Tag Archives: Horton’s



Restaurant Brands reported Q2 earnings this morning and disappointed the investment community, primarily because of softer sales (by a couple of points) at Burger King than expected and EBITDA comparisons that were anywhere from flat to up 6%, depending on the “standard” employed. The stock was trading down several percent as the conference call was being conducted, recovering to be down just slightly at the opening.

In summary: Comp sales at TH were flat, BK was up 1.8%, Popeye’s was up 2.9%. Net restaurant growth was up 3.0%, 6.4% and 7.5% respectively.  There are two “standards” of reporting here, as discussed below. On the “new” versus “previous” standard, Adjusted EBITDA was down 1.1%, up 1.8% and down 5.4% respectively. Total Adjusted EBITA, Net Income, and Adjusted Diluted Earnings Per Share were virtually flat YTY. On the “previous” standard versus “previous”, Adjusted EBITDA was up 2.7%, up 7.0%, up 28.0% respectively, up 6.0% overall. We discuss the differences further below.

 The Conference Call:

Management, CEO Daniel Schwartz, started off the call by saying that “we plan to provide more details than we historically have on initiatives across each of our brands”.

There was, predictably, substantial discussion by management about the continued growth at Burger King, the effort to generate renewed growth at Tim Horton’s as a result of the “Winning Together” program, and worldwide expansion of the Popeye’s brand.  There was major emphasis on the improved communication with the Tim Horton’s franchise community. Over 1/3 of the franchise network have agreed to renovate their stores in ’18 and ’19, with QSR helping to finance that investment.  Supply chain margins at Tim Horton’s improved from Q1 to Q2, as a result of seasonal sales influences. Management indicated that profits and EBITDA at Tim Horton’s should improve in the second half as the price adjustments in the supply chain, and the introduction of Espresso (when equipment was sold to franchisees), about a year ago are lapped.

We have no doubt that a major effort is being made to repair the relationship with the TH franchise community. Peace will be made, because it will be in everyone’s interest, but the profit growth in the supply chain in the future will be far less than in the past.

In terms of management’s guidance for overall future growth of profits and EBITDA, management declined to provide an objective, maintaining that their objective is unit growth, sales growth, and profit growth at each brand.

The question was asked about menu price increases, but management declined to quantify that. Menu prices have obviously been increased, so traffic would be something like a couple of points less than the comps indicate.

When asked about the profitability at the franchisee level, management declined to be specific but said that profitability is up at all three brands.

When asked about the TH performance, country by country, management talked about softness in the US (being countered by renovations, etc.), differences by each market, and long term optimism about each, but nothing more specific.

In reference to supply chain margin at Horton’s, and the $100M capex there over ’18 and mostly ’19, management said that the current structure is good, and should be more efficient in the future with new distribution centers in Alberta and BC. Management declined to provide specific objectives in terms of improved profitability, for franchisees or QSR.


It has to do with revenue recognition, as described in the following note from the first quarter’s 10Q filing:

 Note 4. Revenue Recognition

Revenue from Contracts with Customers

We transitioned to FASB Accounting Standards Codification (“ASC”) Topic 606, Revenue From Contracts with Customers(“ASC 606”), from ASC Topic 605,Revenue Recognition and ASC Subtopic 952-605, Franchisors – Revenue Recognition(together, the “Previous Standards”) on January 1, 2018 using the modified retrospective transition method. Our Financial Statements reflect the application of ASC 606 guidance beginning in 2018, while our consolidated financial statements for prior periods were prepared under the guidance of Previous Standards. The$249.8 million cumulative effect of our transition to ASC 606 is reflected as an adjustment to January 1, 2018 Shareholders’ equity.

Our transition to ASC 606 represents a change in accounting principle. ASC 606 eliminates industry-specific guidance and provides a single revenue recognition model for recognizing revenue from contracts with customers. The core principle of ASC 606 is that a reporting entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the reporting entity expects to be entitled for the exchange of those goods or services.

There are a lot of complexities these days relative to accounting treatment, and many companies are reporting all kind of “adjusted” results. Our comments here could be considered cynical, but we don’t see other franchising companies changing their “standard”, reporting both ways, and the net effect here of the “New Standard” was A REDUCTION OF SHAREHOLDER’S EQUITY OF $249.8 MILLION ON 12/31/17. As analysts would say, there are a lot of “puts and takes”, but the bottom line is that shareholder’s equity is materially less than had been reported.


Restaurant Brands, International (QSR) is a strong company, to be admired from many standpoints. We stand by our previous discussions which have pointed out that the financial engineering of the past will not be possible in the future. The company is already levered up pretty fully, though they could be tempted by the availability of Papa John’s.  The reduction of G&A at Burger King, and especially at Tim Horton’s, combined with the supply chain “efficiencies” (price increases to franchisees) will not be possible going forward. The growth rate of profits and EBITDA will obviously be lower in the next several years than has been produced in the past.



The stock charts, shown below, of the largest capitalization restaurant stocks raise serious questions about Starbucks fundamental prospects. Charts and fundamentals don’t always go hand in hand, especially over the short term, but longer term the stock price and the company’s performance converge.  Starbucks has been one of the great stock market winners of all times since going public in 1992, up well over 100x over 25 years. However, all good things come to an end at some point, at least level out in this case, and over the last two years Starbucks’ stock has substanially lagged the general market and its large cap restaurant industry peers.


It’s a “bum rap”. The media, and the skeptics like to point to the folly of customers paying $5.00 for a cup of coffee. However, we priced (before tax) Starbucks, Dunkin’, and Horton’s in Detroit (to avoid NYC prices) this morning. Starbucks’ 12 oz.“tall” coffee is $2.20, Dunkin Donuts 10 oz. “small” is $1.75, and Horton’s 10 oz. “small” is $1.58. Per oz., Starbucks costs $.183, Dunkin’ is $.175 and Horton’s is $.158. If you want a latte’, the gap is wider ($.312 per oz. at Starbucks, $.253 at Dunkin’, and a materially cheaper $.222 at Horton’s). A latte’ costs more at Starbucks, but Dunkin’ and Horton’s don’t even offer the Soy Latte’ that I order. I can’t vouch for the “quality” of latte’ at Dunkin’ or Horton’s. You can judge for yourself whether the service component, or the type of coffee, is worth the price premium at SBUX but, in any event, it is not a “$5.00 cup of coffee”, and Starbucks’ prices are not grossly higher than the competition.


In my opinion, what has distinguished Starbucks over the years has been the corporate “culture”, which they have incredibly duplicated in 27,000 stores worldwide. Their employees, selected, trained, and motivated to an unmatched degree in food service, look you in the eye, remember your name and drink if you are anything close to a regular customer, and become part of your daily social life. A couple of years ago, about the time that Chipotle ran into trouble, I asked a SBUX employee if he knew anything about Chipotle. This young man, perhaps 18 or 19 years old, told me he used to work at Chipotle, then gestured kind of frenetically with his hands saying: “at Chipotle it was all about speed. Starbucks makes me a better person”. That’s what Starbucks has been all about, creating a uniquely welcoming retail environment that produces “better persons” of their employees.


BARRON’S MAGAZINE this morning has a front cover entitled THE FUTURE OF COFFEE (AND RETAIL). The subtitle reads “Starbucks has succeeded where Silicon Valley hasn’t: changing the way consumers pay. The behavioral shift holds big promise for the coffee giant and its stock”.

Not exactly, in my opinion. It is not just about “the law of large numbers”, and the difficulty of satisfying investors by building on profit margins that are well above peers. The business model has changed, and the question becomes whether the new model will match the original. It’s well known that a new loyalty program bothered some customers and also that an increasing number of customers are ordering and paying online, often in advance of entering the store. In the most recent quarter, 30% of US transactions were paid using the smartphone app, up from 25% a year earlier and 20% two years ago. More important, to my view, is that 9% of US orders were ordered and paid for in advance. The company has been discussing the store level congestion for several quarters now, as mobile orders slow down service for customers going through the line. Perhaps it’s just me, but I am put off somewhat when the line at the register (where I like the human contact) is short, but I have to wait while eight or ten orders are pumped out ahead of my own.


It’s not so long ago that pundits dismissed the internet as a retail venue. The public was not expected to give out their credit card information, and certainly was not going to buy “touchy, feely” products like apparel or shoes through online channels. The public is not only ordering “everything” through Amazon and others, but relationships are maintained through Facebook and other social channels. As a corollary, customers are increasingly seeking “experiential” retail situations, rather than visit the malls, with their undifferentiated stores and restaurants, most often staffed with poorly trained employees.


Relative to Starbucks, their leadership with mobile order and pay, increasingly in advance of the store visit, may well be appropriate and necessary, but the business model has changed. It’s become a production challenge, not a relationship driven enterprise. The employed “people person” who was the star of the previous model, is not going to be as easily satisfied, because most of the employees, for most of their time, are busy pumping out product. It’s going to be harder to find someone as described above who says that Starbucks “is making me a better person”. From the customer side, there are 27,000 stores already existing that are already tightly configured and can’t be reconfigured too much to handle a lot more production. From a customer standpoint, some, like myself (perhaps in the minority these days), who value the human contact, may decide that the local independent shop, or even the home or office kitchen, can provide an adequate cup of coffee at a competitive price without the “tumult”.


I remember when Howard Schultz said that food will never be a material part of Starbucks’ sales. Today, it represents 30% of revenues. Schultz originally envisioned his coffee shops as a “third place”, to hang out other than home or office. That’s a little hard today, in a small busy shop, but we can call this an “unintended consequence” of building one of the still growing premier worldwide brands. Comps and traffic have slowed in recent years, due to the “law of large numbers”, the natural limitations of small stores that were not originally built to handle today’s volumes, and the evolving environment that every successful retailer must adjust to. Starbucks is one of the most successful retailers ever created, and we don’t doubt that they will continue to succeed in a major way. We caution however, that the rate of progress demonstrated in the past, already slowing, will be increasingly difficult to replicate. The business model has evolved. Starbucks was a retail “disrupter” but their previous approach may not be quite as successful. Accordingly, valuation parameters that have applied to SBUX equity in the past may not apply in the future. The stock chart that has languished over the last couple of years may well be reflecting the most likely future business model; still good, just not quite as great.





Restaurant Brands, Inc. (QSR) – is a relatively “pure” franchising companies, owning three well known brands, Burger King, Tim Horton’s, and recently purchased Popeye’s Louisiana Kitchen. The largest cash flow generator (55% of total EBITDA) in the last twelve months has been Tim Horton’s, a 75 year old Canadian based brand named after the legendary hockey player. Burger King generated the balance, since Popeye’s was acquired at the very end of Q1’17. As of 3/31/17 there were 4,644 systemwide TH units (up 4.6% YTY), 15,768 BK locations (up 5.1% YTY) and 2,743 PLK stores (up 5.8% YTY). All three chains are virtually 100% franchised.

We published a rather full description of QSR at www.rogerlipton.com in April, which we suggest you peruse, though we did not update the writeup to reflect Q1’17 results.  We deal here with the implications of the recently filed Tim Horton’s franchisee class action lawsuit, as it may affect future growth in earnings, cash flow, and the valuation of QSR. This is especially so since TH generates 55% of trailing twelve month EBITDA for the Company as a whole.  Suffice to say, regarding Q1’17, that results were “in line”, sales trends were sluggish again, just as in Q4’16 (and reflecting industry wide trends), unit growth was steady, the company was enthusiastic about growing the Popeye’s footprint on a worldwide basis, and improving the operating margins at PLK as they had done at BK and TH. An accelerated pace of pace of expansion at PLK is also expected to improve the overall net unit growth for QSR. However, “Business as usual”, as described during Q`17 may become a footnote, as further details and eventual “disposition” of the TH franchisee litigation takes place.

Over the last two years, the Company has gained credibility not only by the strong operating results, largely driven by improved operating margins at TH, but from Berkshire Hathaway’s purchase of $3 billion of a 9% Preferred stock (with warrants attached to buy about 3.5% of QSR for $.01/share) which helped finance the Tim Horton’s acquisition. Other major shareholders are 3G Capital, the Brazilian private equity firm that purchased Burger King in 2010, which still controls 42.5% of the shareholder vote through “Partnership Exchangeable Units” as well as Berkshire’s 12.9% voting rights, and William Ackman’s Pershing Square Funds with 43M shares representing 18.3% of the common shares and 8.4% of the vote. Ackman’s interest derives mostly from the public vehicle he helped create that purchased Burger King from 3G Capital, as well as 1 million open market shares purchased in early 2016.

Based on the operating record of 3G and then QSR, the investment attractiveness of “asset light” free cash flow generating franchise companies, and perhaps the “affiliation” with Warren Buffet, QSR has attained an enviable valuation. There are currently nineteen sell side restaurant analysts that cover the stock, according to Bloomberg. Eleven currently rank QSR a BUY, eight say HOLD, none say SELL. Target prices for the analysts that say buy range from $60 to $70/share.



On June 14, 2017, Oppenheimer & Co, Inc.’s restaurant analyst upgraded QSR to “Outperform”, with a $70.00 price target. The key points cited were:

  • EPS upside from consensus ’18 estimates ($2.70 vs. $2.42 consensus) largely based on redemption of the Berkshire 9% Preferred. No operational improvement is assumed.
  • Accelerated growth, and improved margins at Popeye’s, maintaining and perhaps improving the overall growth in earnings and cash flow for QSR.
  • Possibility of same store sales improvement at all three brands, vs. current industry malaise.
  • Free Cash Flow Yield of 5.5% based on ’18 estimates, vs. peers at 4.5%.
  • P/E multiple of 21x based on new above consensus $2.72. The price target of $70. Is based on a 4.5% FCF yield and 26x P/E, modestly higher than peers, slightly lower than QSR’s history.

In summary, this latest upgrade reflects the assumption that the historical success of management in improving margins at Burger King, and most recently Tim Horton’s will continue, and be augmented by similar success at Popeye’s.


One June 2, Grant’s Interest Rate Observer, provided a “bearish analysis” (their term) on QSR common stock. The quotes are as stated by Grant. We have not confirmed every number, but have spot checked to confirm that they are at least generally correct. The key points cited were:

  • After paying top dollar for BK, TH, and PLKI, QSR is highly leveraged with debts of $12 Billion, representing 6.1 times trailing pro forma EBITDA.
  • TH (representing 55% of QSR’s total EBITDA) generates revenues from franchisees in the form of royalties (3-5% of sales), rents (as high as 10% of store sales), and, most concerning at this juncture, a markup on sales of food, paper, and other consumable supplies.
  • Grant spoke to TH franchisees that claimed prices had been raised substantially on required purchases from TH parent. In fact, over the 24 months from Q1’15 to Q1’17, margins on those sales increased from 13.3% to 23.7%. For the five years under previous ownership, gross margins on those sales ranged between 11.9% and 14%.
  • Franchisees further complained that the required 3.5% contribution to the national marketing fund had been used by TH parent for “non-marketing endeavors” contending that the company is “misdirecting advertising funds”. Grant’s points out that G&A expense at TH, after declining in 2016, rose in Q1’17 to $25.1M, up from $16.2M in Q1’16, “after franchises started raising issues with the advertising fund”. FYI, Total G&A for TH during calendar 2016 declined to $78.9M from $93.2M in ’15.
  • TH franchisees complained to Grant’s that TH inspections have become unnecessarily harsh and provide a pressure to report profit margins that are inflated. As Grant’s writer Lorenz relates: “Three franchisees tell me that RBI rejects P&L statements if profit margins are too low. 129 TH franchisees responded to an anonymous online survey in Alberta. They reported an average 6.29% operating margin, roughly half the 13-14% margin that the company claims that franchisees earn company-wide.”
  • Grant’s points out that the low tax rate of 2016, at 20.3%, as a result of QSR’s Canadian domicile, is cited as a “risk factor” in the annual 10-K report, saying that ‘Future changes in U.S and non U.S. tax laws could materially affect the Company’. Grant’s implication, obviously, is that the tax rate is more likely to go up than down.
  • Franchisees told Grant’s that the “Great White North” franchisee group has engaged a Toronto law firm to represent a case they were building against QSR.
  • Grant’s related that “the recruiting site, Glassdoor.com had 31 reviews from Restaurant Brand (QSR) employees that gives the Company 1.8 out of a possible five starts. ‘RBI has cut costs to the bone by getting rid of all the professionals…..and hiring kids’ says a comment dated March 24. ‘Turnover rate is at nearly 50%….there is no meritocracy and process goes out the window. Decisions are made by a couple of key decision makers usually based on cost, not what’s best….they have destroyed not only the corporation but the many small franchisees….in the Burger King brand….the same thing at Tim Horton’s. Popeye’s is next.’”

Grant’s concludes: “The criticism seems not to accord with the fancy RBI multiple.”.


To quote portions of the release: Franchisees claim their costs have increased but they haven’t been allowed to raise prices to recoup their costs. “Since the acquisition, RBI has used various strategies to extract more money out of the TH franchise system at the expense of the franchisees” Among the allegations is that the parent company is misusing the millions of dollars that franchisees pay for marketing. (3.5% of franchisee sales). The claim says that “RBI has funneled this money to itself, TDL(?), and the individual defendants at the wrongful expense of the franchisees”.

The Company responded by saying “it is very disappointing that a few restaurant owners have opted to take actions against us when our focus remains on protecting and enhancing the brand. We vehemently disagree with and deny all allegations….we remain committed to working together with our restaurant owners to ensure the incredible TH brand continues to be strong for many years to come.”

Grant’s at the very least proved to be accurate in terms of describing the disaffection of Tim Horton’s franchisees. Above we have provided the bull and bear cases. In terms of making a contribution to the debate, however, we should at least summarize the potential financial impact of the suggested “misallocation” of advertising funds to “other purposes” as well as the higher markup on supplies provided by TH to franchisees.


According to the 2016 10K, total revenues from the TH segment were $3001M, up 1.4% from $2957M. The segment income for Tim Horton’s was $1,072M, an increase of $165M from 907M in calendar ’15. SG&A expenses were down about $14M, from $93.2M to $78.9M. Cost of goods was 78.0% versus 83.3% in ’15. Had the cost of goods, on $2,112M of sales to franchisees been 83.3% in ’16, segment income would have been $112M lower. Summarizing, $126M, or 76% of the $165M improvement at TH in ’16 came from the combination of improvement in supply chain margin and a reduction in G&A. At a 20% tax rate, the effect would be $100M or $0.43/share.


We are not trying to take sides in this debate. The only reason our bear case description is longer is because the bull case is pretty well entrenched and well known by the investment community. Cynics, in this case “Grant’s”, always have the burden of proof, at least at the beginning, so we provide more details regarding their argument. Notwithstanding the red flags provided by Grant’s,  QSR is a strong company and no doubt will grow further through the years. We have no way to know to what extent the franchisee complaints are valid, but certainly such a dramatic increase in margins from sales to franchisees is worthy of explanation. There are always some franchisees that are less happy than others. The lawsuit will play out over time. We do suggest, however, that this “cloud” over the division that provides 55% of trailing EBITDA will not enhance the valuation in the short run. It is probably safe to say that the next $0.43 of earnings contribution from lower G&A and better supply chain margins will not be so easily achieved. Whether or not the franchisee claims are valid, no doubt the low hanging fruit has already been picked in terms of improving the earnings contribution from Tim Horton’s.