Diversified Royalty: 9.0% Yield; A Low-Risk Play (BEVFF)

Values are in CAD unless noted otherwise. Convertible Debenture Issues trade solely on TSX.

Canada based, Diversified Royalty Corp. (OTCPK:BEVFF) (TSX:DIV:CA) earns royalty from the top line sales of a number of franchise businesses in North America.

Oxford Learning provides tutoring services, Sutton is a real estate company, Mr. Lube is an oil change and automotive service provider, Air Miles is a loyalty program enabling customers to earn points on their purchases which can be redeemed for a variety of goods and services, Nurse Next Door provides senior home health care, Mr. Mikes feeds the hungry in lieu of payment. Stratus is a recent addition to this “diversified” pool of businesses. This one is based in California and provides commercial cleaning and building maintenance services in North America.

Diversified royalty earnings from the above are based on either fixed payments with built in periodic increases or on percentage of gross sales. The company also earns some management fees from a few of them. We have touched upon these in the course of our previous coverage of this business. Interested parties can also get their fill from the financial reports on the company’s website. Diversified, just like most royalty plays, has few expenses of its own. The journey from revenue to net income has a very few stops along the way, namely, salaries and benefits, G&A, professional fees and interest on credit facilities. Substantially all of what remains after these expenses is paid out to the shareholders.

Our Choice

Each of the two times we have written on this business, we passed on the common equity in favor of their convertible debentures. The idea was of the debentures being more appealing to the retirees or income investors as they provided a comparable yield with far less risk. The cumulative performance of the two debentures has been decent during the course of our coverage. DIV.DB, delivered a solid 7% total return with minimal volatility. The common equity has had that beat by a margin.

Furthermore, with the announcement of the completion of the Stratus deal, Diversified also restored its dividends to the pre-pandemic levels (23.5 cents/year). At the current price of $2.99, the stock yields close to 8%.

The second set of debentures, DIV.DB.A is about flat since we wrote about it after counting interest payments. However, we still stand by the debentures as the better alternative for the aforementioned target audience. Moreover, the debt is now trading at a bigger discount offering up an even higher yield to maturity. This by itself may not be enough for the discerning investor and we wholeheartedly agree with that viewpoint. The recent events though, have made the debt even more appealing and we shall discuss that and more next.

Equity Issuance

Diversified completed its 16,428,900 common shares issuance in November 2022 for $2.80/share.

The proceeds of this offering were partially used to pay down the amount drawn on the credit facility for the Stratus deal.

Debenture Redemption

Diversified had two unsecured debenture debt liabilities on its books prior to Q4. One of them, the Diversified Royalty Corp. 5.25% Convertible Unsecured Subordinated Debentures (DIV.DB) matured in December 2022 and was subsequently fully redeemed. Point to note is that most of this issue was redeemed by Q3 with only around $5 million worth outstanding at the end of the quarter.

However, Q4 will see the dual impact of the redemption of the balance along with the above mentioned equity issuance showing a much improved debt to asset ratio.

Q3 Results

Continuing the trend of Q2, the third quarter also had all the royalty partners come through with higher revenues compared to 2021.

This was partially driven by the removal of all the COVID-19 related restrictions for businesses. Some other notable factors included the increase of the Mr. Lube royalty pool, higher demand for travel helping the Air Miles business and the 2% annual contractual increase for Sutton that come into effect at the beginning of the quarter. Mr. Mikes Q3 and year to date revenue numbers include $0.55 million and $1.13 million, respectively, of partial payment of the royalty and management fees that were deferred due to pandemic hardships, which hit restaurants particularly hard. Diversified is on course to collect the balance deferments from the restaurant chain by the end of 2023.

Our Choice Revisited

Diversified Royalty Corp. 6.00% Convertible Unsecured Subordinated Debentures (DIV.DB.A) was issued earlier this year filling the void that was to be expected on the redemption of DIV.DB. These mature in 2027.

This one has a higher coupon versus the 5.25% for the redeemed convertibles. The holder can exercise the option to convert these into common stock at the conversion price of $4.05. This semi-annual interest payer can also be redeemed by the company on or after June 30, 2025. For the one year period starting that day, Diversified can only redeem if the volume weighted average price of the common stock for 20 consecutive trading days is not less than 125% of the conversion price i.e. $5.06. After June 30, 2026, these can be redeemed anytime by the company at par plus accrued and unpaid interest.

The current yield to maturity is the only reason we are interested here and the we don’t believe the stock conversion factor will come into play. The current balance sheet looks great with about $160 million in net debt serviced by about $40 million of EBITDA. This is before the impact of the share issuance and new Stratus transaction funded solely by equity. Considering that Diversified has a strong positive correlation with inflation with almost none of its downside, we see the 9.0% yield to maturity as a low risk play.

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.