Sunday, December 20, 2015

6th AIM student equity update (by Brendan Fanning). Restaurant Brands International (ticker: QSR): What’s Cooking at Burger King and Tim Hortons?

QSR (Restaurant Brands International): What’s on the Menu at QSR Brands in 2016?
By: Brendan Fanning, Student at Marquette University

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

·         QSR - the large Canadian restaurant firm - announced a $300M share buyback plan in December 2015 as a result of a number of divestitures from 3G Capital’s private equity affiliates

·         The Q3 2015 earnings report announced strong same store sales trends for both the Burger King (BK) and Tim Hortons (TH) brands

·         Continued net restaurant growth and expansion plans into the U.S. for the TH brand show increasing strong growth prospects within the company

·        Current metrics and consumer trends (lower gasoline and heating costs) paint an attractive picture for the quick service restaurant industry going forward in 2016 

Restaurant Brands International, Inc. (NYSE:QSR): Recent News
On December 4, QSR announced the buyback of 8.15M shares for around $300M. The buyback represents exchange notices from shareholders of 30.9M units, including 25.7M units held by the affiliate, 3G Capital. However, it is important to note that none of the shares being converted by 3G are owned directly by the principle partners of 3G. The sellers represent other private equity partners affiliated with 3G who entered in the early stages of the BK transformation looking to exit their positions within normal PE harvest periods. The offering will lower 3G’s ownership stake in QSR from 51.3% to 47.5%.
During the September 2015 earnings call, CEO Daniel Schwartz announced a quarter of strong comparable sales performance across both the Burger King and Tim Hortons’ brands. According to Schwartz, recent success has been driven by successful product introductions and a continued focus on guest satisfaction. Specifically, Schwartz cited the introduction of the Extra Long Jalapeno Cheeseburger and Fiery Chicken Fries at BK and new breakfast and lunch wraps at TH. Behind the strength of these introductions, BK’s same store sales grew by 6.3% and TH’s same store sales increased 5.3% for the quarter. On the development front, the company has experienced net restaurant growth of 210 units, representing a 5.2% increase on a trailing 12 month basis.

Regarding TH’s expansion strategy, QSR has reached an agreement with their partners to establish around 150 TH locations over the next 10 years in the Cincinnati area. It will be interesting to see how the US consumer takes to the TH brand, which has seen much of its success in Canada and the Buffalo, NY area. This expansion effort speaks to QSR’s commitment to expand TH’s presence in the U.S. and possibly on a global scale. The success or failure of this Cincinnati area expansion will likely be the turning point for the TH brand in the U.S. and will be watched carefully.     
Current Economic Environment
According to data from Black Box Intelligence, restaurant industry traffic was down 1.7% in November, while average check sizes grew 2.0% for the month. Monthly same store sales growth shifted positively for the month at a rate of 0.5%.

For October, industry traffic fell 2.8% and same store sales dipped 0.2%; however, average check size rose 2.6% for the month. Higher pricing within the industry helped offset the lower traffic for the month.

Overall, substantial drops in commodity prices, declining gasoline costs, and lower unemployment suggest a stable environment - pointing to continued strength within the quick service restaurant industry. Additionally, the University of Michigan Preliminary Consumer Sentiment survey came in at 91.8 for December, an increase from the 91.3 November number. The survey recorded notable strength in personal finances and buying plans among consumers. The Sentiment Index has averaged 92.9 during 2015, which is the highest since 2004.  

Competitive Environment
While the quick service restaurant environment is certainly marked by fierce competition, CEO Daniel Schwartz made it clear during the Q3 earnings call that QSR doesn’t comment on their competition and their strategy doesn’t change regardless of how the industry is or isn’t performing. The emphasis continues to be on creating great guest experiences and running profitable restaurants. As evidence of this strategy, QSR remodeled 40% of restaurants in the system as of the end of 2014, and has slimmed down both BK and TH’s menus to be more operationally efficient. Additionally it is interesting to note that according to Credit Suisse research, there has been particularly strong positive same store sales correlations among the QSR industry leaders during times of accelerated growth, especially for the period of 2001-2011.     
What has the stock done lately? QSR has bounced around quite a bit YTD with a big run up in late September and early October after an optimistic earnings call for Q3. However, news of the stock buyback in December caused a slight decline bringing the YTD price change to -7.9%. In terms of valuation, QSR is currently trading with a P/E (NTM) of 28.2x compared with McDonald’s P/E (NTM) of 21.9x and YUM Brands P/E (NTM) of 20.4x.        

   Source: FactSet

My Takeaway

3G Capital’s divestiture and the subsequent share buyback is a minor blip on the radar screen for QSR. With the principle partners of 3G still invested, and two of the company’s other top shareholders, including Pershing Square and Berkshire Hathaway, it seems that some of the greatest minds in the investment world are behind Restaurant Brand’s story. The brand recognition of BK globally and TH in its Canadian home market, coupled with a 99% franchised model, should continue to drive shareholder value. A few key indicators for QSR going forward include the consumer spending environment, both in the U.S. and abroad, and also how the expansion of TH shakes out in the US. The result of crashing oil prices for consumers (i.e. lower gasoline and heating costs) could again make QSR a featured item in 2016 for investors!

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