RESTAURANT BRANDS MEETS ESTIMATES IN Q3 – STOCK DOWN OVER 3%, HOW COME?

CONCLUSION

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.

COMMENTARY ON THIRD QUARTER

Restaurant Brands, INC. (QSR) – franchisor of Tim Horton’s, Burger King and Popeye’s reported their third quarter this morning, and bottom line results largely met analyst expectations. Adjusted net income was up 13.4%, Adjusted Diluted Earnings Per Share was up 14.2%. Since QSR is considered a “free cash flow” and “asset light” story, EBITDA is a major concern and Adjusted EBITDA was up a more modest 5.4%.

By segment, and by size:

Tim Horton comps were down 1.4%, unit growth was 1.7%, Adjusted EBITDA was up 0.6%.

Burger King had 4.8% comp growth (with the Impossible Burger rollout), unit growth of 5.8%, and Adjusted EBITDA growth of 10.0%.

Popeye’s had comp growth of 9.7% (with the success of their chicken sandwich), unit growth of 5.6% and Adjusted EBITDA growth of 14.6%.

THE MOST IMPORTANT DETAILS

We won’t detail here the various operating initiatives, other than reflect on the most important investor (and management) concerns, in order of magnitude.

Tim Horton is the largest division, by EBITDA measure, with $301M generated by this segment in the third quarter (up from $299M). Sales continue to be lackluster, comps down 1.4%, traffic (though not disclosed) likely down more than that. Management outlined a variety of initiatives, including a new brewing platform, new cold beverages, ongoing emphasis on digital and loyalty, etc.etc. The troubled franchisee relationship is supposedly repaired. Analysts, as evidenced by questions on the conference call,  are apparently losing patience, and confidence, in the timing of the improvement at Tim’s. In the words of one analyst, Tim’s sales “have been slack for the last three years”. We have been cynical for some time about the likelihood of near term improvement, and remain so. Recall that a large part of the EBITDA improvement (corporate wide) after QSR bought this chain was from higher ingredient prices charged to franchisees and that “low hanging fruit” has been picked. Since that portion of the QSR financial magic no doubt helped to create lawsuits involving over half of the Tim’s franchisee system, it is safe to say that future price increases will be more measured, segment EBITDA improvement will have to come from sales improvement and unit growth, both of which have been tepid. We continue to feel that this division’s EBITDA growth will be modest, at best.

Burger King has been the major star in the QSR universe, continuing to generate solid comps and unit growth, especially overseas.  Segment EBITDA was $254M, up from $231M. Q3 included the systemwide introduction of the Impossible Whopper. As we suspected, this introduction didn’t come anywhere close to the 17% sales increase in the test market. While the 5% US comp (4.8% systemwide) was the best since 2015, it was only a couple of points better (as we suspected) than it had been running. We would like to know what was the trend of Impossible Whopper sales, intra-quarter, and David Tarantino of Baird asked the question on the conference call. The answer was….”we saw really good performance….essentially in line with what we expected…..lot of traffic and trial that came from new guests….the feedback was really positive…we don’t discuss specific performance and details over the quarter beyond, but we continue to see good performance….and we’re excited about it being a long term platform for the business….” We have written that the “meatless” products will fade from prominence over time. The size of the potential market for folks that will pay a premium for a product that costs more, tastes no better, has roughly the same calorie and fat content, has no cholesterol but five times as much sodium has yet to be defined. As you can tell, we think the market is likely smaller than currently thought, and negative publicity regarding the “processing” of these products is starting to develop. However, Burger King, within Restaurant Brands’ portfolio, continues to be a growth vehicle. We believe that the 10% segment EBITDA growth in Q3 is the order of magnitude of growth that is most likely in the foreseeable future.

Popeye’s Louisiana Kitchen had a solid quarter. Unit growth was 5.6% and the comp was 9.7%. Popeye’s is by far the smallest division, with segment adjusted EBITDA contribution of $47M, up 14.6%. The highly publicized (much of it free) very successful chicken sandwich was an important contributor, and is about to be relaunched. Popeye’s has great potential for growth, both in the US and abroad, and will add to the overall corporate growth rate. It is worth noting that the 14.6% segment EBITDA growth was almost exactly the growth in system sales. There is so far no “leverage” of G&A, even with substantial growth in units and comps. Restaurant Brands managed to leverage G&A very quickly after acquiring Burger King and Horton’s, not the case so far at Popeye’s.

THE FREE CASH FLOW STORY

This portfolio of brands is generating something over $2B of “free cash flow” annually. Of course, with $12.8 Billion of debt, $11.0 Billion net of cash, the lenders, still accommodating QSR as they reach for yield in a zero interest rate environment, might not always consider the bottom line as quite “free cash”. The net debt, which has not been reduced in recent years, compared to Adjusted Free Cash Flow is quoted as 4.8x, not so very high in this zero interest rate environment, but the lion’s share of cash generation after dividends has been used to buy back exchange units from Brazilian based 3G, still the controlling owner of QSR. “Returning cash to shareholders”, through dividends and stock buybacks, is the oft quoted phrase by CFOs. In this case, the “return to shareholders” mostly applies to 3G.

CONCLUSION – Provided at the beginning of this article

Roger Lipton