Restaurant Brands International (QSR)—The Devil Is In The Details


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Roger Lipton

Roger is an investment professional with decades of experience specializing in chain restaurants and retailers, as well as macro-economic monetary developments. He turns his background, as restaurant operator and board member of growing brands, into strategic counsel for operators and perspective for investors.

An archive of his past articles can be found at RogerLipton.com.

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Restaurant Brands is here to stay (not surprisingly), but the operating details of this situation reflect a great deal of financial engineering rather than predictable, above average, long term operating progress.

The unit growth at Burger King will continue, but the profitability “levers” are largely played out. Tim Horton’s has serious franchisee tension still to be dealt with, and we are sure that peace will be made. However, the improvement in franchisor margins at Horton’s, (which the franchisees claim was largely at their expense) will not be duplicated. Popeye’s is no doubt the best growth vehicle within this brand portfolio, but their scale is not large enough to move the overall corporate profitability or cash flow by much.

The bottom line is that the earnings and cash flow of this situation are unlikely to grow by more than mid single digits in the near future, having grown by even less than that in calendar 2018. The cash generation may well be used to reduce the $11B of net debt, but that hasn’t been the case in the last two years. The dividend, yielding 3.2% currently, is secure, but the stock is no bargain at 23x 2019 earnings, and about 20x trailing EBITDA.

THE RESULTS:

Restaurant Brands (QSR) is one of the highest visibility “asset light and free cash flow” multi-brand franchisors, with Tim Horton’s, Burger King, and Popeye’s. The highlights of the fourth quarter report follow: Readers should know that the fourth quarter sales were reported in mid-January, and the stock ran up about 10%, from $57 to $63 on something of a relief rally. Today’s report filled in the accompanying profit numbers.

Refreshing our memory of the comps, Tim Horton’s had 4th quarter and calendar 2018 comps of 1.9% and 0.6%, respectively. Burger King had comps of 1.7% and 2.0%, respectively. Popeye’s had comps of 0.2% and 1.6% respectively. Traffic has not been disclosed but can be assumed to be two or three points less than the same store sales.

Unit growth was better. Tim Horton’s net unit growth in 2018 was 2.1%. Burger King’s was 6.1% and Popeye’s was 7.3%.

The reported GAAP (General Accepted Accounting Principles) earnings per share are a bit confusing because of a change in accounting standards. In the 4th quarter, Diluted EPS was $0.64 under the new Standard versus $0.68 under the previous standard. Compared to a year ago on the previous standard the number was $1.59 per share. For the twelve months were EPS was $2.42 (New) and $2.49 (Previous) versus $2.54 (Previous). Setting aside the 4th quarter fluctuation, 2018 on a GAAP basis, was down on either standard.

Investors are very interested these days in EBITDA, so that was provided by segment on an “adjusted” basis.

Tim Horton’s had adjusted EBITDA in the 4th quarter of $297 million (New Standard) and $295 million (Previous Standard) vs. $304 million (Previous standard). That’s down. For the year, Tim Horton’s had segment EBITDA of $1.127 billion (New) and $1.128 billion (Previous) versus $1.136 billion (Previous). That’s down.

Burger King had adjusted EBITDA in the 4th quarter of $247 million (New) and $265 million (Previous) vs $265M (Previous). That’s flat to down. For the year, Burger King had $928 million (New) and $950 million (Previous) versus $903M (Previous). That’s up 2.7% and 5.2% respectively.

Popeye’s had adjusted EBITDA in the 4th quarter of $37 million (New) and $42 million (Previous) vs. $37 million (Previous). That’s flat to down. For the year, Popeye’s had adjusted EBITDA of $157 million (New) and $169 million (Previous) vs. $107 million (Previous). That’s up sharply, 47-58%, but we will come back to this.

Adding up the segment EBITDA, total 4th quarter adjusted EBITDA was $581 million (New) and $602 million (Previous) vs. $606 million (Previous). That’s down.

Total calendar adjusted EBITDA was $2.212 billion (New) and $2.247 billion (Previous) versus $2.146 (Previous). That’s up 3.0-4.7%.

However, in a note following the segment breakdown, the company says this: “Since RBI’s consolidated results include Popeye’s starting in Q2 of 2017 (post acquisition), RBI’s consolidated year-over-year results…are favorably impacted by the inclusion of a full year of Popeye’s in 2018 and only a partial year in 2017.”

While we cannot know what Popeye’s organic annual change in EBITDA was, it seems reasonable that an “adjustment” to the $50-$62 million apparent increase in Popeye’s annual EBITDA would have largely wiped out the increase in adjusted EBITDA for the company as a whole.

It’s possible that our interpretation of the above is misguided, but, at best, QSR’s EBITDA is growing year-to-year at a very modest rate. If we are right, it is growing hardly at all.

Net unit growth, however, is steady, most importantly at Burger King, the most well established worldwide brand with 17,796 locations, up 6.1% in 2018. Popeye’s is growing nicely, up 7.3% on a smaller base of 3,102 units. Tim Horton’s continues to grow at a 2.1% rate in 2018 on a base 4,846 restaurants. This in spite of the well publicized franchisee unrest. Clearly, unit growth, internationally in particular, is the largest opportunity for improved profitability and cash flow. The potential for growth at Tim Horton’s in China was emphasized, with an objective of 1,500 units over ten years, the growth led by an affiliate of QSR. Ongoing growth in Brazil is also predictable, also led by a QSR affiliate, in this case publicly traded in Brazil. The same Brazilian affiliate is leading the growth there of Popeye’s.

The conference call consisted of the company reiterating their dedication to building profitable sales for each of their franchise systems. Analysts questioned management about the unit level profitability, and the company continues to claim that franchisee profitability improved in 2018 versus 2017. Various questioners seemed skeptical, citing wage increases as a continuing burden. Since comp sales are up 2% at best, and traffic (while not disclosed) is likely down, virtually every publicly held company has reported that profit margins are suffering under these conditions and it is unclear why Burger King, Tim Horton’s or Popeye’s would be an exception.

The company adhered closely to their mantra of building top line sales for each of their franchise systems, which truly does solve all other issues. As referenced above, while one could question their assertion of improved franchise profitability, we can’t doubt the company dedication to improved future sales. Loyalty programs, digital ordering, renovations, and other operating initiatives are important elements in maintaining market share at the very least, and hopefully building it.

In terms of capital allocation, reference was made to ongoing “delevering” of the balance sheet. This is an important objective since net debt is 5.1x the adjusted EBITDA of 2.1 billion. However, the free cash flow of $1.1 billion was a lot less, after dividends and $550 million of repurchased exchange units from their 3G affiliate. Furthermore, there has yet to be any “delivering,” since net debt is still $11.8 billion, virtually unchanged from a year earlier, still at a year end high after calendar 2017 capital allocations to dividends, another $500 million plus repurchase from 3G and redeeming Warren Buffet’s $3 billion of preferred stock.

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