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It is not a coincidence that QSR stock was uncharacteristically weak, in a strong market, on Friday, as Kraft Heinz (KHC) was “taken out and shot”, down 25% on the day.

Both KHC and QSR are heavily owned by 3G, a Brazilian based holding company. It should be noted that Warren Buffet’s Berkshire Hathaway owns 22% of KHC, with a much smaller (3.3%) holding of QSR. Berkshire cashed out $3 billion of preferred stock in QSR a little over a year ago.

An extensive article in the weekend edition of the Wall Street Journal described how 3G “became the standard bearer for zero-base budgeting (ZBB), the accounting practice invented in the 1960s that 3G perfected and popularized, first with its acquisitions of Brazilian beer companies, and then globally. It requires justifying every expense each year, no matter how small, rather than using the prior year’s budget as a starting point”.

Quoting 3G co-founder, Jorge Paulo Lemann, the WSJ reported: “I’m a terrified dinosaur. I’ve been living in this cozy world of old brands and big volumes. You could just focus on being very efficient and you’d be OK.  All of a sudden we are being disrupted in all ways. We bought brands and we thought they would last forever. Now, we have to totally adjust to new demands from clients”.

The WSJ followed Lemann’s comments by saying: “The results are exposing the limits of 3G’s hyperfocus on a financial strategy to manage the companies, while not putting enough toward marketing, research and development.”

Relative to Restaurant Brands:

Later in the same article: “3G shook up the restaurant industry with the purchase of Burger King in 2010, followed by acquisitions of Tim Hortons and Popeyes. Cost cuts led to higher margins, and RBI stock price soared. Restaurant Brands wasn’t keeping up with change to the industry and consumer tastes, said Jeremy Scott, an analyst with Mizuho Securities, USA. Competitors such as McDonald’s, Starbucks, and Panera moved to remodel their restaurants, adopt technologies including self-service kiosks and emphasize fresh ingredients. The firm was forced to pour money last year into restaurant remodeling, introducing new espresso drinks (at Tim Horton’s) and simplifying menus. It is also modernizing Popeye’s cash registers to more easily track what customers are buying.”

Duncan Fulton, chief corporate officer for RBI (QSR) said the company is not only focused on cost-cutting but has invested to grow the number of restaurants at its chains.”

WSJ continued: “It’s preferred measure of profitability, adjusted earnings before interest, taxes, D&A, grew 2.6% in the fourth quarter of 2018, the slowest growth the company has reported since BK’s merger with TH. Mizuho’s Mr. Scott said he expects the high spending to continue for another two years as RBI races to catch up, putting pressure on profits.”


We have written extensively over the last year or so (you can use the “Search” function on our Home Page) about the slowdown in earnings and EBITDA growth at QSR. The largest contributor to overall corporate EBITDA growth, from 2015-2017, was the improvement at Tim Horton’s. This was not only the result of ZBB inspired cost cutting, but price increases of supplies sold to the TH system, which has resulted in major lawsuits from the franchise community. We have predicted that the lawsuits will be settled, but the tactics are history not to be repeated.  The cost cutting referred to above no doubt also took place at Burger King, Tim Horton’s in turn, and have already been implemented at the most recently acquired Popeye’s. The unit growth is real, especially at Burger King and Popeye’s, less so at Tim Horton’s, but the “catchup” in systemwide support will absorb most of the increased royalties, and the “magic” at TH is no longer. We believe Mizuho’s Jeremy Scott is correct in his analysis.

Furthermore: as we have pointed out in the past, a great deal of QSR’s free cash flow (about $900M over the last two years) has been paid out to 41% owner, 3G, buying back stock at about 19x trailing “adjusted” EBITDA and over 20x forward earnings per share, hardly a bargain price. Obviously, the Board of Directors, with all but two members categorized as independent, thought a $550M stock buyback in ’18 was more important than reducing debt.  The debt, net of cash, of $11 billion was unchanged in the last twelve months, in spite of $2B of “adjusted EBITDA”.

One final, call it “cautionary”, note. Perhaps an analyst with more legal background than our own, familiar with governance standards in Canada (where QSR is domiciled), can explain why 3G’s ownership is in the form of “Partnership Exchangeable Units”. There must be an advantage for 3G, unlikely to help common shareholders, or this structure wouldn’t be in place. Whether this issue is material or not, full transparency is always a positive. As Ronald Reagan put it: “TBV”  😊

Roger Lipton

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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 ’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.


Restaurant Brands (QSR), one of the highest visibility “asset light”, “free cash flow” multi-brand franchisors, with Tim Horton’s, Burger King, and Popeye’s, and they reported their ’18 yearend result this morning. We have written many times on this situation, which readers can access through the “Search” function on our home page. With that background, the highlights of the fourth quarter report follow. Readers should know that the fourth quarter sales were reported in mid-January, and QSR 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 Q4 and calendar ’18 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 described 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 was 2.1% and 2.1% respectively. Burger King was 6.1% and 6.1%, Popeye’s was 7.3% and 7.3%.

The reported GAAP (remember General Accepted Accounting Principles?) earnings per share are a bit confusing because of a change in accounting “Standards”. In Q4, Diluted EPS was $0.64 (New Standard) and $0.68 (Previous Standard) vs. $1.59 (Previous). The twelve months were $2.42 (New) and $2.49 (Previous) vs $2.54 (Previous). Setting aside the Q4 quarterly adjusted large fluctuation, the year, 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, and adjusted EPS was provided as well.

Tim Horton’s had adjusted EBITDA, in Q4 of $297M (New Standard) and $295M (Previous Standard) vs. $304M (Previous). That’s down. For the year, TH had segment EBITDA of $1,127M (New) and $1,128 (Previous) vs $1,136M (Previous). That’s down. Burger King, in Q4 had adjusted EBITDA of $247M (New) and $265M (Previous) vs $265M (Previous). That’s flat to down. For the year, BK had $928M (New) and $950M (Previous) vs $903M (Previous). That’s up 2.7% and 5.2% respectively. Popeye’s, for Q4, had adjusted EBITDA of $37M (New) and $42M (Previous) vs. $37M (Previous). That’s flat to down. For the year, Popeye’s had adjusted EBITDA of $157M (New) and $169M (Previous) vs. $107M (Previous). That’s up sharply, 47-58%, but we will come back to this, in the next paragraph. Adding up the segment EBITDA, total Q4 was $581 (New) and $602M (Previous) vs. $606M (Previous). That’s down. Total calendar adjusted EBITDA was $2,212M (New) and $2,247 (Previous) vs $2,146 (Previous). That’s up 3.0-4.7%.

However, in a note following the segment breakdown, the company says “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-$62M apparent increase in PLKI’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.

Moving on, net unit growth is steady, most importantly at Burger King, their most well established worldwide brand, with 17,796 locations, up 6.1% in ‘18. 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 ‘18, on a base 4,846 restaurants, 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 ’18 vs. ’17. Various questioners seemed skeptical, citing wage increases as a continuing burden. Since comp sales are up 2.0% 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 2.1B. However, the free cash flow of $1.1B was a lot less, after dividends and $550M of repurchased exchange units from their 3G affiliate. Furthermore, there has yet to be any “delevering”, since net debt is still $11.8B, virtually unchanged from a year earlier, still at a year end high after calendar ’17 capital allocations to dividends, another $500M plus repurchase from 3G, and redeeming Warren Buffet’s $3B of preferred stock.

CONCLUSION: Provided at the beginning of this article

Roger Lipton

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The long term investment appeal of well established franchising companies is accepted by the investment community. Most of the prominent franchisors’ equities sell at price to trailing twelve month EBITDA multiples in the mid to high teens (Denny’s (DENN), Dine Brands (DIN), Dunkin’ Brands (DNKN), Pollo Loco (LOCO), McDonald’s (MCD), Restaurant Brands (QSR), Wendy’s (WEN), even higher in a couple of instances Domino’s (DPZ), Shake Shack (SHAK), Wingstop (WING), lower in a number of “challenged” situations like Jack in the Box (JACK), Red Robin (RRGB), Brinker (EAT), Fiesta Rest. (FRGI).

The attraction of asset light franchisors revolves around the presumably free cash flow for franchisors, a steady stream of royalty income unburdened by capital expenditures to build stores. The operating leverage is at the store level.  Franchisees are responsible for building the stores, then controlling food costs, labor, rent and all the other operating line items. Franchisors receive the royalty stream and have the obligation of supporting the system with brand development, site selection advice, marketing support, and operating supervision. These supporting functions, it should be noted, are optional to a degree, and we have written extensively about system support sometimes being short changed by corporate priorities such as major stock buybacks.


We acknowledge that in every franchise system there will be some operators less satisfied than others. In the same way, customer reviews on Yelp or Facebook are more frequently written by critics. Bad news is more noteworthy and more customers are inclined to criticize than applaud, so we have to listen to the complaints but dig further for the reality. With that in mind, we hear the following from franchisees of various restaurant systems:

“I’ve been in this business for thirty years, and I’ve never seen it this bad. Everyone is making money but me; the landlords, the franchisor, the banks. My margins have been killed, and I’m up against my lending convenants”.

“All the franchisors want to do is build sales to build their royalties. The dollar deals are trading people down. My franchisor doesn’t care about my margins. I can’t maintain my margins, especially with the increasing cost of labor, let alone build it”.

“The franchisor is putting pressure on me to sell, even though I’ve always been considered a good operator, with high performance scores. I’m up to date on my development agreement, but they want somebody else to take me out, and the new buyer will agree to what I consider to be a ridiculously aggressive development contract”.

“The franchisor has replaced experienced long term field support with lower priced (and inexperienced) younger people. They’re cutting corporate overhead, but these kids, who never ran a store, are telling me to how to control costs.””

“I’m doing my best with the development objectives, but it is almost impossible to build stores with today’s economics. Rents are too high, labor costs are killing me, and I can’t raise prices in this promotional environment”.

“As if things aren’t tough enough, I’m being nickeled and dimed with demand for higher advertising contributions and fees on services (including software) that I thought would be provided”.

The valuations provided to the publicly held companies do not reflect the situation as described by the admittedly anonymous franchisees. The commentators quoted above don’t want to aggravate their franchisor, and we don’t want to be unfair or misleading to particular companies by relying on just a few conversations, though they do support one another. For the most part, franchisees are strongly discouraged from talking to the press or investment community. The companies will say that “competitive” issues require some secrecy, but there are few secrets in this industry.

The optimistic view, as represented by the valuations in the marketplace, is that the comments above are not typical or representative of the health of the subject franchise systems. Allow me to provide a short story which leads to a suggestion.


Twenty six years ago, in 1992, IHOP had just come public. I was a sell side analyst, thought the numbers were interesting and the stock was reasonably priced. The company, led by the now deceased CEO Kim Herzer, invited me to attend their franchisee convention, which I did. I obviously had the opportunity to interface with many franchisees and it was clear that, while all was not perfect, the franchisor was providing a great deal of support that was embraced by an enthusiastic franchise community. IHOP stock tripled over several years for me and my clients who owned millions of shares. I attended several more of their annual conventions and maintain some of those relationships to this day. Obviously, the conviction I gained from their open attitude was critical to the success of the investment. I should add, that many of those buyers in 1992 owned the stock for many years, not living and dying on quarterly reports.


As you are no doubt by now anticipating, my suggestion to publicly held franchising companies: open up your franchisee conventions to the investment community. The companies may quickly respond that lenders are already invited to franchise conventions, but franchisees are unlikely to express their system oriented concerns when they are making a pitch to a potential lender. Companies may also respond that their lawyers think it would be a bad idea, not consistent with full disclosure and analysts would be getting “inside information”. Let’s not allow the lawyers to provide “cover”. A good lawyer will provide a solution to the problem, not just provide the pitfalls. Analysts attending a franchise convention are not being told what sales or profits are going to be. Attending a franchise convention is  a “channel check”, no more than talking to a supplier or customer of a manufacturing company, which any decent analyst will do.

The anecdotal critical comments, as described above, have likely been heard by others, but may be atypical of most restaurant franchising companies. There are no secrets in this business. One of the investment appeals of this industry is its transparency. Notable news is going to leak out anyway. The objective of any publicly held company is to build stock ownership by well informed investors. Investment analysts pride themselves on their ability to “build a mosaic”, enhance the information provided in quarterly reports, SEC filings, and conference calls, with “channel checks”. What channel check would be more pertinent than meeting the franchisees of a company that is dependent on franchisee success? Putting it another way, and taking the highest valuation relative to EBITDA as an example: Wingstop (WING) is a company I have the highest regard for. However, you could call it irresponsible to pay almost fifty times trailing EBITDA for Wingstop stock (and I haven’t) if I couldn’t talk to franchisees of my own choosing?

There’s no particular need to invite this writer if I’m not considered influential enough. I have not spoken to these analysts on this subject, but qualified industry followers such as David Palmer, Nicole Reagan, Matt DiFrisco, David Tarantino, Jeff Bernstein, Andy Barish, Bob Derrington, Mark Kalinowski, Michal Halen, Gary Occhiogrosso, Howard Penney, Jonathan Maze, Nicholas Upton, John Hamburger and John Gordon provide the beginning of an invitation list.  I rest my case.

Roger Lipton

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We wrote an article on October 11th, discussing the three major positions in Bill Ackman’s Pershing Square Capital portfolio, within our knowledge base, that comprise a massive 41% of his $8.3 billion portfolio.

At the close of business, October 11th, Restaurant Brands (QSR) was $56.26, Chipotle (CMG) was $434.06, and Starbucks (SBUX) was $54.87. Our conclusion on October 11th was that he should switch his QSR immediately into McDonald’s (then at $163.98), sell his CMG to take advantage of the huge move since new management has been installed, and hold his SBUX (which has moved up nicely).

We have no reason to think that he has made any moves in the last several weeks, but Restaurant Brands, McDonald’s and Chipotle have all reported third quarter results. Starbucks reports tonight.

From the close of business October 11th to last night’s closing price, Restaurant Brands, at 53.06 was down 5.7%, or $85M on the $1.5B position. McDonald’s, at $178.42 was up 8.8%, so would have made Ackman’s Pershing Square Capital a profit of $132M. Chipotle closed at $465 so Ackman would have foregone a profit of 7.1% or $63M on his $900M investment.

Our advice, less than three weeks ago, to Ackman can definitely be considered “theoretical” in terms of the practical ability to switch $1.5B positions instantly, or sell $900M worth of Chipotle on the spur of the moment, and Ackman’s positions are established on the basis of long term prospects. Acknowledging that three weeks doesn’t “make a season” or prove a thesis, Ackman’s portfolio would be ($132M+85M-$63M) a cool $154M better off, or 4.5% of the $3.4B in these three positions, especially costly when all hedge fund managers are fighting for every basis point in a difficult market environment.

Our points here are (1) too many multi-billion hedge funds, and other institutions are playing hunches rather than making well informed long term judgements. This is a function of not enough really attractive reward/risk investment propositions when trillions of dollars of capital are competing to generate “alpha” after nine years of a bull market (2) there is too much emphasis on short term performance, trying to “game” the monthly comps for example,  rather than evaluate long term strategic positioning (3) in too many cases, the self confidence of multi-billion dollar money managers is unjustified. They are very smart, hard working, in many cases have become very rich (which breeds inflated egos), and can’t be expected to know as much they should about every industry. Rather than make Bill Ackman an undeserved particular example: Eddie Lampert, still a billionaire, had no chance whatsoever to turn around Sears based on his strategies, and there were lots of highly experienced retailers that could have told him so. It has taken ten years to play out, but it was clear to many of us years ago that the brilliant and successful Lampert was wasting enormous time and money on Sears.

If we were speaking with Ackman today, we would suggest that it’s not too late to adjust the portfolio. The last three weeks are history.  Let’s see what happens over the longer term.

Roger Lipton

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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.

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This morning’s release by Restaurant Brands International relating to initiatives at Tim Horton’s, its now admittedly troubled subsidiary that contributes about half of its corporate EBITDA tells us a lot about the prospects for the RBI over the next few years. The now well publicized lawsuits by the franchisees has obviously gotten the attention of their parent company. RBI management acknowledged today that “some things could have been handled better, but management has changed……in an effort to bolster that relationship….and it’s just going to be a matter of time to prove out that this is a new day, and there’s a very sincere interest in working collaboratively with all the franchisees”.

Recall that Tim Horton’s is the largest contributor to RBI’s cash flow and earnings, and the distribution margins, along with G&A efficiencies at TH have been major contributors to the overall corporate progress. To be precise, thecost of sales” at TH distribution has gone from 99.2% in 2014, on a straight line, to 83.3% in 2015 to 78.0% in 2016, 76.6% in 2017, finally up ticking modestly to 77.9% (up 160 bp YTY) in Q1’18. (Might the franchisee complaints have anything to do with the recent uptick?). At the same time, TH segment G&A went from 4.6% in ’14, to 3.2% in 2015, to 2.6% in 2016 with a modest uptick in calendar ’17 to 2.9%. In just the last two years ending 12/31/17: total corporate adjusted EBITDA, grew $480M, up 28.8%. The Tim Horton segment grew $229M, representing 47.7% of the total increase (up 11.8% in ’16, slowed to 5.9% growth in ’17, and decreased 5.0% in Q1’18). Burger King contributed $143.6M of the two-year increase (29.9% of the corporate total) and Popeye’s contributed $106.9M, all of it in ’17.  The improvement in CGS at TH contributed $122M of that. G&A efficiencies at TH contributed another $5.9M.  So the better distribution margin and G&A “efficiencies” accounted for 127.9M or 55.8% of the two year EBITDA improvement at Tim Horton’s.

The first quarter of Q1’18 showed total corporate adjusted EBITDA up by 12.2% or $54.5M. That included an increase of $27.0M at BK, or 14.4%, a contribution of $38.5M from Popeye’s versus nothing a year earlier, and a decrease of $11.0M at TH with non-recurring adjustments (to be discussed later) flowing through TH’s first quarter results.

The lawsuits will be settled at some point, there may or may not be monetary damages applied to QSR, but that will be one time in nature, easy to overlook by investors. Especially in light of the operating initiatives outlined just today, including delivery, advertising of all day breakfast and a new kids menu, roll out of a new loyalty program, profit margins and EBITDA at TH will be very difficult to improve from the current level and could even come down.

Summarizing the entire situation, RBI management is very smart, but they are not magicians. Popeye’s has a great deal of potential, but corporate efficiencies may be more difficult to employ here, especially considering the history at Tim Horton’s and Popeye’s is too small to move the corporate needle by much. Even though Burger King’s contribution could continue to grow at a 15-20% rate (not without their own set of challenges), TH will be hard pressed to grow from here. There is an increasingly aggressive competitor called Starbucks, Dunkin’ Donuts is not going away and McDonald’s does all day breakfast and all three have a head start against the latest programs at Tim Horton’s. We view QSR as an adequately leveraged (and valued) single digit growth company over the next several years.

Company Overview  

Restaurant Brands International was created in December 2014 from the merger of then Burger King Worldwide (BKW) and Tim Hortons International (THI).  Early in 2017, Popeye’s Louisiana Kitchen was added to the portfolio. Headquartered in Oakville, Ontario, the company is now the operator and franchisor of over 24,000 Burger King (BK), Tim Horton (TH), and Popeye’s (PLKI) brand restaurants generating system-wide sales of over $29B in over 100 countries.  All three brands are virtually 100% franchised and are operated as independent segments from their traditional headquarters (BK in Miami, FL, TH in Oakville, Ontario, and Popeye’s in Atlanta, GA.) to preserve their respective heritages.

BK is the second largest burger chain by locations (after McDonald’s), and third largest by sales (after Wendy’s).  The menu features its signature flame-grilled hamburgers, chicken and other specialty sandwiches, french fries, desserts and beverages.  In 2017, the system generated a little over $20B in sales from approximately 16,800 units (about 48% in the US).   The principal sources of the BK segment revenues are franchise royalties (normally 4.5% in the US) and fees, since the chain is nearly 100% franchised.  The remaining revenues derive from the 12% of BK locations leased or subleased to franchisees and from sales at 52 company units. QSR does not discuss the development costs of a new Burger King, but the largest franchisee, Carrols Restaurant Group (TAST) does. As described by TAST in their 10K, the initial cost of franchisee fee, equipment, signage & other interior costs is approximately $400,000. Additionally, their cost of land ranges from $500k to 900k and the cost of building and site improvements generally ranges from $850k to 1,025k. Using the midpoint of these numbers, the total development cost would be $2,037,000 – a fairly high total cost for a unit that averages $1.3 million. In spite of a sales/investment ratio (fully capitalized) well below the long accepted 1:1 objective, the Burger King system continues to thrive.  We attribute TAST operating success and BKs continuing unit development to the fact that many units were built years ago (with lower development costs), the long term operating success of the system that attracts build-to-suit development, and of course the very low interest rate environment of the past decade. It is also worth noting that QSR does not indicate how many units are “traditional” versus “non-traditional” such as kiosks, food courts, etc. We suggest that not too many units in the US in particular, are built from the ground up these days, and fewer still will be built if interest rates rise. Of course, in any event, BKs primary expansion will be overseas from this point forward.

Tim Hortons quick service restaurants have a menu that includes premium blend coffee, tea, espresso-based hot and cold specialty drinks, fresh baked goods, (donuts, cookies, muffins, pastries), grilled paninis, sandwiches, wraps and soups. It generates about $6.7B in system-wide sales from about 4,700 units (about 80% in Canada).  The TH segment generates revenue from sales of supplies and equipment and packaged products to retailers; from property revenues from the 80% of properties leased or subleased to franchisees; from franchise royalties and fees; and from sales at 24 company restaurants.

While BK’s supply operations are largely outsourced to approved third parties (procured in the US by a purchasing entity jointly managed with franchisees), TH operates a significant supply system to procure, store and distribute raw materials, and supplies to most of its Canadian restaurants (US units are supplied by a third-party distributors).  It operates 2 roasting facilities for blending coffee for its Canadian and US restaurants (and retail), and it operates facilities for the manufacture of icings and fills for its products, though all donuts are purchased from a third-party supplier.  TH has a variety of franchise agreements which largely reflect the extent of its ownership interest in franchised locations.  Franchisees who lease land and/or buildings from the company typically pay a royalty rate of 3%-5% plus rent of 8.5% to 10.5% of sales.  Where the premises is owned by the franchisee or is subleased from TH or leased from a third party, the royalty rate is higher; and where the franchisee essentially operates a fully outfitted company property (i.e. includes equipment, signage and trade fixtures), a rate of about 20% covers royalties and rent.

Popeyes Louisiana Kitchen, Inc. (PLKI), QSR’s most recently completed acquisition, develops, operates and franchises over 2,700 quick service restaurants with system-wide sales in 2016 of $3.4B in 48 states, D.C., and 25 foreign countries.  Popeyes specializes in strongly flavored Louisiana-style offerings, particularly chicken, but also fried shrimp, red beans and other regional specialties. PLKI is nearly entirely franchised (98% of system’s units).  The US stores averaged about 2.7k square feet with AUV’s of $1.4M in 2016.  US franchisees generated EBITDAR of $340K on average (23% margin).  From 2008 through 2016, comps averaged 3.2% (though slowing in 2016, and further in 2017), which was the major factor in the 4.9% CAGR in the AUV’s and EBITDAR margin expansion of over 500bps (along with new store performance).  In 2016 revenues were $268.9M ($108.3M company stores, $154.8M from franchise royalties & fees, $5.8M rent from franchised restaurants), EBIT at $74.5M (27.7% margin), EBITDA of $84.6 (31.5% margin) with free cash flow of $56.0M (20.8% margin).  Aside from the strong financial track record, QSR said Popeyes leadership position in the chicken QSR category (26.5% market share in 2016, up from 25.5 in 2015) fits well in its brand portfolio.  Also attractive, obviously is the “asset light” highly franchised structure, with further growth potential, especially overseas.

3G Restaurant Brands Holdings LP (3G RBH), with 43.6% voting rights, provides 3G effective control of QSR.  3G is an international activist fund specializing in consumer brands and a frequent partner with Berkshire Hathaway, which provided $3B to finance the TH acquisition in the form of 9% preferred equity, redeemed in late ‘17.  The 3G playbook is to acquire and fix up mature brands (e.g. Anheuser-Busch InBev SA/NV (Euronext Brussels: ABI) and The Kraft Heinz Co (NYSE: KHC), but unlike most activist investors, 3G is a patient investor, with an investment horizon measured in years.  In order to judge QSR’s future, including incorporation of PLKI, it’s worthwhile to understand 3G’s historical initiatives in turning around BK and TH.

Burger King – For at least a decade before 2010, management and franchisees had been in growing conflict over repeated failures to revive the brand. The conflict peaked with a franchisee lawsuit charging management with driving system sales with promotions (specifically $1 Double Cheeseburgers) that were good for royalties but costly for franchisees.  Into this poisonous atmosphere, 3G stepped up to acquire the company.  The fund, which had been instrumental in assembling global beer behemoth AB InBev, also had established a reputation as a long-term investor that achieved strong returns by turning around flagging brands, often with aggressive cost cutting and management changes.

When 3G acquired the company in October 2010, it promptly installed partners onto the board and inserted itself in operations, staffing key executive positions with partners from a deep bench of proven managers from other investments.  It instituted cost controls centered on zero-based budgeting (every budget item must be justified afresh each year).  It moved quickly to restore trust with the franchisee community by giving them a larger voice in the decision-making process and by making franchisee profitability a top priority. This included simplifying the menu and eliminating money-losing promotions.  To this end, new menu introductions and LTO’s aim more for flavor variations on legacy standards (e.g. “Angry Whopper”) than additions that are more operationally challenging. Management has, however, attempted to fill gaps in the core menu with added or improved items such as salads, chicken strips, beverages and desserts.  These additions aim to broaden brand appeal beyond its traditional young male customer to include women and seniors.  Management also attacked overhead bloat, again using the zero-based budgeting which requires justification of both historical and incremental expenses.  The payoff was a reduction in G&A from $356M in 2010 to about $160M by 2015 and 2016. The dramatic reduction in G&A, while improving profitability at the franchisor level, has not been without controversy, however. Some franchisees feel that support has been compromised along with the reduction of expenditures on behalf of the franchise system. The response of the franchisor has predictably been something like “in every large system some franchisees are happier than others, but our priority continues to be the profitability and financial health of every franchisee”.

Additionally, the company accelerated a refranchising initiative that had been under way, becoming virtually 100% franchised by 2013 (from 89% at acquisition in 2010).   Importantly, the 1,200+ refranchised units were placed with the system’s strongest hands, such as Carrol’s Restaurant Group (NASDAQ: TAST), BK’s largest franchisor and an exceptional operator.  As of year-end 2017, only 26 company stores remained, which the company has intended to retain principally for test purposes.  The new management also launched a store re-imaging initiative of the US and Canadian stores.  The company provides incentives, principally in royalty and advertising fund relief, to accelerate the pace of remodeling.  According to management, the remodels cost about $300K per unit and drive a 10%-14% sales lift.  At the end of 2017, we estimate over 70% of the stores have been remodeled.

Finally, it launched a strong international push, particularly into under-penetrated regions.  In a departure from BK’s traditional franchise agreements, the company aims to accelerate international growth through master franchise joint ventures (MFJVs) and master development agreements with experienced local partners.  The structure of these agreements varies significantly, but in general local partners are granted exclusive regional rights to develop or sub-franchise units.  The partners commit to aggressive development targets and franchisee support. They usually pay discounted upfront fees and royalty rates (vs the usual 5% rate) based on the characteristics of each market.  The partners make substantial upfront equity contributions, while the company usually obtains a meaningful minority stake in the MFJV’s with little or no capital contribution. Of course, this enhanced growth comes with financial and brand risks, principally because the company’s operational control over sub-franchisees is weaker than with direct franchisees.  QSR believes it protects against these risks by entering agreements with experienced, well-capitalized partners supported by strong management teams.

So far, results at Burger King have been impressive. The unit growth rate has more than tripled in the 8 years since the acquisition vs the preceding 6 years—from 1.5% CAGR, to 6.5% unit growth in ’17.  (In validation of the MFJV strategy, the international MFJV’s have generated most of BK’s 3,800+ unit growth since acquisition, notably: Brazil >600 in 2017, up from <150 in 2011, China >650 units in 2017, up from <90 in 2012 and Russia >400 units in 2017, up from <90 in 2012.) There has been an increase over six years in AUV’s from $1M to $1.4M and a 30% increase in profitability (according to management).

Tim Hortons  At the time of the December 2014 merger, the TH brand did have its challenges, but overall performance was strong.  In the five years before the merger system units grew at a 5% annual pace, while quarterly same store sales (20Q’s) averaged 3.1% in Canada and 4.1% in the US, turning negative only once, in Q1’13, and then only modestly (-0.3% Can & -0.5% US).  Meanwhile, operating margins were consistently around 20% and free cash flows averaged around $300M, with average FCF margins ~11.0%.   The company’s challenges were (and are) to protect the brand’s Canadian dominance (>40% traffic share), particularly from the encroachments of SBUX, to expand in the US where it has struggled to gain critical mass, and to exploit the large untapped opportunity it sees on other continents (~1% system units are located outside North America).  In Canada, management’s principal focus is on solidifying its lunch and breakfast dayparts and improving its coffee business.  In the US it closed 27 underperforming stores in New York and Maine during 2017, to concentrate instead on building density in priority markets in the Midwest.  To that end, it has signed development area agreements with partners in the Cincinnati and Columbus, Ohio DMAs and the state of Minnesota.  Internationally, it also concluded MFJV agreements with partners in Mexico, Great Britain and the Philippines.

The company has focused on G&A which, at $78.9M, was down 15.4% in 2016 over 2015, the first full year of operation under new management, then rose back to $91.0M in 2017.  (The reductions may be more significant when compared with the pre-acquisition G&A levels, > $150M USD, but it isn’t clear this is an apples-to-apples comparison.)  While TH’s capital-intensive supply chain operations seem ripe for management overhaul, nothing on that front has been reported yet.  While management disclosed that though it will be maintaining capital incentives to remodel stores, which it deems an important priority, it seems this is aimed more at the smaller franchisees.  Separately it has announced it will be reducing capital support for new stores, principally the leased and subleased locations.  This shift to a more asset-light corporate structure is consistent with its strategy for seeking out larger, well-capitalized MFJV partners to drive growth.

As of the end of 2017, with only 3 full years of TH ownership under its belt, the results were promising, but have proved to be controversial. This “progress” at the franchisor level has apparently not been shared at the franchisee level, at least as described in a number of lawsuits filed by something like half of the Canadian franchisee base, and US franchisees as well. They claim that, while their sales progress has stalled, QSR has raised the price of supplies and food, contracting franchise margins further. Additionally, the franchisee lawsuit claims that advertising contributions have been “misallocated” somehow to reduce corporate overhead. Since most of the improvement from 2015 through 2017 within the TH operating results came from “distribution” and to some lesser extent G&A efficiencies, the strained relationship with franchisees is obviously a material development. While management may claim that they went through similar “growing pains” after acquiring Burger King, there was not a similar distribution segment, and BK has built sales more successfully than TH, which takes the sting out of higher costs. As strong as MCD has been vs. BK, SBUX is an even more powerful dominant competitor in the coffee segment.

Restaurant Brands International Consolidated On a consolidated basis, QSR’s EBIT in 2016, at $1.666.7M was up about 90% over a pro-forma $875.6M USD for 2014 (i.e. assuming TH was owned the entire year), driving 1,950bps of operating margin expansion to 40.2% from 20.7%. Calendar year 2017 showed a further increase of 4.1% to $1.735M.

As a result of its acquisition strategy, QSR is leveraged at the top of the range for peer “pure play” franchisors. Total net debt at 3/31/17 of $11.4B was about 5.1X adjusted TTM EBITDA of $2.25M versus 4-5X more typically for its franchising peers. The current dividend, yielding 2.86% requires over $500M of the free cash flow and management has allocated C700M over the next four years to help TH franchisees with re-imaging stores.

QSR: Current Developments – Per Q1’18 Corporate Release and Conference Call

“Adjusted Diluted” earnings, on a “New Standard” were $0.66 vs. $0.67 a year earlier, which is the number that seems to be carried by analysts and the reporting services. GAAP earnings, reported on a “Previous Standard” were $0.66 vs $0.36. The difference in “Standards” relate (among other things) to franchise agreement amortization, amortization of deferred financing costs and debt issuance costs, reflection of advertising fund contributions and expenses, supply chain related revenues at TH, and foreign exchange impact. Forgive us for presenting these technical features of the reporting approach, but this is an unusually complex financial structure, obviously requiring these various methods of disclosure.

In any event, the “organic” EBITDA for Q1’18 was up 5.0%, including Popeye’s, driven primarily by an increase in revenues at BK and PLK, partially offset by a decrease in supply chain related revenues at TH. A breakdown of Adjusted EBITDA by Segment is roughly as follows: Tim Horton’s was down 4.3% to $250M, Burger King was up 14.4% to $215M and Popeye’s was up $80% to $40M.  We’ve “mixed and matched” these numbers between the “adjusted New and Previous Standards”, but, in spite of the reporting complexity, we have confidence that the direction and order of magnitude is indicative of the operating trends. More simplistically, comps were down 0.3% at TH, up 3.8% at BK, and up 3.2% at PLK. Systemwide sales growth was up 2.1% at TH, up 11.3% at BK and up 10.9% at PLK.

Per the conference call: Tim Horton’s reported flat sales in Canada and softness in the US. Early in the call, management addressed the tension in the TH franchise system, describing the press as mischaracterizing RBI intentions, citing inaccurate information that “usually reflect a purposely negative tone dictated by a group of dissident franchisees”. Changes have been made in communication strategy, both with the press and the franchisees, which will presumably bear fruit over time. First quarter sales at TH reflected softness in coffee sales, partially offset by breakfast foods. The results of some new lunch products are encouraging.  A new Brand President at TH, Alex Macedo, previously President of Burger King, North America, is leading the effort. A “Winning Together” plan has been put in place, based on restaurant experience, product excellence and brand communications. A new TH restaurant design, called the Welcome Image has been put in place at 10 locations, with an encouraging customer response. Management “admittedly should have done more of this in the past……we are confident that this plan will help us achieve long term sustainable comparable sales growth for TIMs.”

We won’t dwell here on the Burger King discussion. Delivery and technology applications are among the current programs. Suffice to say that results within this segment continue to be fine and the positive prospects are undiminished.

Popeye’s is focusing on delivery and technology as well, and international franchising is a major focus, Brazil being the first master agreement. With EBITDA of $40M in Q1’18 out of close to $500M for RBI in total, substantial improvement within this segment will not affect short to intermediate term overall results in a major way.

The single largest “elephant in the room”, supply chain margins at TH, was addressed when the question was asked relative to the Q1’18 decline at TH in supply chain revenues. Management responded that “we passed on some supply chain savings to our franchisees through a reduction in pricing in the second half of last year. We continued to maintain this pricing for franchisees, so margins in the first quarter of 2018 are relatively consistent sequentially with the margins from the second half of last year. Looking ahead…. we expect the organic growth profile at TIM’s to improve throughout the year.” Maybe.

Our conclusion regarding the prospects for QSR is provided at the beginning of this article.



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RESTAURANT BRANDS, INC. (QSR) – A Great Number of Moving Parts, Financial, Legal, Operationally

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  • Broad economic insight. As described in “Restaurants/Retail – Why Bother?” the restaurant and retail industries provide a leading indicator of far broader economic trends. You no longer have to be the last to know.
  • Two to three analytical pieces per week (“Roger’s Rap”) personally written by Roger Lipton describing corporate developments within his industry specialization, including their relevance to the broader economy.
  • Periodic “macro” discussions personally written by Roger Lipton, analyzing fiscal and monetary matters that will likely affect your investments and your business.
  • Opportunity to “Ask Rog” about your personal concerns, regarding individual companies or broader economic trends. Roger will use his best efforts to answer questions submitted, obviously limited by the number of requests . He may answer your question by email directly and/or include your question with his “Roger’s Rap” releases.
  • You are provided access to “Friends of Rog”, depending on your financial and operational needs. The outstanding individuals suggested here, have been personally “vetted” by Roger over decades. Roger receives no compensation based on whether or not use their services.
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RESTAURANT BRANDS INTERNATIONAL – WRITEUP – click above at “publicly held companies”

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  • Broad economic insight. As described in “Restaurants/Retail – Why Bother?” the restaurant and retail industries provide a leading indicator of far broader economic trends. You no longer have to be the last to know.
  • Two to three analytical pieces per week (“Roger’s Rap”) personally written by Roger Lipton describing corporate developments within his industry specialization, including their relevance to the broader economy.
  • Periodic “macro” discussions personally written by Roger Lipton, analyzing fiscal and monetary matters that will likely affect your investments and your business.
  • Opportunity to “Ask Rog” about your personal concerns, regarding individual companies or broader economic trends. Roger will use his best efforts to answer questions submitted, obviously limited by the number of requests . He may answer your question by email directly and/or include your question with his “Roger’s Rap” releases.
  • You are provided access to “Friends of Rog”, depending on your financial and operational needs. The outstanding individuals suggested here, have been personally “vetted” by Roger over decades. Roger receives no compensation based on whether or not use their services.
  • A free copy of the legendary best selling book, How you can Profit from the coming devaluation, as shown at right, written in 1970 by Harry Browne, which predicted the 2000% rise in the price of gold. This profound piece is more relevant today than ever, so Roger re-published it in 2012. This book will help you preserve the fortune you are in the process of accumulating.


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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.


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