Investment thesis
Our current investment thesis is:
- QSR’s franchise model de-risks the business and allows for better growth.
- Sales per restaurant from QSR’s 3 core businesses are still increasing, despite weakening performance from Tim Horton.
- The business has flaws, such as the decline in margins, but is still performing well relative to peers.
- QSR is trading at a noticeable discount to its peers, suggesting upside based on these factors.
Company description
Restaurant Brands International Inc. (NYSE:QSR) is a quick-service restaurant company that operates internationally. The company operates through four segments: Tim Hortons, Burger King, Popeyes Louisiana Kitchen, and Firehouse Subs.
Share price
QSR’s share price has traded sideways since its inception, formed as a merger between Burger King and Tim Hortons. This is a reflection of the company’s valuation relative to the development of its earnings potential.
Financial analysis
Presented above is QSR’s financial performance for the last 8 years.
Revenue
Before doing a deep dive into QSR’s revenue, it is worth considering how the current iteration of the business is structured. 64% of its system-wide revenue is derived from Burger King, with a further 18% from Tim Hortons and 15% from Popeyes.
The key growth segment for QSR has been Popeyes, which has generated a CAGR of 9.9% since 2015. With locations only increasing by 7%, the company has experienced an increase in sales per location. This is likely a reflection of locations maturing, with the impact likely to continue given the continued growth in locations. The story is similar for Burger King, although to a lesser extent, suggesting these brands are continuing to remain highly regarded by consumers. Tim Horton on the other hand has performed poorly, with a decline in sales per restaurant. This suggests the business is seeing declining demand at some of its locations, with new locations unable to reinvigorate improvement. Finally, the newest addition of Firehouse has initially diluted the average sales per restaurant but is growing. It looks unlikely that it will reach the levels of other segments but the key for QSR is for it to contribute to growth, which it is doing at an impressive ratio.
Franchising is beneficial, and a trend we have seen in the industry, as it allows the company to derisk its profile. Property risk, employment risk, etc. are all borne by the franchisee. The franchisor on the other hand does not need to own any assets and can drive growth by increasing its franchise licenses, which is a quicker and cheaper route than opening a location itself. This is the primary reason restaurant count has been able to grow as it has, which is the driver for revenue.
As the above table illustrates, the vast majority of QSR’s restaurants are franchised. The business is not a restaurant operator in nature and is not an “asset-heavy” business as a result.
Commercial consideration
To assess QSR’s commercial might, the key considerations are around Burger King and to a lesser extent, Popeyes and Tim Hortons in our view.
As the above illustrates, Burger King and Popeyes have seen improving interest according to Google over the last decade, reflecting quality marketing returns and continued strength in their brands. This is an important metric to consider as with many discretionary industries, consumer trends can quickly change and move against brands. This is arguably seen with Tim Hortons above, which has remained flat, far below its peak interest.
The data above suggests Tim Hortons is stagnating, with Mashed speculating that their cafes are not considered cool anymore, blue-collar customers are being turned away by menu choices, and independents are taking market share. This is a reflection of how consumer trends can change, placing importance on Management to strategically focus on pivoting the business toward consumer interests again. In the most recent quarter, Tim Hortons’ comparable sales were up 11%, with Management highlighting it as a result of its strategic focus. It is too early to suggest growth is back on track but this is a positive development and a reflection of Management’s ability to execute commercially.
With the potential for saturation in key domestic markets such as the US and Europe, the fast-food industry is increasingly seeking to develop globally. In recent years, Burger King has expanded into Sub-Saharan Africa, seeing growth potential in a region that is both rapidly growing and lacking a QSR footprint. This should help offset saturation risk but is predicated on QSR gaining market share. So far, this looks to be successful as restaurant returns continue to be accretive.
Although the company has 4 businesses within its group, the company is not well diversified. A trend away from Burger King, for example, would materially impact the business. This being said, the company does gain from the fact Tim Hortons is a coffeehouse, reducing its exposure to purely fast-food.
The fast-food industry is facing increasing pressure as consumers are seeking healthier food options, as well as plant-based foods. This is part of a wider change in consumer habits, driven by greater education and market signaling around healthy diets and sustainability. QSR’s response to this across its franchises has been to launch new products, seeking to innovate its way through this change. Some success has been found, with Burger King’s Plant-based Whopper, Bakon King, and Vegan Royale. However, Tim Hortons has been less successful in this endeavor, rapidly introducing and ending Plant-based burger choices.
With the rise of third-party delivery services and the convenience they provide, more customers are opting for delivery and takeout options rather than dining in at restaurants. We have covered other fast-food businesses and our view is that this is an issue for established brands and an opportunity for growing ones. The reason for this is that consumers traditionally consumed based on the handful of brands they knew and enjoyed, with QSR, YUM, and McDonald’s (MCD) leading the pack on this. However, consumers can now scroll through hundreds of restaurants that have been reviewed by users, giving them greater choices. On the other hand, digitization of the industry allows for improving economics through developing a digital customer experience. Burger King, for example, has “YourBurgerKing”, which is a reward scheme that encourages sales directly through the company. Digital sales grew 30% Y/Y, now representing 1/3 of system-wide sales.
Overall, we like QSR’s revenue and commercial profile. Gains continue to be accretive, with returns over restaurant count. We still see strong a runway for location growth through geographical expansion and interest in the brands remains strong. The key concerns for us are whether Management can reignite growth beyond restaurant count with Tim Hortons and how competition develops in the coming years with greater delivery-app usage.
Economic considerations
Current economic conditions are impacted heavily by inflation which is leading to slowing consumer spending as living costs increase rapidly. There is a suggestion that spending on discretionary activities such as eating out could be impacted, especially if things continue to weaken. Our view is that there will be a minor impact on the business as some consumers do cut back on spending but the degree will not be significant due to the affordability of fast food. This does mean Tim Hortons may struggle further, however, as the pricing structure and target market differ. In the most recent quarter, consolidated sales were up 8%, supporting this view.
Margin
QSR’s margin performance has been poor, with GPM declining 3ppts and EBITDA margin declining 5ppts. The strong NIM development is due to below-the-line variability.
GPM’s decline is partially impacted by inflation, with supply chain and commodity costs rapidly increasing. Not only is this impacting QSR’s costs but its franchises are struggling with declining margins, which could impact top-line growth. Inflation is trending down but remains stubborn, making it difficult to take a forward view. The key is where these costs will normalize, as it will be difficult to take positive pricing action with franchises already struggling.
Further, the business has seen S&A cost slippage, with expenses increasing as a % of revenue by 1ppt. Although this is not a material amount, it compounds the underperformance when we would expect improving scale economies.
Balance sheet
With a relatively asset-light balance sheet, the key consideration for investors is debt.
QSR currently has a ND/EBITDA ratio of 3.9x, which is a ratio that has trended up over the last 8 years. Debt has been raised primarily to fund distributions, supplementing operational cash flow. Our view is that a 3x level is good for the “average” business, although a company like QSR can bear more due to the risk profile of its earnings. Regardless, 3.9x leaves minimal room to grow, which could mean future distributions are smaller. Dividends paid in the last 7 years have grown at a 15% rate, while large buybacks occurred in the last 2 years. Further, QSR’s payout ratio has exceeded 100% in 5 of the last 8 years.
Presented below is QSR’s debt maturity profile, with no material amount due until 2025. This should mean QSR can refinance once rates decline but do not leave the business with much margin for error. Interest payments already comprise 8% of revenue and so an increase in this would be damaging.
Outlook
Presented above is Wall Street’s outlook for the coming 5 years.
Growth is marginally below what was achieved in the historical period, which aligns perfectly with our view. Uncertainty around Tim Hortons and greater competition will likely contribute to a degree of softening.
Margins are expected to improve, although remain below those levels seen before FY19. Once again, this looks fairly reasonable as inflationary pressures should subside although QSR has shown an inability to make marginal/efficiency gains.
Peer analysis
To consider QSR’s relative performance, we have compared the business to a range of leading food companies, which are presented above.
From a growth perspective, QSR looks relatively average compared to the peer group chosen. Its 5Y revenue growth is slightly below average but exceeds Yum and McDonald’s. On a forward basis, QSR equally outperforms Yum and McDonald’s. Issues are with EBITDA-M, which we know is an area of weakness.
Although margins have slipped, QSR remains extremely strong relative to its peer group. The business is only outperformed by McDonald’s on an EBITDA basis, and Yum too on a NIM level.
Valuation
The average trading multiples of the peer group are:
- F P/E – 26x
- LTM P/E – 30x
- F EV/EBITDA – 19x
- LTM EV/EBITDA – 21x
QSR is trading at a discount on every level we believe to be an appropriate metric. A degree of this is warranted due to Chipotle Mexican Grill (CMG) and McDonald’s rightly lifting the average due to their superior performance. This said the degree to which it trades at a discount looks unwarranted, suggesting some upside.
Key risks with the thesis
The key risks with this investment are:
- Uncertainty around Tim Hortons’ performance going forward.
- Execution of expansion strategy.
- Continued weakening of franchisee performance impacting QSR.
- Market reaction to distribution cuts, should they occur.
- 3G ownership, with the risk from this explained below.
Final thoughts
QSR is growing well on the basis of a strong commercial standing, with sales per restaurant improving over time (excluding the recent Firehouse acquisition). Although margins have slipped, the company is highly profitable which can be directed toward investor distributions. Relative to other fast-food businesses, QSR performs well with good growth and great margins. QSR is trading at a discount which to us suggests upside.