Restaurant Brands: Good Margins Drive Value (NYSE:QSR)

Investment thesis

Our present funding thesis is:

• QSR’s franchise mannequin de-risks the enterprise and permits for higher progress.
• Sales per restaurant from QSR’s 3 core companies are nonetheless growing, regardless of weakening efficiency from Tim Horton.
• The enterprise has flaws, comparable to the decline in margins, however remains to be performing properly relative to friends.
• QSR is buying and selling at a noticeable low cost to its friends, suggesting upside based mostly on these components.

Company description

Restaurant Brands International Inc. (NYSE:QSR) is a quick-service restaurant firm that operates internationally. The firm operates by 4 segments: Tim Hortons, Burger King, Popeyes Louisiana Kitchen, and Firehouse Subs.

Share worth

QSR’s share worth has traded sideways since its inception, shaped as a merger between Burger King and Tim Hortons. This is a mirrored image of the corporate’s valuation relative to the event of its earnings potential.

Financial analysis

Presented above is QSR’s monetary efficiency for the final 8 years.

Revenue

Before doing a deep dive into QSR’s income, it’s price contemplating how the present iteration of the enterprise is structured. 64% of its system-wide income is derived from Burger King, with an additional 18% from Tim Hortons and 15% from Popeyes.

The key progress phase for QSR has been Popeyes, which has generated a CAGR of 9.9% since 2015. With areas solely growing by 7%, the corporate has skilled a rise in gross sales per location. This is probably going a mirrored image of areas maturing, with the impression prone to proceed given the continued progress in areas. The story is analogous for Burger King, though to a lesser extent, suggesting these manufacturers are persevering with to stay extremely regarded by shoppers. Tim Horton then again has carried out poorly, with a decline in gross sales per restaurant. This suggests the enterprise is seeing declining demand at a few of its areas, with new areas unable to reinvigorate enchancment. Finally, the latest addition of Firehouse has initially diluted the typical gross sales per restaurant however is rising. It seems to be unlikely that it’s going to attain the degrees of different segments however the important thing for QSR is for it to contribute to progress, which it’s doing at a powerful ratio.

Franchising is useful, and a development we’ve seen within the trade, because it permits the corporate to derisk its profile. Property danger, employment danger, and so on. are all borne by the franchisee. The franchisor then again doesn’t have to personal any belongings and may drive progress by growing its franchise licenses, which is a faster and cheaper route than opening a location itself. This is the first purpose restaurant depend has been capable of develop because it has, which is the driving force for income.

As the above desk illustrates, the overwhelming majority of QSR’s eating places are franchised. The enterprise isn’t a restaurant operator in nature and isn’t an “asset-heavy” enterprise consequently.

Commercial consideration

To assess QSR’s industrial would possibly, the important thing issues are round Burger King and to a lesser extent, Popeyes and Tim Hortons in our view.

As the above illustrates, Burger King and Popeyes have seen enhancing curiosity in response to Google during the last decade, reflecting high quality advertising and marketing returns and continued energy of their manufacturers. This is a crucial metric to think about as with many discretionary industries, client traits can rapidly change and transfer in opposition to manufacturers. This is arguably seen with Tim Hortons above, which has remained flat, far under its peak curiosity.

The information above suggests Tim Hortons is stagnating, with Mashed speculating that their cafes are not considered cool anymore, blue-collar prospects are being turned away by menu decisions, and independents are taking market share. This is a mirrored image of how client traits can change, putting significance on Management to strategically concentrate on pivoting the enterprise towards client pursuits once more. In the newest quarter, Tim Hortons’ comparable gross sales had been up 11%, with Management highlighting it because of its strategic focus. It is just too early to recommend progress is again on observe however this can be a optimistic improvement and a mirrored image of Management’s capability to execute commercially.

With the potential for saturation in key home markets such because the US and Europe, the fast-food trade is more and more searching for to develop globally. In current years, Burger King has expanded into Sub-Saharan Africa, seeing progress potential in a area that’s each quickly rising and missing a QSR footprint. This ought to assist offset saturation danger however is based on QSR gaining market share. So far, this seems to be to achieve success as restaurant returns proceed to be accretive.

Although the corporate has 4 companies inside its group, the corporate isn’t properly diversified. A development away from Burger King, for instance, would materially impression the enterprise. This being stated, the corporate does achieve from the very fact Tim Hortons is a coffeehouse, decreasing its publicity to purely fast-food.

The fast-food trade is going through growing stress as shoppers are searching for more healthy meals choices, in addition to plant-based meals. This is a part of a wider change in client habits, pushed by larger training and market signaling round wholesome diets and sustainability. QSR’s response to this throughout its franchises has been to launch new merchandise, searching for to innovate its method by this transformation. Some success has been discovered, with Burger King’s Plant-based Whopper, Bakon King, and Vegan Royale. However, Tim Hortons has been much less profitable on this endeavor, quickly introducing and ending Plant-based burger decisions.

With the rise of third-party supply providers and the comfort they supply, extra prospects are choosing supply and takeout choices somewhat than eating in at eating places. We have coated different fast-food companies and our view is that this is a matter for established manufacturers and a chance for rising ones. The purpose for that is that customers historically consumed based mostly on the handful of manufacturers they knew and loved, with QSR, YUM, and McDonald’s (MCD) main the pack on this. However, shoppers can now scroll by a whole bunch of eating places which have been reviewed by customers, giving them larger decisions. On the opposite hand, digitization of the trade permits for enhancing economics by growing a digital buyer expertise. Burger King, for instance, has “YourBurgerKing”, which is a reward scheme that encourages gross sales instantly by the corporate. Digital gross sales grew 30% Y/Y, now representing 1/3 of system-wide gross sales.

Overall, we like QSR’s income and industrial profile. Gains proceed to be accretive, with returns over restaurant depend. We nonetheless see sturdy a runway for location progress by geographical growth and curiosity within the manufacturers stays sturdy. The key considerations for us are whether or not Management can reignite progress past restaurant depend with Tim Hortons and the way competitors develops within the coming years with larger delivery-app utilization.

Economic issues

Current financial circumstances are impacted closely by inflation which is resulting in slowing client spending as dwelling prices improve quickly. There is a suggestion that spending on discretionary actions comparable to consuming out could possibly be impacted, particularly if issues proceed to weaken. Our view is that there might be a minor impression on the enterprise as some shoppers do in the reduction of on spending however the diploma won’t be vital as a result of affordability of quick meals. This does imply Tim Hortons could wrestle additional, nevertheless, because the pricing construction and goal market differ. In the newest quarter, consolidated sales were up 8%, supporting this view.

Margin

QSR’s margin efficiency has been poor, with GPM declining 3ppts and EBITDA margin declining 5ppts. The sturdy NIM improvement is because of below-the-line variability.

GPM’s decline is partially impacted by inflation, with provide chain and commodity prices quickly growing. Not solely is that this impacting QSR’s prices however its franchises are combating declining margins, which may impression top-line progress. Inflation is trending down however stays cussed, making it troublesome to take a ahead view. The secret’s the place these prices will normalize, as it is going to be troublesome to take optimistic pricing motion with franchises already struggling.

Further, the enterprise has seen S&A price slippage, with bills growing as a % of income by 1ppt. Although this isn’t a cloth quantity, it compounds the underperformance after we would anticipate enhancing scale economies.

Balance sheet

With a comparatively asset-light steadiness sheet, the important thing consideration for buyers is debt.

QSR at the moment has a ND/EBITDA ratio of three.9x, which is a ratio that has trended up during the last 8 years. Debt has been raised primarily to fund distributions, supplementing operational money movement. Our view is {that a} 3x stage is sweet for the “average” enterprise, though an organization like QSR can bear extra as a result of danger profile of its earnings. Regardless, 3.9x leaves minimal room to develop, which may imply future distributions are smaller. Dividends paid within the final 7 years have grown at a 15% charge, whereas giant buybacks occurred within the final 2 years. Further, QSR’s payout ratio has exceeded 100% in 5 of the final 8 years.

Presented under is QSR’s debt maturity profile, with no materials quantity due till 2025. This ought to imply QSR can refinance as soon as charges decline however don’t go away the enterprise with a lot margin for error. Interest funds already comprise 8% of income and so a rise on this can be damaging.

Outlook

Presented above is Wall Street’s outlook for the approaching 5 years.

Growth is marginally under what was achieved within the historic interval, which aligns completely with our view. Uncertainty round Tim Hortons and larger competitors will doubtless contribute to a level of softening.

Margins are anticipated to enhance, though stay under these ranges seen earlier than FY19. Once once more, this seems to be pretty cheap as inflationary pressures ought to subside though QSR has proven an incapability to make marginal/effectivity positive aspects.

Peer analysis

To take into account QSR’s relative efficiency, we’ve in contrast the enterprise to a variety of main meals corporations, that are offered above.

From a progress perspective, QSR seems to be comparatively common in comparison with the peer group chosen. Its 5Y income progress is barely under common however exceeds Yum and McDonald’s. On a ahead foundation, QSR equally outperforms Yum and McDonald’s. Issues are with EBITDA-M, which we all know is an space of weak spot.

Although margins have slipped, QSR stays extraordinarily sturdy relative to its peer group. The enterprise is simply outperformed by McDonald’s on an EBITDA foundation, and Yum too on a NIM stage.

Valuation

The common buying and selling multiples of the peer group are:

• F P/E – 26x
• LTM P/E – 30x
• F EV/EBITDA – 19x
• LTM EV/EBITDA – 21x

QSR is buying and selling at a reduction on each stage we consider to be an applicable metric. A level of that is warranted attributable to Chipotle Mexican Grill (CMG) and McDonald’s rightly lifting the typical attributable to their superior efficiency. This stated the diploma to which it trades at a reduction seems to be unwarranted, suggesting some upside.

Key dangers with the thesis

The key dangers with this funding are:

• Uncertainty round Tim Hortons’ efficiency going ahead.
• Execution of growth technique.
• Continued weakening of franchisee efficiency impacting QSR.
• Market response to distribution cuts, ought to they happen.
• 3G possession, with the chance from this defined under.

Final ideas

QSR is rising properly on the premise of a powerful industrial standing, with gross sales per restaurant enhancing over time (excluding the current Firehouse acquisition). Although margins have slipped, the corporate is extremely worthwhile which could be directed towards investor distributions. Relative to different fast-food companies, QSR performs properly with good progress and nice margins. QSR is buying and selling at a reduction which to us suggests upside.