The business generated stable results in the quarter and importantly, indicated that it was comfortable with the distribution (buoyed by cash reserves) and the rebound in sales witnessed since covid restrictions were rescinded.  While there will clearly be an Omicron impact to the first quarter, this hopefully is the last quarter of material covid impact.   After two years of Covid impact, how is the Keg holding up? 

Keg Royalties depends solely on cash paid from the Keg Operating business (KRL), so looking at the health of the combination of corporate and franchise restaurants is key.  On www.sedar.com, the operating company (KRL) files its own statements, which lays out how things are progressing.

In the fourth quarter, KRL lost around 1% of hours due to lockdowns, which hit very late in the quarter.  Adjusting for this would put sales around $151 million on 106 stores, or $5.7 million annualized run rate per store (the run rate in 2018 and 2019 was about $6.2 million per unit, as some of the customer strata, such as seniors, have been slow to return).  The timing of the lockdowns caused many holiday parties to be cancelled, so this likely disproportionately hurt sales and traffic at a key point in the quarter.  

For the full year, the KRL generated $44 million in cash from operations, which doesn’t include $20 million in lease expense and $5.6 million in interest costs and $4.5 million in sustaining capital expenditures.  So conventional FCF (free cash flow) would be $13.9 million, or 5.2% on reported revenue.   Adding back the royalties paid to KEG ROYALTIES of $17.2 million to the FCF gets FCF to $31.1 million, were it a standalone private restaurant operation.  What if KRL had no government help during 2021?   Would the business have bled badly?   The combination of CEWS (wage subsidy) and CECRA (rent subsidy) provided about $22 million in 2021.   So yes, it would have been challenging, but the cash burn would have been modest, about $8 million in 2021 after royalties paid.  Moreover, management would have taken more actions to stem the burn had govt assistance not been forthcoming. 

What about the KRL balance sheet?   It looks fine.   Of the long-term debt of $33 million, $12.5 million is a BCAP loan issued by BDC in its Co-Lending program (along with KRL banking syndicate).  The $12.5 million is interest only for year one and subsequently has a 5 year term, with a rate of prime + 1.5%, relatively low cost debt.  KRL’s EBITDA easily supports its debt.   As at December 26, 2021, KRL has cash on hand of $30,882,000, and $35,986,000 in unused borrowing capacity.

In other words, assuming we are finally at the end of COVID, KRL and its franchisees emerge in a relatively stable position, important considering the hope that additional units can be added over time (but will only happen if econonic to both KRL or the franchisees).  

Food inflation continues to be pervasive, as laid out in the Bank of Canada January Monetary report (https://www.bankofcanada.ca/wp-content/uploads/2022/01/mpr-2022-01-26.pdf) and as we all see daily.  With the reduced supply of agricultural raw materials (i.e. fertilizer, etc) emanating from the Russia/Ukraine war, food prices likely move higher at least for the near term.  The Canadian economy seems in decent shape, with 337,000 new jobs created last month and unemployment rate of 5.5% now down to pre-covid levels.  How the inflation picture will impact discretionary spending and “appetite” to dine out remains a question mark.   Canadians’ balance sheets look very good, boosted by home price inflation and savings accumulated during Covid, obviously helped by massive government transfers.   KEG ROYALTIES realizes a royalty of 4% of gross sales at KRL, so no question menu prices have been going up to compensate for operating and ingredient inflation.   The only question left is the impact higher prices will have on traffic, the other part of the sales equation (avg customer bill * number of customers = total sales).  I’m betting that the menu price points of the KEG remain in a reasonable range, such that it remains a viable option for Canadian consumers, and this point was made by management in the latest press release. Lastly, a key demographic for Keg, Seniors, have stayed away during Covid, according to my anecdotal observations and chats with Keg store managers.  This hopefully changes in the remainder of 2022.  

“The Trustees are very pleased with The Keg’s performance through difficult COVID times, both as a Company and as a Brand. The Fund’s fourth quarter results are directly due to those efforts,…I would also like to remind Unitholders that the Fund’s historical practice of building adequate cash reserves during normalized periods, allowed the Fund to maintain distributions at a higher level than would have otherwise been possible during the slower sales periods. At this point, the Fund’s cash reserves remain substantial, and we currently anticipate being able to maintain our pre-COVID distribution level, as we have been doing since October 2021,…We feel The Keg’s 2021 results were certainly satisfactory considering the operational limitations which were imposed by various levels of government in order to combat the spread of COVID-19. The ongoing desire of our guests to get back to enjoying our hospitality was very evident in our fourth-quarter results, when many of the restrictions on dining out were substantially reduced. To all of us at The Keg, this is invigorating and encouraging,…The temporary measures mandated by certain provinces on restaurant operations late in the fourth quarter of 2021 in an effort to slow the spread of the Omicron variant were relatively short lived. Those issues now seem to be behind us. Since then, our results have far exceeded our expectations;…”

Good luck to all.