Diversified Royalty Stock Forecast: One of the most-often quoted lines from Romeo and Juliet implies that names don’t matter in the slightest, or “A rose by any other name would smell as sweet.” While that might be true for Shakespeare’s star-crossed lovers, the business world isn’t quite as simple.
Great businesses must build their brands and make their names synonymous with quality. That process takes time and painstaking effort.
All too often, new companies go under before their name is established, and they never have an opportunity to capture consumer interest and grow their market share.
Diversified Royalty Growth Rate Is Steady, But Why?
Franchises essentially sell new business owners the right to operate under an established name. This, in addition to support with the logistics of managing and operating the business, can dramatically improve the likelihood of long-term success. Businesses that own multiple locations succeed under this same principle. All locations operate under the parent company’s name, which attracts customers already familiar with the brand.
The ability to use an established name is valuable, and businesses ensure they protect their right to exclusive control of their brands through their trademarks. When they license their trademarks to other business owners, giving those businesses the opportunity to benefit from the power of a well-known brand, the trademark owners collect royalties. They profit based on the power of the name.
Some organizations have built a business model that is entirely focused on the value of a business name. They acquire strong trademarks and other intangible business assets, then license the right to operate under that name. Often, they add a comprehensive package of management consultation and business tools to ensure licensees have the best possible chance of achieving long-term success.
Diversified Royalty is one such company, and it is growing at a steady rate. However, investors who are unfamiliar with this business model are hesitant to purchase shares. After all, how does such a company generate profits? Is Diversified Royalty stock a smart buy?
Diversified Royalty Licenses IP & Trademarks
Diversified Royalty identifies strong, growing brands, then it acquires the trademarks and related intellectual property. It licenses the rights to use those trademarks to qualified owner/operators, and it offers managerial support to ensure success.
While the purchase of trademarks is costly, the Diversified Royalty business model is structured in a way that ensures the company profits from the deal. Licensees make annual royalty payments that eventually offset the initial investment. After that, the royalty payments contribute to Diversified Royalty’s profitability.
Diversified Royalty is Canada-based, and it buys trademarks for North American businesses. The company currently owns five trademarks, all of which have strong reputations and growing sales. These include the following:
- Sutton Group Realty Services – Sutton is one of the top residential real estate brokerage franchisors in Canada, and it currently has more than 200 offices nationwide.
- Mr. Lube – This popular vehicle maintenance business is best known for its quick lube service. It is the number one quick lube service in Canada, and it currently operates 182 locations nationwide. The most recent financial reports show annual system sales of more than $235 million.
- AIR MILES – Loyalty programs are growing exponentially, and AIR MILES has the distinction of being Canada’s largest. Roughly two-thirds of all Canadian households are active participants, and the program boasts more than 200 brand-name sponsors.
- Mr. Mike’s – When it comes to casual steakhouses, Mr. Mike’s is a winner. This company operates 44 restaurants across the western part of Canada, which collectively generate more than $85 million in annual sales.
- Nurse Next Door – This trademark is the newest addition to Diversified Royalty’s portfolio. The deal closed November 1, 2019. This company may be the most valuable of Diversified Royalty’s brands, as it caters to the growing demand for home health services. The aging population is anxious to stay at home as long as possible, and Nurse Next Door offers the services needed to prevent lengthy hospital stays. This company was founded in 2001, and it currently has a total of 177 locations. Two are owned by the corporate offices, and the remaining 175 are franchises – 65 in Canada, 109 in the United States, and 3 in Australia. Annual system sales exceed $100 million.
This collection of strong brands seems impressive, but is it generating value for shareholders? In other words, is Diversified Royalty stock a buy?
Is Diversified Royalty Stock a Buy?
Overall, Diversified Royalty revenues are growing, as evidenced by third quarter 2019 financials. The company generated $8.1 million in royalty revenue and management fees, which is a year-over-year increase from third quarter 2018’s $6.7 million.
The improved revenues are primarily credited to the acquisition of Mr. Mike’s trademarks as of May 2019, as well as the May 2019 opening of four new Mr. Lube locations. In addition, Mr. Lube’s same-store sales figures increased year-over-year.
Finally, the annual 2 percent increase in Sutton Group Realty’s royalty rate was effective on July 1st, contributing to Diversified Royalty’s third quarter revenue growth. The nine-month figures also showed improved royalty revenue, rising from $19.5 million during this period in 2018 to $22.1 million for the nine months ending September 30, 2019.
The biggest area of concern is consumers’ apparent weakening interest in the AIR MILES program. The quantity of reward miles issued in the third quarter decreased by one percent, and for the year, the figure was flat. For the nine month period ending September 30, 2019, the number of reward miles redeemed by consumers was down by three percent.
Overall, Diversified Royalty appears to have a solid handle on the types of trademarks worth acquiring, and it has been successful in generating and distributing profits to shareholders. However, this stock has unique risks that potential investors must consider before making a decision to buy.
What are the Risks of Buying Diversified Royalty?
While it is true that Diversified Royalty is reliably distributing profits to shareholders – and declared distributions have increased regularly – the truth is that the company appears to be making promises it can’t really afford to keep.
For the third quarter of 2019, distributable cash was $5.4 million or $0.0501 per share. Declared dividends exceeded distributable cash by $0.6 million for that three month period.
Fortunately, shareholders can elect to reinvest dividends, and a number did, so the payout ratio was 85.2 percent for the quarter. Due to this option, there was no cash shortfall when dividend payments were made.
Since most of the company’s cash is going into the Nurse Next Door deal, Diversified Royalty expects a payout ratio of under 100 percent again in coming quarters. This isn’t ideal, and it is a risk shareholders must consider carefully before buying stock.
Finally, Diversified Royalty is a small company that depends on the success of other businesses and their management teams for its own success. Net income for third quarter 2019 came in at $3.9 million, which was an increase from third quarter 2018’s $3.4 million. However, this is a relatively small number that could easily be wiped out if any of the five brands gets into trouble.
Diversified Royalty Stock Forecast Summary
The bottom line is that Diversified Royalty is an interesting opportunity that shows some promise – but those potential rewards come with significant risk.
Stock prices are low, so taking a gamble could add some inexpensive excitement to your portfolio. Just be sure anything you invest is an amount you can afford to lose.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.