A&W (OTC:AWRRF) is a revenue royalty income fund that distributes dividends based on gross sales from franchised restaurants. The company has over 1,000 locations combined in the U.S. and Canada and has seen consistent growth over the last few decades. The stock is down almost 30% YTD, but we believe nothing has fundamentally changed about the business, and the stock has great long-term potential.
(Seeking Alpha A&W Market Chart, 2020)
A&W is well-positioned in the QSR industry, and their long-term strategy focuses on notions that are becoming increasingly valued by the public
A&W is perhaps the only prominent fast-food restaurant chain that focuses tremendous energy on ‘natural ingredients’ and superior food quality. The company’s entire marketing strategy and advertisements are based around these health-related notions, as A&W believes they are the “#1 choice for millennial burger lovers (A&W Investor Presentation, 2020).” This unique strategy allows A&W to price their products slightly higher than competitors such as McDonald’s (NYSE:MCD), while the additional cost of supplying these healthier products is fully born by the franchisee and not the corporation itself. Furthermore, this premium of higher supplied ingredients has a nominal effect on the bottom line, and we would not be surprised if burger margins are not far off from McDonald’s figures, given A&W’s price mark-up.
We believe that this strategy bodes well for the long term, especially as the younger generation becomes more focused on eating healthier. There are many reasons why this has become a trend as of late, one being the countless number of new academic articles that discuss the disadvantages of highly-processed foods, but more importantly, the fact that individuals have much easier access to information in the first place through digital outlets. For example, Super Size Me, a documentary that exposes the questionable food processes at McDonald’s, has become readily available on prevalent platforms used by the younger generations such as Netflix (NASDAQ:NFLX). A&W’s #1 long-term goal at the moment is to ‘harness the power of natural ingredients’, and we do believe that consumers are willing to pay the extra few dollars as a result.
A&W has been nothing but consistent in the last few decades
(A&W Investor Presentation, 2020)
Since 2002, A&W has seen an increase in royalty pool gross sales every single year up to 2019. If it wasn’t for COVID-19, A&W would have most likely surpassed 2019 figures this year. That’s an incredible feat in the restaurant industry and points to the job that management has done over a long period of time.
(A&W Investor Presentation, 2020)
Evidently, the growth in gross sales is attributed to the growing number of restaurants in the royalty pool over the last few decades; there has never been a year with a net decrease in royalty pool restaurants since the stock went public in 2002.
We believe that there is still lots of room to grow in terms of gross sales and the number of contributing restaurants, especially in the United States. A&W locations are spread all over the U.S., but there is a tremendous opportunity on the entire Eastern Ridge of the United States. In comparison, there are almost 14,000 McDonald’s locations in the U.S., compared to only 600 A&W locations. It’s also encouraging that as A&W is focusing on growth, “60% of new stores that are being built today are being built by existing operators, because they’re making money.” This metric is complemented by a 33% growth on average of same-store sales since 2011 (A&W Franchising, 2020). There is no better indicator of continued success than seeing existing operators open new locations, and 60% is a very notable amount. This leaves plenty of room for new franchisees to partner with A&W, and existing operators to potentially enter new markets with their existing knowledge, such as in the Southeast of the U.S.
A&W has lifted the temporary suspension of their monthly dividend, which points to the easing of regulations and bounce-back of store sales
(A&W Investor Presentation, 2020)
In July, A&W resumed its monthly dividend payout, this time at a rate of about 10 cents per month. Although this is a 37% drop from the pre-COVID-19 15.9-cent payout, the dividend yield sits at almost 5%, given the tumble in share price.
We believe that, in the next few quarters, A&W will increase its dividend back up to near the pre-COVID-19 rate of about 15.9 cents. A&W saw consistent increases in dividend payouts during and after the 2008 recession and even paid out 2 bonus dividends within 10 months of the market crash. The dividend rate right before 2008 was around 10 cents.
It is important to remember that the A&W royalty fund gets the ability to pay out a dividend based on a fixed percentage of gross sales, rather than the net income of each restaurant in the royalty pool. The COVID-19 shutdown definitely took a toll on franchisees as they had to bear potential food waste costs and operating costs, but this does not directly affect A&W corporate’s ability to collect revenues. We also understand that many speculate that another shutdown will affect the ability of A&W locations to produce sales, but we believe that the QSR industry can leverage food delivery services and drive-through stations to boost revenue. This is one significant advantage that restaurants like A&W have over Boston Pizza, where the traditional pizza chain is notoriously known for their dine-in experience. A&W has also been working on its mobile ordering capabilities, and there is no better time than now to take advantage of directly targeting consumers through digital outlets. Moreover, offering special coupons during a pandemic may simultaneously boost revenue and nominally affect the bottom line for franchisees because there are less cleaning and staff wage costs.
A&W competes in an extremely competitive industry and has many indirect rivals
At the end of the day, the growth of A&W is reliant on consumers continuously choosing the food chain over other popular competitors. A&W not only directly competes with McDonald’s, Popeyes, and KFC, but their strategy puts them potentially in ‘no man’s land’. If consumers wanted to eat really good fast food, they would potentially go to McDonald’s. If consumers wanted healthier alternatives, they might not want to go to A&W, but cook at home, or eat at traditionally healthier food shops like salad bars. Another shutdown of dine-in services may cause unexpected stress for many franchisees and potentially cause permanent closures.
In summation, we believe that A&W has a unique strategy and has positioned itself well in the QSR industry. The company has an excellent management team that has curated consistent growth in many areas for the past several decades. The stock has fallen far from previous recent highs, and their consistent dividend is a compliment to their high potential for stock growth. Look for long-term returns as the company enters eastern parts of the U.S. and potentially internationally.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.