2023-11-28 10:34:09 ET
Summary
- Shares of Restaurant Brands International have performed well since my initial coverage early last year, returning around 45% and comfortably outperforming the wider market.
- Burger King U.S. has been troubled in recent years, but recent increased investment looks to be having a positive impact.
- International growth prospects remain robust, with all the company's brands in position to grow their footprints outside the U.S.
- These shares still have reasonable return potential, but with peers like McDonald's offering a similar valuation and growth prospects, the investment case is less compelling than it was last year.
Global quick service restaurant giant Restaurant Brands International ( QSR )("RBI" hereafter) has done well since initial coverage in early 2022. Shares of the Burger King owner have gained a little over 45% in that time (with dividends), handily outpacing returns from the broader market.
Source: Seeking Alpha
Just to recap from last time out, RBI owns the Burger King (~43% of Q3 EBITDA), Tim Hortons (~44%), Popeyes Louisiana Kitchen (~11%) and Firehouse Subs (~2%) brands. This portfolio of brands is currently somewhat of a mixed bag. On the negative side, Burger King's domestic position is weak, and that means franchisees have little reason to open new stores. Domestic Burger King outlets have seen a net decline as a result. On the positive side, this is more than offset by stronger performance outside of the States.
Tim Hortons has also had issues with poor domestic performance, and is at a stage of maturity whereby meaningful growth in its domestic market is tough in any case. On the flip side, management is starting to realize the brand's growth potential outside North America, so there is still reasonable growth to be had overall.
Popeyes is somewhere in what you might call the 'Goldilocks region', enjoying a solid position at home while possessing a long runway for international expansion.
Firehouse is still very small at this point and not a big driver of group-wide performance.
RBI's portfolio is basically all franchised, which is a high returning activity since growth is funded by franchisees rather than the head company. It also operates a supply chain business in the domestic Tim Hortons segment – likewise a relatively stable source of cash flows.
Paying a nominally high multiple for these types of capital light businesses can make sense, as most of the earnings are available for distribution via dividends and buybacks. That ultimately drove my initial 'Buy' rating at a then 17x forward EPS.
The stock has since re-rated up to the around the 22x EPS market. While that still points to at least high single-digit annualized returns against a backdrop of mid-single-digit global unit count growth, these shares no longer offer the degree of upside they did 18 months ago, and with better peers like McDonald's ( MCD ) offering a similar profile I downgrade RBI to hold.
Better Trends At Burger King U.S.
Burger King's domestic footprint ("BK U.S.") accounts for around $2.8 billion, or 25%, of RBI's total global system sales. It had also been one aspect of its business that was struggling, with weak comps and average unit volume ("AUV") growth lagging other burger-focused chains like McDonald's. At $1.6 million, BK U.S. AUV remains around $1.8 million below McDonald's domestic AUV.
Among other negatives, weak unit level economics impede growth. For BK U.S., average restaurant-level EBITDA was around $140,000 last year according to management. That is slightly lower than, for instance, pizza chain Domino's ( DPZ ). Given the much higher investment required to open up a Burger King, cash-on-cash returns are likely not all that attractive, and the lack of operating leverage from weak AUV growth hasn't helped. Franchisees thus have little incentive to open up more outlets, and unsurprisingly Burger King's domestic store count has been declining modestly.
Data Source: Restaurant Brands International Quarterly Results Releases
The company is making some sensible moves to try to right the ship, announcing its "Reclaim the Flame" plan to drive growth and higher franchisee profitability. This involves around $400 million of fresh investment into BK U.S., split between store remodels, technology, upgrading kitchens and more cash for the advertising budget.
One of the issues with BK U.S. was that a large portion of its estate was simply getting old, probably having previously been neglected by the head firm, hence the current need for remodeling and upgrade investment. The good news is that while this will weigh a little on near-term earnings, it is a well established way to get a sales uplift. Indeed, BK U.S. is already starting to post some more positive trends, with traffic levels stabilizing and quarterly year-on-year comps looking respectable in the 6-8% range.
Data Source: Restaurant Brands International Quarterly Results Releases
International Still The Main Growth Engine
In a good way, Burger King outside the U.S. hasn't been the same story as the domestic estate, with international restaurants typically more modern and technology-enabled:
Over 75% of our international BK restaurants have modern image, and with this generally comes a more digital guest experience, including having kiosks and over 50% of our international restaurants. This has helped drive over 50% of international sales through digital channels, and that number is closer to 90% in some markets like Korea and China.
Josh Kobza, Restaurant Brands International CEO, Q3 2023 Earnings Call
The international Burger King segment has been posting positive comps and mid-single-digit annualized unit count growth, leading to a ~7% system sales CAGR.
Data Source: Restaurant Brands International Quarterly Results Releases
Like Burger King, Tim Hortons had been struggling domestically in previous years, posting very weak comps in the latter part of the 2010s. However, Tim Hortons' international footprint has been rising rapidly in recent years, with store count and system-wide sales increasing five-fold since 2018, led by expansion in China.
Source: Restaurant Brands International Q3 2023 Investor Presentation
Unlike its other brands, Popeyes has not struggled domestically. Restaurant-level EBITDA lands around 50% higher than at Burger King, with system sales growth up nicely since the introduction of its chicken sandwich in 2019.
Data Source: Restaurant Brands International Quarterly Results Releases
Fried chicken concepts have global appeal, as evidenced by competitor KFC's ( YUM ) 29,000-plus global restaurant count. With Popeyes still only at 4,373 units and growing rapidly, the brand will likely continue to be a strong growth outlet for the company.
With all of its concepts offering varying degrees of solid international growth, RBI's longer-term goal of mid-single-digit unit count growth looks achievable. System restaurant count has slowed below that rate recently, increasing 4.2% year-on-year in Q3 and around 0.8% quarter-on-quarter, but this is probably a result of a tougher macro environment, namely higher funding costs and tighter consumer finances, rather than a sign of a company-specific problem.
Valuation Reasonable, But No Longer Compelling
At $69.37 in current trading, RBI stock trades for around 21.5x consensus FY 2023 EPS estimates . The company currently pays a quarterly dividend of $0.55 per share, implying a current yield of 3.2% and a payout ratio of approximately 70%. Notwithstanding the occasional need to invest more in its underlying brands (as per BK U.S. above), RBI should be able maintain a high payout ratio given its franchised business model has inherently low capital requirements.
The company's long-term growth algorithm remains unchanged from last time out, with mid-single-digit unit count growth plus a low-single-digit contribution from comparable restaurant sales growth pointing to high single-digit annualized system-wide sales growth and at least the same earnings growth. I expect dividend growth to broadly match earnings, which on a 3.2% yield would point to 9-10% annualized shareholder returns all else equal.
While that arguably leaves the shares around fair value versus the returns investors usually demand, I would note that more successful peer McDonald's trades on both a similar P/E multiple (~22x) while also targeting a broadly similar growth algorithm. Lacking the upside potential it did 18 months ago and without a stronger buy case relative to its higher quality peer, I downgrade RBI stock to hold.
For further details see:
Restaurant Brands: Shares Near Fair Value Amid Signs Of Stabilization At Burger King