STARBUCKS (SBUX) AND RESTAURANT BRANDS (QSR) GET HIT – A SIGN OF THE TIMES
Two prominent restaurant companies are in the news today, both SBUX and QSR are down materially today, and there are lessons to be learned. From a broad brush standpoint, It continually amazes me how the “wealth effect” as a result of worldwide zero interest rates has inflated stock and bond prices to unheard of multiples of cash flow and earnings per share. We have lived through similar periods of new valuation parameters, the “one decision” stocks of the early 1970s that sold (for a while) at 50-100x expected earnings, and the dotcom bubble of 1999-2000 when companies were valued based on eyeballs and multiples of sales and business plans, rather than operating results.
RESTAURANT BRANDS (QSR)
Restaurant Brands’ (QSR) controlling shareholder, 3G Capital Partners, a Brazilian company, has owned most recently 41% (190M shares, worth a cool $14B) of the fully diluted shares of QSR. QSR has been a great investment for 3G, and Bill Ackman’s Pershing Square Capital (who currently owns owning 15M shares, worth about $1B). While earnings and cash flow progress have slowed down in recent years, and you can read all about it within our website. The QSR stock has continued to levitate, currently selling very near its all time high, at almost 30x ’19 EPS estimates and 20x TTM EBITDA. Considering that EPS is growing at about 10% annually and EBITDA growth closer to 5%, this “asset light”, “free cash flow” franchising company that happens to be carrying $11B of debt, not too many observers would call QSR a great bargain. It is therefore no wonder that 3G just announced the sale of 17M shares, worth about $1.3B, and of course the institutional market snapped it up. It’s worth noting that 3G sold $530M worth of shares in calendar ’18 and $330M worth in’17, and QSR bought those shares, rather than reducing their debt. For whatever combination of reasons, QSR stepped aside this time, and let the market absorb those shares. On a smaller scale, Pershing Square Capital Management, has lightened up as well, selling 4M shares in Q2’19 and 8M shares in total in the last twelve months. We believe that the current valuation is mostly supported by “TINA” (there is no alternative) investing in equity markets when $16 trillion of sovereign debt around the world yields nothing.
Starbucks (SBUX) is a different story. Just a couple of months ago the Company raised guidance for earnings over the next year or so, and combined with firming comp sales and the prospect for growth in China, the stock has hit a new high close to $100 per share, selling at 33x EPS estimates for the year ending 9/30/19 and 22x TTM EBITDA. This is a great worldwide brand, but, here too, the current valuation is far from a bargain relative to the expected growth of about 10% per year. SBUX was down 4% today because they presented at a Goldman Sachs conference and lowered EPS growth expectations to something short of 10% in the year ending 9/20. We haven’t seen the details of the presentation yet but the headlines indicate that this adjustment of several percent is apparently the result of tax comparisons and a lower stock repurchases in ’20 vs. ’19. The fundamentals do not seem to be deteriorating, so the 3-4% stock decline seems to be a result of “uncertainty” combined with SBUX being “priced for perfection” and leaving room for disappointment. SBUX is a far stronger company, in lots of ways, than QSR, but, here again, the valuation is far from a bargain, and we believe the downside “adjustment” could be much more substantial should a further disappointment develop.
There are a couple of very recent examples of the danger of complacency relative to valuation of growth stocks. Ulta Beauty (ULTA) and Olllie’s Bargain Outlet Holdings (OLLI) have both been outstanding investments in the retail sector for years, for good reason. In the last five years, with the EPS ramping, ULTA moved from about $100/share to $350, and OLLI went from $20 to about $100. Valuations of both companies moved up to the range of 40-50x expected earnings, “priced for perfection”, just like SBUX and QSR. Just in the last week, both ULTA and OLLI reported strong quarters, met earnings estimates, had positive comps, but both “adjusted” guidance by a few percentage points, still projecting continued solid growth, just not so quite so solid as previously assumed. The bottom line is that ULTA sold off 25% in one day, now trading at $233, down 36% from a high of bout $365 a month ago, and 0LLI sold off about 30% in one day, now trading at $56, down 44% from over $100 several months ago. ULTA is now selling at a much more reasonable 20x ’19 EPS, and OLLI is selling at “only” 28x ’19 EPS. Both these companies are debt free, by the way. In our view, ULTA is a category killer in it’s space, generating a 38% ROE and 18% ROA. OLLI is not quite so impressive, but generates a 15% ROE and 11% ROA, a lot better than the 2.7% ROA generated by QSR, not as good as the 27% ROE generated by highly leveraged QSR which has bought back so much stock. In a nutshell, while ULTA and OLLI are not a close fundamental comparison to SBUX and QSR, we believe the the very recent “adjustment” in valuations illustrate the substantial risk that investors sometimes overlook.
Companies that are “priced for perfection”, as are SBUX and QSR at the current time, have serious downside price risk, even if small disappointments have been previously overlooked in a generally strong equity market. An unexpected new chink in the armor, as demonstrated recently by ULTA and OLLI, can create an “air pocket” in the stock price that wipes out multi-year stock price appreciation. The company specific risk is in addition to that of the general market. Be careful out there.