THE CONTEXT AND THE PRINCIPLE
Restaurant Brands (QSR), owner (in order of EBITDA importance) of Tim Horton’s, Burger King, Popeye’s and Firehouse Subs, has been widely followed since it became publicly held in late 2014. It is worth noting that TH and BK are by far the largest EBITDA generators. Out of $2.378B of Adjusted EBITDA in calendar ’22, TH, BK, PLK and FH contributed $1.073B, $1.007B, $.242B and $.056B respectively.
Our coverage of Restaurant Brands over the years, a number of the reports provided below, consistently referenced their “financial engineering” skills, rather than operating success. At Tim Horton’s that consisted of materially raising the price of products distributed to franchised stores, sparking improved results for Restaurant Brands, at the expense of franchisees’ profitability, and resulting in well documented lawsuits that took years to resolve. The “rationalization” of G&A at Burger King was not detailed to Wall Street analysts, but industry participants were well aware that field support of franchisees was seriously undermined by replacing experienced personnel with (probably younger) less qualified and lower paid individuals. With the stock performing reasonably well in the wake of increased cash flow generation (at the expense of TH and BK franchisees), with more presumably to come, billions of dollars were spent to repurchase stock from Brazil based 3G Capital, QSR’s largest shareholder, as well as in payment of common stock dividends. A couple of billion dollars of annual Adjusted EBITDA, to this day has not been used to reduce the long-term debt ($12.2B at Dec’22, vs. $11.8B at Dec’17) or materially reduce the number of fully diluted average shares outstanding ($455M in ‘22 vs. $477M ’17, down only 4.7%). In the absence of sufficient reinvestment into QSR’s franchised brands. It should be no mystery why Starbucks’ results have run rings around that of Tim Horton’s, and McDonald’s and Wendy’s have consistently outperformed Burger King. The story of Restaurant Brands vividly illustrates the cost of under-investing in the long term health of franchised brands. “Asset light” does not mean “Investment Absent”.
This discussion is not intended to be exhaustive in terms of the fundamentals, but to illustrate the broad principle that “you can’t solve a problem until you acknowledge that the problem exists”. We believe that it is no accident that Restaurant Brands (QSR) fundamental performance is improving and the stock is breaking out to a new all time high.
THE INFLECTION POINT WAS SUGGESTED IN DECEMBER, 2021
The recent excellent podcast interview of Burger King’s US and Canada President, Tom Curtis, conducted by Restaurant Business’ Editor in Chief, Jonathan Maze, brought into focus the importance of qualified long term oriented leadership. Curtis, after 35 years at Domino’s, most recently as Executive VP, US operations, was named COO at Burger King, America, in March ’21, and elevated to his current position in August’21. We noted this in our report, below, in December ’21. We did not know Curtis. Most important to us was Jose’ Cil’s “Houston, we have a problem”.
We said “Current management, led by Jose’ Cil, obviously can’t change the past, but are acknowledging the shortfalls and taking steps. Cil acknowledged recently that “our drive-thru speed-of-service declined significantly” and he told analysts recently that “the company is increasing overhead spending for field operations and training specialists. We’re giving them better tools, investing in that from a technology standpoint.” Cil just hired Tom Curtis away from Domino’s to oversee BK operations, and other changes are no doubt in the works. Restaurant Brands may yet deliver on its potential”.
THE PLOT THICKENS FURTHER WITH PATRICK DOYLE’S INVOLVEMENT
You can read the Curtis/Maze transcript, and follow developments over time, if you want to learn more about the operational developments under Curtis’ guidance, and we will report periodically in this regard. For this discussion, we reflect only upon Patrick Doyle’s meaningful commitment to Restaurant Brands, not only becoming Executive Chairman in November ’22, but purchasing $30M worth of QSR stock. That’s what pushed us over the edge to become a shareholder. We were a shareholder of Domino’s early in Doyle’s regime there, made 50% on our money in less than a year. Unfortunately left about 1000% on the table😊. Who said you never go broke taking a profit?
We analysts sometimes we don’t notice the forest for the trees, and get too involved in short term considerations to appreciate the longer term picture. We provide a number of our discussions below, from 2/11/19 to the “inflection point” in December, 2021. Considering that Curtis and Doyle are out of Domino’s, we wouldn’t be surprised if other qualified DPZ team members find their way to BK, TH, PLK or FH. By definition, they will have a history of success, and that would make a big difference at Restaurant Brands. Whether that should come into play or not, stay tuned. There are at least a couple of new, and qualified, sheriffs in town.
February 11, 2019 – QSR stock at $63
RESTAURANT BRANDS REPORTS FOURTH QUARTER RESULTS – BEATS BY $.01 “ADJUSTED” – THE DEVIL IS IN THE DETAILS
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 ’18. 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 ’19 earnings, and about 20x trailing EBITDA.
October 28, 2019 – QSR stock at $65
We urge our readers to use the Search function to peruse our previous writings relative to QSR.
Restaurant Brands, Inc. is a fascinating case study about the opportunities to create a fortune in an accommodating financial environment. A creative management team, backed by Brazilian based 3G, attracted prominent investors such as Warren Buffet (no longer a shareholder) and Bill Ackman’s Pershing Capital, and had little difficulty borrowing a cool $12 billlion over the last five years. While the music has been playing and QSR stock has gone from the low 30s in early 2015 to a high close to 80 a month ago, most observers have been willing to overlook the problematic aspects of the “low hanging fruit” that was picked by Restaurant Brands, as they streamlined operations at Burger King and Tim Horton’s, most lately attempting to do the same at Popeye’s. Bottom line operating results were impressive enough at Burger King, once acquired, that Horton’s could be acquired, “efficiencies” could be implemented (some of which haven’t been embraced, to say the least, by franchisees), and Popeye’s could then be acquired. The capital markets, equity and debt, have viewed Restaurant Brands favorably.
At this point, and over the last couple of years, with Horton’s “stuck”, Burger King growing, and Popeye’s too small to matter much, we have felt that total corporate EBITDA growth is most likely to be in the 6-8% range. Our view continues to be that QSR is adequately leveraged and fully valued.
February 11, 2020 – QSR stock at $67
We have written on Restaurant Brands many times over the last several years, and have correctly predicted that the growth in earnings and cash flow would be flattening out now that the operating “efficiencies” in the wake of the Burger King and Tim Horton’s acquisitions were unlikely to be repeated. The stock has, accordingly, done very little over the last two years. QSR stock is not overpriced relative to its “asset light” peers, and it’s 5% “Free Cash Flow” yield is intriguing, but we do not consider possible growth of 7 or 8 percent annually to be be sufficient to render attractive a 22x price earnings multiple or about 19x trailing EBITDA.
December 16, 2021 – Restaurant Finance Monitor’s “Follow the Money” – QSR stock at $61
RESTAURANT BRANDS (QSR) “RETOOLS”
Progress takes time in the real world and Jose’ Cil’s appointment as CEO at QSR in early 2019 is starting to bear fruit. Cil is an ex- bankruptcy lawyer who originally joined Burger King (BK) in ‘00 as an in-house counsel. With the exception of 10 months at Wal-Mart in ’10, he worked his way through worldwide and US operations at BK. Some historical context is necessary here. QSR, controlled by Brazilian 3G Capital, put BK and Tim Horton’s (TH) together in late 2014, creating a publicly held multi-branded “free cash flow”, “asset light”, franchisor. Popeye’s was added to the mix in 2017 and Firehouse Subs is about to become the fourth brand. While Popeye’s struck gold with their chicken sandwich, and there has been consistent systemwide unit growth at Burger King, Tim Horton’s has had well publicized friction (to be charitable) with their franchisees, and both chains’ same store sales have lagged their competition.
At the operational level over the last seven years, QSR demonstrated its platform’s administrative efficiency by closely controlling corporate G&A at both BK and TH, designed of course to maximize the cash flow for the franchisor. Setting aside (1) the widely known price increases (of food supplies, etc.) imposed on the TH franchise system, the wider profit margin providing a very large portion of the increase in TH operating income and (2) anecdotal reports that have circulated for years about less than ideal field support for BK franchisees.
The reported financials were muddied a bit between ’17 and ’18 as a change in accounting treatment took place and advertising fund contributions from franchisees were added to revenues as well as G&A expenses (mostly netting out). However, at Burger King, absolute dollars of G&A were down from ’15 to ’17 and virtually flat (up 0.2%) from ’18 through ’20. At Tim Horton’s, absolute G&A was down from ’15 through ’17, and down again from ’18 through ’20. During those same five years the systemwide units at Burger King grew steadily from 15,003 to 18,625. Even with the problems at TH, the number of systemwide units grew from 4,413 to 4,949. Therefore the systemwide units grew by 24% at Burger King and 12% at Tim Horton’s but dollars spent for G&A went down from 2015 through 2020. If you are not good to your franchise system, your franchise system will not be so good for you.
While QSR, the stock, has done “OK” since 2014, going from about $40 to $60, the free cash flow generated since 2015 has allowed for about $6.2 Billion of dividends and corporate purchase of (controlling parent) 3G’s partnership units. The long-term debt, by the way, has gone from $8.5B at the end of ‘15 to over $12B today, so “free cash flow” largely benefited 3G Capital rather than the public.
Back at operations, in spite of Tim Horton’s selling an addictive product line and Burger King’s large number of drive-thru locations, results have lagged competitors throughout the pandemic. Average Unit Volumes the past eight quarters (according to Technomic) have been down 0.49% at BK, versus a positive 7.0% at McDonald’s, 5.5% at Wendy’s, and 7.5% at Jack in the Box. Tim Horton’s results have been worse, down 15.7% in ’20, only partially recovering in ’21. Current management, led by Jose’ Cil, obviously can’t change the past, but are acknowledging the shortfalls and taking steps. Cil acknowledged recently that “our drive-thru speed-of-service declined significantly” and he told analysts recently that “the company is increasing overhead spending for field operations and training specialists. We’re giving them better tools, investing in that from a technology standpoint.” Cil just hired Tom Curtis away from Domino’s to oversee BK operations, and other changes are no doubt in the works. Restaurant Brands may yet deliver on its potential.