Restaurant Brands QSR

Restaurant Brands International Inc.

We don’t have a full ten years graphed because Restaurant Brands was only formed in late 2014. For stock trading purposes, Burger King is a predecessor company and we could have added that history to the graph. But we are much more interested in how it has done since Burger King and Tim Hortons came together as Restaurant Brands. They later added Popeyes and then Firehouse Subs.

Revenue per share has grown at a reasonable but unspectacular rate and has now more than fully recovered to pre-pandemic levels.

Adjusted earnings per share have also grown at a reasonable rate and have now surpassed pre-pandemic levels.

Restaurant Brands International Inc. (QSR, New York and Toronto)
RESEARCH SUMMARY  
Report Author(s): InvestorsFriend Inc. Analyst(s)
Author(s)’ disclosure of share ownership:  The Author(s) holds shares 
Based on financials from: 2021 + Q2 ’22
Last updated: September 2, 2022
Share Price At Date of Last Update:  $                                  59.25
Currency: $ U.S.
Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): Buy at $59.25
Qualifies as a stock that could be bought with confidence to hold for 20 years? Yes
Has Wonderful Economics? Yes
Has Excellent and Trustworthy Management? Yes although ruthless and they are aggressive income tax avoiders and as such may not be trustworthy
Likely to grow earnings per share at an attractive rate over the next decade? Yes
Positive near-term earnings outlook? Yes
Valuation? Fair
SUMMARY AND RATING: The graph of revenues per share (red line) shows  reasonably good and steady growth except for the pandemic dip in 2020. Adjusted earnings per share growth was also reasonably good and steady except for the dip with the pandemic in 2020. The Value ratios in isolation would indicate a (lower) Buy to Buy rating given the high ROE but tempered by a somewhat high P/E. Management quality appears to be quite strong although they have a reputation of being quite ruthless and have in the past had very poor relations with a large group of Tim Hortons franchise owners.  Management is also very aggressive at income tax avoidance which may call into question their trustworthiness. (Today, they short the taxman, tomorrow they abuse the share owners?) The company does well on the Buffett criteria except for its high debt. Higher interest rates on its high debt is a concern but he great majority of the debt is locked in for at least the next three years. The insider trading signal is neutral. Executive compensation is higher than we would like but is not a big concern. The outlook based on same-store sales growth and the growth in the number of locations does not appear to be for growth of more than 8 to 10% long term but the short term outlook is for strong growth as the recovery from the pandemic continues.  The economics of the business are strong with reliable recurring cash flows. It has competitive advantages in terms of its market position and brand awareness. The balance sheet is somewhat weak with high debt but the cashflows appear to be sufficient to sustain the debt. Overall, we will rate this a Buy. All investments face the headwind of higher interest rates which put downward pressure on P/E ratios. A reasonable strategy would be to take a modest position and revisit after the next earnings report.
LONG TERM VALUE CREATION: Value creation in terms of the share price since Restaurant Brands was formed and took over Burger King around the end of 2014 has been relatively modest. In part this was due to the pandemic. In part it was also due to investors bidding the shares up to quite a high P/E ratio (over 30)  in the earlier years.  In terms of retained earnings value creation has been positive. The ROE has been strong partly due to the high debt leverage.
DESCRIPTION OF BUSINESS: Restaurant Brands International Inc. (RBI) is a holding company that was formed in 2014 to purchase (though leveraged buyouts) Burger King and Tim Hortons and it later purchased Popeyes and in late 2021 purchased Firehouse Subs its 1213 locations. As a result of the purchases, RBI’s balance sheet assets consist largely of purchased goodwill and similar intangibles and it is financed largely with debt rather than equity. RBI was formed by 3G Capital a Brazilian-American investment firm that also was behind the leveraged buyouts of Heinz and then Kraft and which has ties to Warren Buffett. Despite being publicly traded, RBI has many of the characteristics of a private-equity company. RBI is a Canadian company in form but is more of an America company in substance. It has over $30 billion in system-wide sales and over 29,000 franchised locations and 6000 employees. It follows a fully-franchised business model and owns or operates almost none of the locations directly. For all its brands it earns revenue from ongoing franchise royalties as well as initial franchise license fees and from land/building rents in cases where it owns the land/building (which is very much the case at Tim Hortons and to small degree the case at Burger King). In the case of Tim Hortons it also earns significant revenue and profit as the wholesaler of coffee, baked goods and other supplies. In 2021, system-wide sales at the restaurants were 64% Burger King, 18% Tim Hortons 15% Popeyes and 3% Firehouse (as if owned all year). The breakdown by number of locations is quite similar at 65% BK, 18% Tims, 13% Popeyes and 4% Firehouse. However, due to selling supplies to Tim Hortons franchisees and because RBI owns significant Tim Horton locations and charges rent, the segmented EBITDA income is 54% from Tim Hortons, 45% from Burger King and 10% from Popeyes. Geographically, 53% of revenues are from Canada, 35% for the USA and the remaining 12% is spread across about 100 other countries.
ECONOMICS OF THE BUSINESS: With a 32% ROE and with the reliable recurring nature of the revenues and profits, the economics of the business appear quite good. However, it should be noted that is achieved in part by a heavy use of debt leverage. To a good extent, RBI is in a position to license its brand names internationally and receive additional cash with little investment.
RISKS: Refer to the annual report for a more complete list. In our view the most relevant risk would be a major product safety scare that would drive customers away at least temporarily. Another risk is that the brands may not succeed in some international markets leading to lost investment. For example Tim Hortons may struggle in international markets due to low familiarity with that brand in most of the world. The company lists its income tax strategies as a risk. This is likely because they have been aggressive in the use of debt and in transfer payment schemes to transfer income tax to low-tax foreign locations.
INSIDER TRADING / INSIDER HOLDING: Checking from January 1, 2022 to September 2, 2022: The trades listed are somewhat confusing as quite a few executives sold shares on the same dates at the same prices and bought rights on the same dates and same prices. So it’s not at all clear that these were independent actions. Given that, the overall insider trading signal can be considered neutral. The company itself has bought back a substantial number of shares this year at prices up to about U.S. $57. 
WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is  simple to understand and predict (pass), has favorable long-term economics due to cost advantages or superior brand power (pass given brand power and scale), apparently able and trustworthy management (pass), a sensible price – below its intrinsic value (pass), Other criteria that have been attributed to Buffett include: a low  debt ratio (fail), good recent profit history (pass) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) 
MOST RECENT EARNINGS AND SALES TREND: Given the pandemic and the recovery from it results became quite volatile. In the latest quarter (Q2 of 2022) revenues per share were up 17% and adjusted earnings per share were up 7%. The trend is positive as earnings have now edged up past the pre-pandemic levels.
COMPARABLE STORE SALES  OR INDUSTRY SPECIFIC STATISTICS: Same-store sales at Tim Hortons were  up an impressive 12.2% in Q2 2022. Burger King same store sales were up 10% in Q2 2022 driven mostly by growth outside of the U.S. Popeyes same store sales growth was modest at 1% in Q2 2022. In addition the store count in Q2 increased by 5.7% at Tim Hortons (mostly international growth) 2.8% at Burger King and 8.1% at Popeyes.
Earnings Growth Scenario and Justifiable P/E: With a trailing P/E of 20, the stock is “pricing in” fairly high growth of about 7% annually assuming  that the P/E will remain close to the 20 level.
VALUE RATIOS: The price to book value ratio is perhaps meaningless for this asset-light company but is ostensibly unattractive at 6.6. The P/E ratio is moderately unattractively high at 20 (it is basically pricing in reasonably strong growth). The return on equity is very strong at 32% and that is despite the fact that the company paid a high premium to original book in purchasing its three main brands. The ROE is however boosted by the high debt leverage. Due the pandemic and the recovery it is difficult to interpret the recent growth but the latest quarter exhibited strong growth of 16% in revenues and 7% in adjusted earnings per share.  Overall the value ratios in isolation would support a rating of (lower) Buy to Buy given the moderately P/E ratio but also considering the attractive ROE.
TAXATION: Nothing unusual. But note that this is a U.S. company and is not eligible for the Canadian Dividend tax credit even though it trades on the Toronto stock exchange.
SUPPORTING RESEARCH AND ANALYSIS  
Symbol and Exchange: Restaurant Brands International Inc.
Currency: $ U.S.
Contact: investor@rbi.com
Web-site: www.rbi.com
INCOME AND PRICE / EARNINGS RATIO ANALYSIS  
Latest four quarters annual sales $ millions: $6,131.0
Latest four quarters annual earnings $ millions: $1,205.0
P/E ratio based on latest four quarters earnings: 22.6
Latest four quarters annual earnings, adjusted, $ millions:  $1,361.0
BASIS OR SOURCE OF ADJUSTED EARNINGS: Adjusted for items identified by management. Also we adjusted for abnormally low tax rate in Q1 2018. 
Quality of Earnings Measurement and Persistence: Earnings and cashflow are reliable and persistent and growing (after recovering from the pandemic).
P/E ratio based on latest four quarters earnings, adjusted 20.0
Latest fiscal year annual earnings: $1,253.0
P/E ratio based on latest fiscal year earnings: 21.8
Fiscal earnings adjusted: $1,308.0
P/E ratio for fiscal earnings adjusted: 20.8
Latest four quarters profit as percent of sales 22.2%
Dividend Yield: 3.6%
Price / Sales Ratio 4.45
BALANCE SHEET ITEMS  
Price to (diluted) book value ratio: 6.64
Balance Sheet: With the shares trading at over 6 times book value (as of September 2, 2022) the shares are clearly valued for their earnings as opposed to assets but the composition of the balance sheet may be of interest nevertheless. A huge 75% of the assets represents purchased goodwill and equivalent intangibles (brand value). 9% consists of property and equipment (largely land and buildings much of which is leased to franchisees and also equipment and some capital leases). 5% consists of operating leases which is a deemed asset and is approximately offset by the deemed liability for the lease payments. 4% is cash, 3% is accounts receivable, inventories and prepaid amounts and 4% is other assets. The assets are financed as follows: 57% by debt, 17% by owner’s equity, 6% by deferred income taxes, 5% by lease liabilities, 6% by other liabilities and 7% accounts payable and accrued liabilities. This balance sheet is quite highly leveraged and is quite dependent on the cash flows from franchisees.
Quality of Net Assets (Book Equity Value) Measurement: With the shares treading at over six times book value (as of September 2, 2022) the quality of the assets is not a concern. It is the quality and growth of income and cash flows that drive the share price.
Number of Diluted common shares in millions:                                     455.0
Controlling Shareholder: 3G Capital (the Brazilian-American investment company which Warren Buffett has been associated with) owns 29% of the voting interest and effectively controls the company Three large funds including Pershing Square (sometimes and activist investor) own a total of 18% and also likely can exert some control over the company.
Market Equity Capitalization (Value) $ millions: $26,958.8
Percentage of assets supported by common equity: (remainder is debt or other liabilities) 17.9%
Interest-bearing debt as a percentage of common equity 320%
Current assets / current liabilities: 0.9
Liquidity and capital structure: (Updated Q2 2022) RBI has sufficient cash ($883 million or just short of $2 per share). And it has strong and reliable recurring cash flow even after paying interest on its debt. But it is highly leveraged as with debt at 3.2 times the book value amount of equity (though only 0.48 times the market value of the equity). Overall, the liquidity is adequate but the balance sheet has to be considered somewhat weak due to the debt. 
RETURN ON EQUITY AND ON MARKET VALUE  
Latest four quarters adjusted (if applicable) net income return on average equity: 32.2%
Latest fiscal year adjusted (if applicable) net income return on average equity: 34.5%
Adjusted (if applicable) latest four quarters return on market capitalization: 5.0%
GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE  
5 years compounded growth in sales/share 7.0%
Volatility of sales growth per share:  Steady Growth 
5 Years compounded growth in earnings/share 5.8%
5 years compounded growth in adjusted earnings per share 6.5%
Volatility of earnings growth:  Steady Growth 
Projected current year earnings $millions: not available
Management projected price to earnings ratio: not available
Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted)  earnings per share? Yes
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: 9.6%
More conservative estimate of compounded growth in earnings per share over the forecast period: 8.0%
More optimistic estimate of compounded growth in earnings per share over the forecast period: 10.0%
OUTLOOK FOR BUSINESS: Growth will be driven by same store sales growth, growth in the number of locations and efficiencies. Q2 of 2022 had very strong same-store sales growth and this will likely be the case in Q3 as well as travel and eating out have returned to and surpassed pre-pandemic levels. However, the higher U.S. dollar is an immediate headwind.  
LONG TERM PREDICTABILITY: It seems reasonable to assume that Restaurant Brands will continue to grow based on its three existing main brands plus the newly acquired Firehouse Subs brand and possible future acquisition. Higher interest rates are a headwind although the great majority of the debt is locked in for the next 3 years and a substantial portion beyond that..
Estimated present value per share: We calculate  $58 if adjusted earnings per share grow for 5 years at the more conservative rate of 8% and the shares can then be sold at a P/E of 15 and $80 if adjusted earnings per share grow at the more optimistic rate of 10% for 5 years and the shares can then be sold at a P/E of 20. (The recent P/E was 20) Both estimates use a 7.0% required rate of return. 
ADDITIONAL COMMENTS  
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (Pass, as building a new chain required significant investment). No issues with powerful suppliers (Pass, while they may have some fairly dominate suppliers they are likely in a position to switch suppliers if needed). No issues with dependence on powerful customers (pass), No potential for substitute products (Pass, customers could substitute away from the fast food category but that seems quite unlikely) No tendency to compete ruinously on price (Marginal Pass – there is usually somewhat intense competition for the cheapest menu items but there are also premium items where the chains do not tend to compete that fiercely). Overall this industry appears to be attractive for an established incumbent such as RBI.
COMPETITIVE ADVANTAGE: Tim Hortons enjoys clear competitive advantages based on its established dominant position and brand in Canada. It is not clear that it has much in the way of competitive advantage in other countries but they believe that “Canada” as a brand will be popular internationally. However, for all three brands competition may be less intense in many emerging markets. Burger King is not the dominant “hamburger” chain but does possess brand advantages over smaller competitors and is well known in most of the world. Popeyes also has brand awareness and its appeal may be as more of a niche alternative to the larger fast food chains.
COMPETITIVE POSITION: Tim Hortons is the largest fast food chain in Canada and dominates the coffee category. Burger King is the number two burger chain in the U.S. Popeyes is a niche player but is number 2 behind KFC in this category..
RECENT EVENTS: They purchased Firehouse Subs win late 2021 adding about 4% to their total number of locations. The company continues to expand outside of Canada and the U.S. They are also improving the menu and food quality and the physical stores with more automated equipment for better workflow. They have invested in digital menus for the drive-thrus. They have also invested in and expanded mobility ordering systems and the rewards points systems.
ACCOUNTING AND DISCLOSURE ISSUES: In our opinion certain past press release disclosure has been very poor regarding sales of shares by numbered companies that the company does not state is 3G capital. Lack of clear disclosure is a concern. There were a number major accounting changes that make comparisons of year over year growth difficult. Starting in 2018 there was a major change in the way initial franchise fees are accounted for. This led to a large revenue gain in 2018. It also led to a basically a write-off of past retained earnings and increased reported earnings going forward. Starting in 2019 there was a change to lease accounting which increased assets and liabilities but the impact on earnings is apparently minor. Overall, the disclosure of adjusted or comparable net earnings in 2018 seemed like poor disclosure but this has improved in 2019. The required treatment of stock based compensation and the exercise of options and rights options has resulted in huge swings in the income tax rate. Part of the ownership is represented by exchangeable units is presented as minority interest which is confusing but we were able to adjust for that by treating it as part of the common equity.
COMMON SHARE STRUCTURE USED: Technically there are common shares and exchangeable units. But both are essentially treated as common shares by the company and in our analysis.
MANAGEMENT QUALITY: Probably good. But they are known to be ruthless and at times have had a very combative relationship with Tim Hortons’ franchisees (this may now have been resolved). 
Capital Allocation Skills: To date, management’s investments in buying and expanding its three brands has likely been wise.
EXECUTIVE COMPENSATION: (Updated September 2022). Executive compensation in 2021 was quite generous with the two top officers earning $14 million and $12 million. They are paid largely in stock awards. The amounts were lower than 2020 and 2019 which is a good sign given the weaker results due to the pandemic. Overall, this compensation is higher than we would like to see but is probably not a concern given the size and profitability of the company.
BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. RBI’s Board members appear to be well qualified with a mix of investment and relevant business backgrounds.
Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed  analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. 
DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice. 
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