Tag Archives: RESTAURANT BRANDS

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

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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

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RESTAURANT BRANDS (QSR), TEXAS ROADHOUSE (TXRH), BRINKER, INT’L (EAT) REPORT RESULTS — ALL THREE STOCKS ARE DOWN — WHAT’S GOING ON?

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RESTAURANT BRANDS (QSR), TEXAS ROADHOUSE (TXRH), BRINKER INT’L (EAT) REPORT RESULTS — ALL THREE STOCKS ARE DOWN — WHAT’S GOING ON?

Well regarded pure franchising Restaurant Brands, QSR, Best of Breed company operator, Texas Roadhouse, TXRH, mature professionally managed multi-chain company operator/franchisor, Brinker, Int’l.,(EAT) all reported their March quarters within the last 36 hours. What can we learn?

Before we start, because the news is not great and I recently seem to be consistently pessimistic (I would say “realistic”), you should know that I am not “talking my book”. I am neither long nor short two of the three companies discussed, and have a very modest short position in only one of them (which shall go nameless). All three stocks are down since they reported, QSR and EAT more modestly than TXRH, which is down about 10% this morning.

We are not going to provide extensive details, which you can read about elsewhere and which we will discuss in our full writeups to be posted within the next couple of weeks. We will provide just the pertinent highlights as we see them, and our conclusion.

Restaurant Brands (QSR), franchisor of Tim Horton’s, Burger King and Popeye’s, reported EPS down YTY, because of a higher tax rate. Actual Income Before Taxes was up, $302M versus $281M, but it should be noted that Other “Income” this year of $17M was $30M better than Other “Loss” a year ago of $13M. Let’s call it “flat” pretax income, by our simple adjustments. Everybody looks at comps and EBITDA by division here. Tim Horton’s delivered a negative comp of 0.6% in Q1, on top of a negative 0.3% in 2018. Price changes are not discussed relative to any of QSR’s three brands, so we can’t comment on traffic. Adjusted EBITDA at Tim Horton’s was $237M, down from $245M. Burger King had systemwide comps of 2.2% on top of 3.8% in ’18. BK’s Adjusted EBITDA was $222M vs. $214M in ’18. Popeye’s had a comp of 0.6% versus 3.2% in ’18. Adjusted EBITDA was $41M vs. $39M in ’18. The three brands, therefore, had total Adjusted EBITDA of $500M vs $498M a year earlier. Let’s call the results flat, and the bottom line is that, as we have predicted for some time, it will be very difficult to grow the EBITDA and EPS comparisons by more than mid single digits. Combining the “hard” results with the conference call commentary, there is very little happening that will accelerate the cash flow and earnings progress. Readers can refer to our previous commentary regarding QSR, , but, suffice to say: Tim Horton EBITDA growth, which grew from 2015 through 2017 largely by price increases imposed on the distribution chain, is not going to recur, especially in light of the lawsuits by franchisees. Burger King is a steady grower, especially overseas, but the G&A magic has already been imposed on this system so the easy money has been made. Popeye’s is the most rapid growth division, but is too small to move the total needle by much. The dividend of almost 4% supports the stock price, but it has seemed to us for a while that this “mid-single digit” grower is fully priced at 20x trailing EBITDA and 25x forward EPS. It should also be noted that much of the “free cash flow” has been used to buy back partnership interests from their parent, 3G, so this “return to shareholders” has primarily benefited 3G. From 12/31/16 to 12/31/18 the average weighted fully diluted shares outstanding has gone from 470M to 477M to 473M. There is substantial cash flow here, but a great deal of it has been used to buy back exchangeable Partnership interests from 3G. The long term debt was constant at $11.8B in ’18 over ’17 (after $3B was borrowed to buy back Berkshire’s Preferred), and “free cash flow” is not so “free” when debt is over five times trailing EBITDA. The Board of Directors preferred in ’18 to buy back stock from 3G (at 25x expected earnings and 20x trailing EBITDA) rather than reduce the debt. We agree that it seems sensible, from 3G’s standpoint, to lighten up. To be sure, there is a substantial dividend for common shareholders.

Texas Roadhouse (TXRH) is a simpler story. They are truly one of the premier operators in the full service casual dining space, consistently delivering same store sales growth as well as traffic gains. The most recent quarter was no exception, with an admirable comp of 5.2%, including 2.6% traffic. The monthly comps, though decelerating through the quarter were fine, up 7.2%, 4.7%, and 4% in January, Feb., and March. April to date is up 2.9% on top of 8.5% a year earlier. However: Income from Operations was down 6.8%, and diluted EPS was $.70 vs $.76. Restaurant margin (EBITDA) was down 128 bp to 17.9%, and the problem was labor, which cost 118 bp. The discouraging part for investors and analysts is that the Company has predicted ongoing wage pressure, and these guys are not about to disappoint customers by cutting labor.  An additional concern, though a lot smaller, is expected commodity inflation of 1-2% for all of ’19. There’s a lot more that could be detailed here, but the results at TXRH demonstrates what we’ve been saying for a while, that it takes more than even 3-4% comps (and now 5.2%) to leverage the higher costs of operations, labor in particular. We don’t know to what extent the Street will lower expectations for ’19 but at $54.37 at the moment (24.7x ’18 EPS) doesn’t seem like a bargain when it is hard to know when EPS growth will resume. FWIW, $54.37 is 14.5x Bloomberg’s estimate of TTM EBITDA.

Brinker International (EAT) reported Q3 (ending March) with somewhat of a “mixed bag”. The headline indicated that EPS, excluding special items, was up 16.7% to $1.26 vs $1.08. Comp sales for Chili’s was up 2.9% (company) and 2.0% (franchised). Maggiano’s was up 0.4%. Operating Income was 8.4% of Revenues, down 50 bp from 8.9%. Restaurant margin (EBITDA) was 14.3%, down from 16.1% but, excluding the effect of a sale-leaseback transaction, would have been flat YTY. (However, the higher rent is a cash charge vs. depreciation which is non-cash, so the true cash EBITDA margin was truly 180 bp lower). Chili’s results are the main driver of results, and, aside from the sale-leaseback penalty, it was pointed out that: “cost of sales increased due to unfavorable  menu mix, and commodity pricing, partially offset by menu pricing, also partially offset by a decrease in restaurant labor from lower incentive compensation, which in turn was partially offset by higher wages.” So: CGS was up, wages were up, restaurant labor (hours?) was down, and there was less incentive compensation. That doesn’t sound like the industry wide wage increase is abating, and commodity costs are up, which we also heard at Texas Roadhouse. While it is admirable that comps were up again at Chili’s, with traffic up as well, it should be noted that the gain in after tax EPS was entirely due to a lower tax rate and far fewer shares outstanding. Income Before Taxes was $55.5M, down from $58.9M. Adjusted for an Other Gain of $3.5M this year versus a $2.7M loss, the comparison would be $52.0M of Adjusted Pretax Operating Income vs. $61.6M. The number of fully diluted shares was 38.1M vs. 46.0M. From a financial engineering standpoint, EAT chose to do a sale-leaseback transaction, paying higher “rent” vs. non-cash depreciation of the stores in return for retiring a large number of shares. From an operating standpoint, even with flat EBITDA at the store level, we see that same store sales (and traffic) gains of 2 or 3% are not sufficient to overcome higher labor (and other) expenses.

The Bottom Line:

The above capsulized reports show that the operating challenges have not abated, and will not likely relent in the foreseeable future. Restaurant Brands’ results show how ten years of low interest rates have allowed financially astute executives to assemble a portfolio of franchised brands, but mature (Tim Horton’s and Burger King) chains can only be financially engineered to a certain point, especially in a difficult environment. Texas Roadhouse and Brinker results show how operators ranging from a Best of Breed growth company  to relatively mature brands are similarly challenged.

Broader than the Restaurant Industry: There are something like 20M individuals employed in the hospitality industries, including restaurants, retail and lodging and this is a material portion of the entire US workforce. The wage increases that are so evident to us will inevitably start to affect the national averages, and the next step will be price increases. Operators of restaurants and retail stores and lodging will not allow their margins to deteriorate indefinitely. All those surcharges such as baggage fees at airlines, “facility” charges at hotels, and miscellaneous add-ons with car rentals (that add 25-30% to the quote), will increasingly be joined by higher menu prices. It’s not a question of “if”, rather “when”.

Roger Lipton

 

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RESTAURANT BRANDS REPORTS Q4 – BEATS BY $.01 “ADJUSTED” – THE DEVIL IS IN THE DETAILS

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RESTAURANT BRANDS REPORTS FOURTH QUARTER RESULTS – BEATS BY $.01 “ADJUSTED” – THE DEVIL IS IN THE DETAILS

CONCLUSION:

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.

THE RESULTS:

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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BILL ACKMAN, WITH 41% OF ASSETS IN QSR, CMG AND SBUX COMBINED, IS STILL NOT WELL POSITIONED

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BILL ACKMAN, WITH 41% OF ASSETS IN QSR, CMG & SBUX COMBINED, IS STILL NOT WELL POSITIONED

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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BILL ACKMAN BETS $1 BILLION ON STARBUCKS – SHOULD YOU FOLLOW HIM?

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BILL ACKMAN BETS $1 BILLION ON STARBUCKS – SHOULD YOU FOLLOW HIM?

Bill Ackman’s Pershing Square Management (now managing about $8.3 billion), announced on Tuesday a new billion dollar holding in Starbucks. Typical of his disclosure of major new positions, he made a lengthy presentation at an investment conference. We will get to a discussion of his rationale regarding SBUX, but we’ve followed Ackman’s career, since we’re in the same business (on a much, much smaller scale), and a few highlights will likely be of interest to our readers.

His long term record is outstanding. According to Pershing Square’s website, since inception in 2004 through calendar ’17, the compound annual return, after fees, has been 13.6%, versus 8.7% for the S&P 500 index.  However, the really great years were the early ones, when returns from 2004 through 2007 were  up 42.6%, 39.9%, 22.5% and 22.0% respectively. The year’s 2007 through 2014 were still good, though not as spectacularly consistent,  down 13.3%, up 40.6% (must have been short in 2008), up 29.7%, down 1.1%, up 13.3%, up 9.7%, up 36.9%. The last four years, from 2015 through 2018 have been disappointing, down 16.2%, down 9.6%, down  1.6% and up something like 10% YTD in ’18.

Ackman has made some spectacularly big gains, since he makes big bets, and has had equally impressive losses. Among his largest gains have been MBIA, General Growth Properties, Platform Specialties, and Restaurant Brands (which is an outgrowth of his holdings in Burger King and Tim Horton’s, which merged). His losses have included JC Penney, Target and Valeant. He become a household name with a well publicized short position in Herbalife a few years ago, and finally exited the position after an extensive and expensive campaign to put the company out of business.  Ackman’s brilliance and tenacity are unquestioned. One could question, however, whether any money manager has the right to personally decide whether a company deserves to be in business. It’s one thing to announce a short position. It’s another to take it upon yourself to contact bankers and employees and anyone else you can find (in the case of Herbalife: their sales network) in an effort to discredit the organization.

Which brings us to Ackman’s current large bets within the universe that we know pretty well, namely his positions in Restaurant Brands (QSR), Chipotle (CMG), and, most lately, Starbucks (SBUX). His $8.3 billion portfolio is down quite a bit from $18.3 billion in 2015, no doubt due to his lackluster performance lately. His CMG is worth about $900M, his SBUX is worth about $1 billion, and his QSR is worth about $1.5 billion. These three positions, therefore, represent a total of about 41% of his $8.3 billion portfolio.

In summary, we don’t think this major portion of his portfolio will outperform the general market, or even the restaurant industry in general.

Regarding Restaurant Brands (QSR), by far the largest of the three positions: We’ve written extensively, which readers can access through our Home Page. In a nutshell, the stock is more than adequately valued, since the largest contributor to their EBITDA, Tim Horton’s, is a troubled chain, Popeye’s is too small to move the corporate needle much, and Burger King, though it has performed well under QSR’s leadership, continues to operate in a very competitive burger segment. The “low hanging fruit”, that was opportunistically picked by the QSR financial engineers, is gone, so the earnings progress of the past won’t be duplicated from this point forward. We refer readers, again, to our previous more extensive discussions. A heck of a case can be made, in terms of the fundamentals and the relative valuations, that QSR should be switched into MCD immediately.

Regarding Chipotle (CMG), still almost $1 billion holding, Ackman’s original position, taken a couple of years ago, in the 400s, after falling to a low of about $260, has come back to a profitable point, and Ackman’s has exited about 25% of his position. We wrote, a couple of years ago, that he had no “edge” relative to his knowledge of CMG. There was no undervalued real estate, or other opaque asset that  could be monetized. His opinion was no better than yours or mine whether the brand could, or would, regain its previous popularity. Ackman has gotten lucky, because CMG has run back to $440 today (was briefly over $500 in mid ’18), and he is more or less even on the position. The huge move in the stock has more than adequately anticipated the fundamental recovery, now selling at over 50x ’18 EPS, and 27x trailing EBITDA. It is three full years since the crisis of ’15, and same store sales are only up by single digits against easy comparisons. Backing out menu price increases, traffic has barely improved from the lows. Further backing out the progress with their mobile app, in store dining traffic is still less impressive. Suffice to say: CMG, still challenged, is no bargain at current levels.

Regarding Starbucks (SBUX), the most recent purchase. Once again, we have written extensively on this situation, which we encourage you to access with the Search function on our Home Page. This is a great worldwide brand. They will continue to grow, especially in China. They will continue to buy back billions of their own stock. However: the future growth will be slower than in the past, so the price/earnings multiple is unlikely to expand, which Ackman is counting on. Ackman has discovered  that Starbucks is selling caffeine, and we’ve pointed out many times that selling an addictive product is a significant corporate advantage. (Maybe that’s why Constellation Brands, STZ, has invested $4 billion, for a 38% in Canopy Growth, CGC, a cannabis company with a market cap of $10B, over 20x ’19 estimated sales.) However, back at SBUX, food sales are about 25% of sales, so, backing out the increase in food sales,  caffeine sales are down over the last couple of years. In a nutshell, as in the case of his CMG purchase, he has no edge. His argument that the valuation of SBUX, in terms of earnings and cash flow, is well below the long term average, that is almost inevitable when growth expectations are less than was the case historically. Ackman expects SBUX to double in price over the next three years. Since the earnings per share will likely not grow at more than a mid-teen rate, even including stock buybacks (don’t forget the rising labor costs), he is counting on valuation expansion, which we consider unlikely. Having said all that, we consider it unlikely that he will lose money on this position over the next several years. Starbucks is a very strong company. It will just not be as profitable as he hopes.

In summary:

We don’t expect that Ackman’s performance, nominally and relatively, will improve by way of the above 41% of his portfolio. Starbucks is unlikely to do any major damage, but Restaurant Brands is substantially overvalued. He should switch immediately into McDonald’s or something else. He should consider himself lucky if he can exit Chipotle in one piece. From a broader standpoint: If this is the best Ackman (a very smart guy) can find in the marketplace today, it is not a good commentary on the state of the market.  situations.

Roger Lipton

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RESTAURANT BRANDS (QSR) REPORTS Q2 – LACKLUSTER QUARTER – OUR TAKE

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RESTAURANT BRANDS (QSR) REPORTS Q2 – LACKLUSTER QUARTER – OUR TAKE

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.

TWO STANDARDS OF REPORTING

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.

 Conclusion:

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

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