Boston Pizza: A Canadian Success Story

By Will Ashworth | April 25, 2012 AAA
One of the best-performing small cap value funds over the past three years, is the Huber Small Cap Value Fund, with a three-year return of 37.03%. Morningstar quite rightly gives it five stars. The sixth largest holding, Boston Pizza Royalties Inc. (TSE:C.BPF.U), a Canadian casual dining chain, caught my attention. Serving the mid-scale casual market, the competition is fierce. Nonetheless, it holds its own. Huber, whose fund has just around an 11% turnover, obviously agrees.

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Number One

Boston Pizza has a 45-year operating history in Canada. Part sports bar, part restaurant; it is Canada's number one casual dining brand, with 342 locations across the country, including 107 in Ontario. They're in almost every town with a population over 10,000, and the concept continues to outperform the overall growth rate of the Canadian restaurant sector. Its CEO, ironically enough, is an American from Connecticut, who moved to Toronto in 1994 as President of Arby's International, and joined Boston Pizza three years later as its first employee in Eastern Canada (head office in Vancouver).

Since joining the company, it has grown substantially. In 2002, when Boston Pizza International, the franchisor of the Boston Pizza concept in Canada, sold the Canadian trademarks and intellectual property to Boston Pizza Royalties Limited Partnership for over $109 million, itself a subsidiary of Boston Pizza Royalties; there were 162 stores. At the peak of its growth five years ago, it was opening 40 new locations a year. It now will open five to ten annually. However, don't be put off by the fact that it's not opening stores every week of the year. It generates a lot of cash. Shareholders received monthly distributions in 2011, totaling C$1.06 a unit and in 2012, that looks to increase to roughly $1.15 a unit or possibly more, which would be yield of around 6.3%. Income investors who aren't afraid to venture north of the border should be intrigued by this small-cap wannabe.

SEE: An Introduction To Small Cap Stocks

What Makes It a Keeper

On an operational level, it's exceptional. In 2011, its same-stores sales growth was 4.9%. Over the past 10 years, it's averaged 4.3% with only 2009 and 2010 taking a step into negative territory. Generating so much cash, it's been able to distribute $11.33 a unit to unitholders since its IPO in 2002. Between 2008 and 2009, it repurchased almost 2.5 million units at an average price of $10.10 per unit. The repurchases created an accretive benefit of 10.8 cents per unit per year.

Now here's where it gets interesting. Boston Pizza Royalties Income Fund receives 4% of franchise sales from Boston Pizza International, which amounted to roughly C$27.97 million in 2011. It has no responsibility for the expenses or profitability of Boston Pizza International or its restaurants, so essentially you are betting that the proceeds from the royalties will continue to grow. As long as Boston Pizza International continues to open restaurants at the current pace and those restaurants deliver same-store sales growth, it's a virtual certainty.

Boston Pizza and Peers

Company

Current Yield

Boston Pizza Royalties

6.3%

Darden Restaurants (NYSE:DRI)

3.4%

Brinker International (NYSE:EAT)

2.3%

Bob Evans Farms (Nasdaq:BOBE)

2.7%

Cracker Barrel (Nasdaq:CBRL)

1.8%

The Bottom Line

Boston Pizza International, the operator of the franchise, is consistently named one of Canada's 50 Best Managed Companies. That's important, because the only downside to the arrangement between the two companies is that Boston Pizza Royalties Income Fund doesn't own the trademarks outside Canada. In the hands of a poor operator, the gross revenue of its restaurants in Canada might be affected. But given Boston Pizza International's reputation, there's nothing to be concerned about. Up about 30% year-to-date, its stock's done nothing but increase in value since the lows of early 2009. I expect it to continue its gradual ascent. In the meantime, enjoy its hearty dividend.

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

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