RESTAURANT BRANDS (QSR) REPORTS, THREE GREAT STORIES ! HORTON’S, THE IMPOSSIBLE BURGER, AND THE CHICKEN SANDWICH!!

CONCLUSION:

We have written on Restaurant Brands many times over the last several years, and have correctly predicted that the growth in earnings and cash flow would be flattening out now that the operating “efficiencies” in the wake of the Burger  King and Tim Horton’s acquisitions were unlikely to be repeated.  The stock has, accordingly, done very little over the last two years. QSR stock is not overpriced relative to its “asset light” peers, and it’s 5% “Free Cash Flow” yield is intriguing, but we do not consider possible growth of 7 or 8 percent annually to be be sufficient to render attractive  a 22x price earnings multiple or about 19x trailing EBITDA.

RECENT RESULTS:  (Per the Q4 release and Conference Call)

Restaurant Brands (QSR) reported results yesterday, in line with expectations, from a bottom line standpoint. Results at Tim Horton’s continued to disappoint, Burger King slightly underperformed, and Popeye’s shot the lights out ! The analysts and money managers generally considered the results acceptable and QSR stock was largely unchanged.

The Company, predictably, put it’s best foot forward, while admitting that Tim Horton’s results have disappointed: “We have three iconic restaurant brands that are together growing around the world. …. I’m proud that our 2019 results have us solidly on track …Burger King delivered its strongest year of restaurant growth in the last two decades. Popeye’s launched an iconic Chicken Sandwich that has proven to be a game changer for the brand in every way. At Tim Horton’s, our performance did not reflect the incredible power of the brand and it is clear that we have a large opportunity to refocus on our founding values and what has made us famous with our guests over the years, which will be the basis for our plan in 2020”.

The “bottom line” numbers include the following:

Income From Operations was down 1.0% for three months and up 4.6% for the year.

Income Before Taxes was down 5.2% for three months and up 5.1% for the year

Net Income Attributable – common Shareholders, up 1.2% for Q4 and up 5.0% for year.

Diluted Earnings Per Common Share, down 15.7% for Q4 and down 2.1% for year

Some “Non-GAAP” numbers are presented, as usual.

EBITDA was down 0.4% for Q4 and up 4.5% for the year

Adjusted EBITDA was up 7.0% for Q4 and up 4.2% for the year

Adjusted EBITDA, division by division

Horton’s was down 0.1 for Q4 and down 0.5% for the year

Burger King was up 7.7% for Q4 and up 7.1% for the year

Popeye’s was up 62.4% for Q4 and up 20.2% for the year

Combined, up 7.2% for Q4 and up 4.2% for the year

Just as we have suggested over the last two years or so, QSR is growing at an overall rate of mid to high single digits. Horton’s (which provided much of the growth 4 or 5 years ago) is a drag, Burger King continues to grow, and Popeye’s is too small to move the needle by much.

There is one other summarized set of numbers that is worth discussing. “Unlevered Free Cash Flow” is shown as growing steadily from 2015 to 2019, from $1.5B to $2.0B. First,those numbers are after adding back about $500M of interest, so Net Cash Provided by Operating Activities is more like $1.5B. Secondly, some portion of that “Net” cash is not quite so free any more with the requirements of refurbishing the Tim Horton’s chain. Lastly, as we have pointed out before, $330M of the cash flow was spent in 2017 and $561M was spent in 2018 to buy back shares from 3G, the controlling shareholder. Along with the repurchase of Warren Buffet’s Preferrred Shares, this is why, with all the “Unlevered Free Cash Flow, the net debt is still $10.8B, virtually the same as the $10.7B at the end of 2017 and $10.9B at the end of 2018. It always amazes us how cash flow can be considered “free” when there is a great deal of debt outstanding.

THE OPERATING FUNDAMENTALS, very briefly:

The most important Tim Horton’s division, representing about half of the corporate cash flow (with $1.1B of Adjusted segment EBITDA for the year) continues to be troubled. Comp sales were down 4.3% for Q4 and 1.5% for the year. “Winning Together” apparently didn’t get the job done. The effort is being retooled, with a heavy emphasis on the loyalty program. An inflection point could be in the offing but it is far from a certainty.

Burger King (with $994M of Adjusted segment EBITDA for ’19)  continued to grow comps and units steadily. Systemwide comps were up 2.8% in Q4 and 3.4% for the year. However, US comps were only up 0.6% in Q4 and 1.7% for the year, which could be considered a disappointment in light of the Q4 emphasis on the Impossible Burger. We can’t resist taking a bow, for our prediction that the Impossible Burger would not be a game changer, even after 18% comps were touted from the St.Louis test market.  The Company is going back to “basics” now, and there is no reason to think that Burger King will not continue to be a growth segment within QSR.

Popeye’s has obviously hit a grand slam home run with their Chicken Sandwich, driving US comps up 37.9% in Q4 and 12.1% for the year, and The Sandwich wasn’t even there for a full quarter. Popeye’s unit growth was up 6.9% for the quarter and year, and can be expected to move higher. All of this is excellent, but Popeye’s, with $188M of segment Adjuted EBITDA  (up from $157M in ’18) represented only about 9% of three divisions combined.

Putting the three divisions together, going forward we believe it is reasonable to expect Horton’s results to be flat, Burger King to be up high single digits, Popeye’s perhaps up by as much as 30-40%. That would equate to overall growth on the order of 7%.

CONCLUSION: Provided at the beginning of this article

O

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