SIR Royalty Income Fund SRV.UN

The Facts (as of November 3, 2010)

Unit price: $9.40. Book value per unit: $9.62. Market cap: $50 million (small). Distribution: $0.115 per month or $1.38 per year. Current yield: 14.68%. P/E: 6.9x. Debt/equity ratio: 0.0 (no long-term debt). Current payout ratio: 98.4%.

The Story

Service Inspired Restaurants (SIR Corp.) is a Canadian corporation that owns and operates a portfolio of 46 full-service restaurants. We take pride in operating establishments that are best in their market and the first choice of our guests, team members, supplier partners, communities, and investors. By living our values and promises company-wide, we are able to offer an exceptional level of quality and attention to service. We have a diverse portfolio of restaurants designed to appeal to a wide range of consumer tastes. Our restaurants include: Jack Astor’s Bar and Grill®, Alice Fazooli’s® Italian Grill, Canyon Creek Chop House®, the casual Loose Moose Tap & Grill® and fine dining restaurants reds® and Far Niente® / Four™ and Petit Four™. Our passion is reflected in our name, a vision to bring people together, build lasting relationships and set the industry standard.

The royalty trust receives royalties equal to 6% of the revenue of the restaurants as well as interest from the SIR loan.

The unit price has persisted a little under $10.00 since issue October 2004. It fell dramatically during the market crash, and has since recovered to a little under $10.00. Distributions began at $0.10 per month in 2005, increased to $0.11 per month in 2006 and to $0.115 per month in 2008. SIR has no plans to convert to a corporation,  maintaining the separation between operating restaurants and royalty trust. Because of the new tax in 2011, distributions are expected to be cut by 30%. The new distribution would be $0.08 per month or about 10% yield.

Pros

The unit price seems low, with a P/E under 10 and the market price is below the book value. This income trust provides a good current yield, and there is some certainty about the relatively high yield that can be expected in 2011. The royalty income fund has no debt, but it is economically dependent on SIR Corporation (see below). Distributions have been consistent, despite economic uncertainty.

Cons

SIR Corporation has a lot of debt, $22 million owing to a lender and $33 owing to SIR Royalty Income Fund. The $22 million is senior debt, so the income fund is second in line for interest payments. The restaurant business is not only seasonal, but the higher end restaurants are particularly sensitive to economic conditions. Results have been reasonably good, with same store sales growth over 3% and management expects economic conditions to slowly improve. This is also a very small company that is thinly traded.

Impression

Because of the separation between the operating business and the royalty income fund, I don’t think the measurements of book value or debt ratios are meaningful. The operating company is heavily indebted and sensitive to economic conditions. It is also relatively focused on the greater Toronto area. For these reasons, I will personally steer clear.

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