number of new stores in the system. There was no change for 2021 in the multiplier.

Additional Background

Pizza Pizza was founded by Michael Overs in the 60s. He owned it until he passed away in 2010. PZA went public as an income fund (remember those?) in 2005 and has Governance Agreement with the Overs Family.

They purchased Pizza 73 in 2007 for $70.25mil with a combination of debt, shares, cash and an earn out. At the time Pizza 73 had 48 restaurants, of which 41 were added to the royalty pool upon closing. Upon closing 62.4 mil in system sales added or about 5.6 mil of net royalty revenue (at 9% royalty fee). Those that were around in 07/08 will remember how strong the Alberta economy was due to the oil boom.

Restaurants

Pizza Pizza has a strong presence in Ontario with over 500 stores and Pizza 73 has a strong presence here in Alberta with nearly 100 stores. The formats are pretty similar.

Restaurant Count (pre-covid)

Slow and steady store count growth was the name of the game until 2019.

The company underwent a review of existing restaurants and closed more than typical in 2019. They were ready to be a more efficient operation in 2020 just in time for covid.

System Performance

Going back to 2011, system sales have been trending upward. For the most part SSS was slightly positive until 2017/18 (and of course in 2020).

The majority of the earnings are from Pizza Pizza, but Pizza 73 does contribute a meaningful amount.

Monthly Distributions

Pizza Pizza GP, as managing general partner of the Partnership, has adopted a policy to distribute the Partnership’s available cash to the maximum extent possible. Such distributions will be made to partners of record holding Partnership Securities of their share of available cash as set out below. Distributions will be made within 15 days of the end of each month and are intended to be received by the Company prior to its related dividend to shareholders.

As an owner of the Royalty Corp your share of the earnings were flattish from 2015 both nominal and per share. Of course, all these earnings were returned to shareholders.

You can see stability in distribution and payout. Interesting that the share price moves around so much.

Risks/Items of Note

  • There are some very confusing change in control measures that prevent a potential take-over
  • Rent a facility and purchase food from the Overs family
  • Independent board members don’t own many shares (22,000 total)
  • CEO doesn’t own many shares (11,600 total), but the MIC does list that an associate of his owns 500k shares
  • Ontario was in a strict lockdown starting in December and that may weigh on results in the near term
  • Reopening may take way longer than anticipated, don’t look at Canada’s vaccination rate compared to other G7 countries
  • Many of the franchisee’s and customers are utilizing government support that may go away soon or go away sooner than business activity returns to normal
  • People may not like pizza today as much as they did yesterday
  • Valuation could drop
  • High inflation would be bad for consumers and hard for franchisee’s to pass on costs

What needs to happen to make money

This isn’t your high growth SaaS company with infinite TAM. Though capital appreciation may be not be the main driver of returns, there are still ways to make money on PZA. Here are some items that will be a driver for future returns.

  • distributions need to remain constant or increase
  • additional restaurants can be opened
  • SSS growth or at least no decline

Summary

As a shareholder your yield based on using the last couple of months payout ratio and today’s price is 6.8%. I would assume that the distribution will get bumped higher as stability returns and the economy reopens. The last two quarters the payout ratio was under 100%. As well, the shares are cheaper than they were in 2015 both on an absolute basis and relative to revenue. One could paint a picture where the valuation and the distribution improve from here.

This operation screams of stability to me. In a world with negligible interest rates, this may fit as a good alternative if you can stomach some share price volatility.

Anyone else look at PZA or other restaurant stocks?

Thanks,

Dean

*the author does not have a position in PZA at time of writing

1 Comment

Filed under Company Analysis

One response to “Pizza Pizza Royalty Corp. ($PZA.to)

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