For Monthly Income: A 6.7% Dividend Stock to Consider

Most dividend stocks work the same way. A company sells products or services, pays all its expenses, and then distributes whatever profits remain to shareholders.

Royalty trusts flip that model on its head. Instead of owning the business itself, you own the right to collect a percentage of revenue generated by the business. That distinction matters more than you might think, especially for income investors.

One lesser-known example on the TSX is Pizza Pizza Royalty (TSX:PZA), a royalty trust tied to the Pizza Pizza and Pizza 73 restaurant chains. Today, the stock yields roughly 6.7% and pays dividends monthly.

What makes a royalty trust different?

When you buy a normal restaurant stock, you are exposed to everything happening inside the operation. Labour costs rise. Cheese prices spike. Delivery expenses increase. Equipment breaks. Margins get squeezed. A royalty trust largely sidesteps those issues.

Pizza Pizza Royalty does not operate restaurants directly. It owns the rights to receive a royalty based on the top-line sales generated by restaurants inside its royalty pool. Every time a customer orders pizza, a small percentage of that sale flows back to the trust.

That means the trust benefits from revenue growth without directly paying operating costs tied to running the restaurants. This structure creates a very different financial profile from a normal operating company.

For example, a traditional restaurant chain may generate operating margins in the single digits after accounting for wages, rent, food inputs, advertising, utilities, and maintenance costs.

A royalty trust, meanwhile, can generate extremely high margins because its expenses are minimal. There are no kitchens to maintain, no staff to pay, and very limited capital expenditures required to keep the business running.

That difference is why royalty trusts and income trusts historically became popular with Canadian income investors. These structures were specifically designed to pass cash flow through to investors efficiently.

Why payout ratios look different here

With most dividend stocks, a payout ratio above 90% would usually raise red flags. For a royalty trust, that can actually be normal.

That’s why investors should evaluate these structures differently from traditional dividend stocks. A bank paying out 95% of earnings might concern investors because it leaves little margin for loan losses or future growth investments. A royalty trust paying out a similar percentage may still remain sustainable if the royalty stream itself remains stable.

Traditional corporations need to retain earnings to fund expansion projects, replace equipment, renovate locations, or build factories. Royalty trusts generally have much lighter reinvestment needs.

Pizza Pizza Royalty currently distributes most of the cash it receives from royalties because there simply are not many internal capital requirements competing for that cash flow.

Where the growth comes from

That does not mean the business is stagnant. The trust still grows when the underlying restaurant system grows. If Pizza Pizza opens more locations, adds restaurants to the royalty pool, or generates higher same-store sales, the royalty payments increase as well.

In other words, investors still benefit from expansion, but they participate through revenue royalties rather than operating profits. Right now, Pizza Pizza Royalty pays a monthly distribution of $0.0775 per share, or $0.93 annually.

For income-focused investors, that monthly payment schedule can also be attractive from a cash flow planning perspective. Many Canadian dividend stocks still pay quarterly distributions, while royalty trusts and income-focused structures often distribute monthly.

The Foolish takeaway

Pizza Pizza Royalty is not the same thing as owning a traditional restaurant stock. You are essentially buying a contractual claim on a slice of system-wide restaurant sales. That creates a business model with high margins, relatively predictable cash flow, and a payout structure specifically designed for income investors.

Of course, there are still risks. Restaurant traffic can weaken during economic slowdowns, consumer spending can decline, and royalty income ultimately depends on the health of the underlying franchise system. Still, for investors specifically looking for monthly income, royalty trusts like Pizza Pizza remain one of the more unique corners of the Canadian market worth understanding.

The post For Monthly Income: A 6.7% Dividend Stock to Consider appeared first on The Motley Fool Canada.

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More reading

• Use a TFSA to Make $500 in Monthly Tax-Free Income
• How to Use Your TFSA to Generate $500 a Month – Tax-Free
• How to Use Just $20,000 to Turn Your TFSA Into a Reliable Cash-Generating Machine
• 3 Canadian Stocks to Buy for a “Pay Me First” Portfolio
• A Year Later: The Dividend Stock That Still Pays Like Clockwork

Fool contributor Tony Dong has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.