I may have shared the idea with Tyler, but he put the time and effort into writing up the SIR Royalty opportunity in more detail than I ever would have. I suggest you read his post twice to understand the investment case before continuing here. This post will focus on the trade postmortem now that the position is closed.
Trade Timeline
- Google alert pings for SIR Royalty as SIR Corp. makes a bid at $3.55/share to take the royalty pool private.
- With the catalyst already in place, I bought a large chunk of shares between $3.75 and $4. I had done enough research on SIR Corp. in the past year after the distribution cut to move quickly once the news broke.
- Lembit James makes a mini tender at $4.25/share, putting a floor under the stock and validating my own theory that SRV.UN is still severely undervalued.
- I made the decision to sell at or above $6.75/share. I think fair value is somewhere closer to $9, but it’s becoming clear that nobody involved has the money or the desire to pay that much for a royalty on a restaurant chain that isn’t allowed to conduct business and is starting to buckle.
- The air is starting to come out of balloon and I have a decision to make: Sell now below my target price, wait to get my $6.75/share, or keep the position as a long-term hold with the potential to pay a large distribution if/when things normalize.
- I decide to take the money and run. I sell the entire position between $6.30 and $5.95.
Based on the numbers alone this is a successful trade, particularly since it didn’t take very long. But my goal with trusts and yield plays is to lock in a nice source of cash flow for a few years when it’s available at an extreme discount. SIR Royalty was paying $1.05/share pre Covid. If SIR resumes distributions at 70% of that, it still results in a yield of close to 20% based on my purchase price.
Most people will tell you yields should be calculated on the current share price rather than the cost price. That line of thinking ignores real life if it’s taken too far. Life is balance. We all have a limited amount of capital and good ideas. We also have bills to pay, enemies to smite (they aren’t going to smite themselves) and lives to live. Maximizing returns at the expense of all else isn’t going to impress the Pilates HottieTM or pay for a kitchen reno, and your spouse really does want a Peloton for Christmas. I try to construct my portfolio with separate buckets for income streams, trades and long-term holds. The size of each bucket varies based on where the opportunities are.
My ideal holding period for SIR Royalty would have played out like this:
- SRV.UN bought at severe discount because of distribution cut.
- Temporary issue is resolved as Covid lockdowns are lifted.
- Distributions resume, resulting in 25%+ pre-tax yield on initial investment.
- With distributions flowing again, SRV.UN starts to approach fair value that is significantly higher than the initial purchase price.
- Like your favourite PE firm, I borrow against SRV.UN to access the equity I’ve built up. Deferring a capital gain, gaining a tax deduction and freeing up cash for newer/better investments.
- A third-tier restaurant chain isn’t a forever hold. The position is sold when the potential of the business is maxed out and the risk of holding is too great. Better opportunities are missed or capital loss awaits if I continue to hold.
That ideal scenario was impossible with indoor dining still shuttered in Ontario. Better to take the money and move on rather than risk a possible CCAA filing by SIR Corp.
