Restaurant Brands: Additional Near-Term Growth Imminent (QSR)

Investment Conclusion

Based on recent quarterly results, Restaurant Brands International’s (NYSE:QSR) business is clearly outperforming. We were encouraged by the dramatic uptrend in sales, driven by: persisting momentum in Tim Hortons’ business, Burger King International’s return to the solid growth trajectory it was enjoying prior to the pandemic, Burger King U.S’s, rebound to same-store sales growth after a few quarters of declines, and upturn in Popeyes’ global sales, including those associated with domestic markets. Further, we were excited to note that gross profits and operating income increased compared to the prior year’s same quarter, fueled by sharply higher sales. In addition, although margins contracted on a year-over-year basis, in our opinion, the development was hardly unexpected given the inflationary environment associated with commodities and labor in the U.S., which remains QSR’s major market. Moreover, we were not overly concerned about the decline in earnings per share on a year-over-year basis, as it was driven by an increase in taxes based on a higher tax rate.

Over upcoming quarters, we anticipate that the sales momentum QSR experienced over recent quarters will continue, driven predominantly by the strong turnaround unfolding at Tim Hortons, which we believe will benefit from the return to normal routines in Canada, as pandemic-era restrictions were lifted roughly four months ago. Therefore, we expect the brand to experience pent-up demand, from customers seeking dine-in experiences, including office-goers turning to restaurants for breakfast, lunch, and afternoon refreshments. Additional same-store sales growth will be derived from: Burger King’s foreign business, where dine-in sales will continue to multiply even as delivery and take-out sales are sustained, the international businesses of Tim Hortons and Popeyes, which are positioned to outperform based on growth of the off-premise segment, even as dine-in transactions expand, and the rebound in Burger King’s U.S. business as funds are invested to foster solid long-term growth in sales and earnings.

Further, although we expect significant revenue leverage from dramatically higher sales to favorably impact margins, overall we anticipate margin contraction on a year-over-year basis, fueled by increases in commodity costs and hourly wages, and higher G&A expenses, as the company ramps on spending associated with technology, operations, and marketing, to secure the organization’s secular growth targets. Therefore, as a flow-through of substantial increase in sales and softer margins, we anticipate boosts in earnings and free cash flows, but at a rate of growth below that evidenced last year. With respect to new unit development targets, management believes restaurant footprint growth in FY2022 will outstrip that experienced over FY2021.

Longer-term, QSR represents a significant growth opportunity, as all four of its brands have substantial growth ahead of them, through international expansion. In that regard, Tim Hortons, Popeyes, and Fire House Subs, are barely penetrated in foreign markets, and although Burger King has a considerable presence outside the U.S., its footprint appears insignificant compared to McDonald’s (MCD), its closest competitor. In addition, management has indicated that all four brands, and particularly, Popeyes, have room to grow in home markets.

Beyond geographic expansion, additional advancement in retail sales, in form of same-store sales growth, is likely to be derived from greater convenience, menu innovation, and loyalty programs. Higher retail sales will reflect in revenue leverage, resulting in margin expansion at the restaurant level and corporate level. In addition, margins will continue to benefit from economies of scale related to procurement of commodities, corporate overhead, technology, the digital platform, and advertising. As a flow-through, profits and free cash flows are likely to surge, on a secular basis.

Given that F2Q2022 results have not altered our long-term outlook on QSR, we remain constructive on the company. Therefore we’re reiterating our 1-year Price Target of $101/share and Buy Rating for the stock. Please note that there is upside to our Price Target as it ignores potential earnings from the acquisition of Fire House Subs. (Please go through our initiation report “Restaurant Brand International: Significantly Under Valued – Buy On Growth Plans” and related notes for our long term opinion on the stock).

Key Take-Aways From The Second Quarter

F2Q2022 Results Summary. For the quarter, retail sales came in at ~$10.1 billion (+14.2% compared with F2Q2021), revenues were ~$1.64 billion (+14% on a year over year basis), above consensus estimates of $1.57 billion, and earnings per share was $0.77 (negative 8.4% compared to F2Q2021), beating analyst projections of $0.73. In addition, comparable sales increased: by 12.2% at Tim Hortons, by 10% at Burger King, and by 1.4% at Popeyes, during F2Q2022. Net income for the period was ~$236 million, reflecting a decline of 11.6% over the previous year’s same quarter. Cash flows from operations and free cash flows were ~$669 million and ~$1.56 billion, for three months ended F2Q2022.

Tim Hortons Leaning On Menu Innovation To Support Turnaround. With same-store sales growth of 14% on a year-over-year basis and 2% compared to F2Q2019, Tim Hortons’ business is clearly on the mend. The key drivers of the outperformance have been core breakfast items, coffee and baked goods, but also specialty and cold beverages, as well as lunch and dinner offerings. In that regard, over three years, the food segment per se has grown by 30%, the specialty coffee and cold beverage category has expanded by 12%, and the lunch segment has advanced by 8%. In addition, on a year-over-year basis, dinner was the fastest growing segment during the second quarter.

Considering that the PM category (lunch, dinner, and late night) combined represents a ~$8.5 billion opportunity, growing at a CAGR of 5%, with Tim Hortons share at 4%, QSR is highly focused on rapidly developing the coffee chain’s presence in the market. To achieve the objective, Tim Hortons previously launched hot and cold sandwiches, and in May introduced its Loaded Platform, debuting its Loaded Wraps in two flavors, Cilantro Lime and Habanero Chicken. Then, on June 15, the brand debuted Loaded Bowls, prepared fresh to order, comprised of hearty grains, chicken, and green sauces.

Given that the Loaded Platform fare is premium priced and presents Tim Hortons with an opportunity to reengage with existing customers and drive usage of its products among younger guests, we are encouraged by the consumer attention the offering is enjoying. Consequently, we expect the Loaded Platform’s sales momentum to continue to expand over the near-term and long-term. In addition, based on its ubiquity in Canada, its perception of value among customers, and its standing as a much loved brand, we believe Tim Hortons is well positioned to capture a significant fraction of the PM food market, within a few years.

Burger King U.S. Turnaround Is Key Focus. Initiatives implemented to improve Burger King’s financial performance in its home market, have generated some traction, with the brand, during F2Q2022, narrowing the same-store sales shortfall it has experienced relative to the competition, and increasing system sales. In addition, policies supporting: simplification of menu preparation, improvement in the customer’s digital experience, and the integration of the loyalty program and marketing activities, have reflected in substantial escalation in guest satisfaction scores, over the recent four quarters. However, management appears dissatisfied with the pace of recovery, and with the objective of generating additional momentum, is committed to making large investments in the business, details associated with which will be announced at the National Franchise Convention, in early September.

Nevertheless, the brand’s international business is outperforming, somewhat offsetting losses associated with the domestic enterprise. The pandemic era growth in off-premise sales supported by drive-thrus, delivery, and carry-out, is being bolstered by the upturn in dine-in sales, as folks are out and about, resulting in sales outperformance, in Western Europe, particularly in Germany, France, and the U.K., and in Latin America, specifically in Spain and Brazil. Based on company data, it appears that the sales growth is driven by a solid shift in customer behavior favoring out-of-the-home dining, rather than based entirely on the uptrend in mobility.

In regard to financial results, it is noteworthy that during the second quarter, Burger King’s overseas business accounted for 60% of the brand’s total global sales and 55% of adjusted EBITDA. Further, foreign system sales expanded by ~$600 million, representing a year-over-year growth of 28%. Considering the recent outperformance, it appears that Burger King’s international business has returned to the strong growth trajectory, it enjoyed prior to the viral outbreak. We are encouraged by the developments.

Popeyes’ Development Engine Continues To Deliver. During F2Q2022, supported by 8.1% growth in the brand’s restaurant footprint, derived from restaurant launches in Turkey, Spain, India, and the U.K., on a year-over-year basis, system sales expanded by 10%, with a solid rebound in U.S. sales, which advanced by 6%. Based on management commentary, FY2022 global new unit development is on track to exceed FY2021 levels. In addition, with respect to North America, a majority of new units will have drive-thrus, which typically generate sales 10% higher than the system average. Outside of the U.S., Popeyes has experienced year-to-date new unit development growth in high single digits. Further, the brand garnered significant interest from potential partners in the U.K., Mexico, and the Middle East, during the second quarter.

Given that geographic diversification is the brand’s primary growth driver, we are encouraged by the rapid growth in restaurant footprint unfolding in home markets and in international territories.

New Unit Development To Ramp During The Back-Half. During the F2Q2022 Earnings Call, management indicated that they expected global footprint growth for the year to outstrip FY2021’s record development. In that respect, it is noteworthy that over the second quarter, QSR’s number of global restaurants increased by 4.1%, with Tim Hortons, Burger King, and Popeyes growing by 5.7%, 2.8%, and 8.1%. Further, the combined global restaurant base of Tim Hortons’ and Popeyes’ restaurants advanced by 20%.

In regard to Tim Hortons, following the merger of SPAC Silver Crest with Tim Hortons China, the plan is to develop the brand’s presence in China to ~3,500 stores over the next five years, from the 410 that were operating at the end of F1Q2022. In addition, discussions are ongoing with development partners in the Middle East, the U.K., Mexico, and India. In the context of Popeyes, top leadership commentary suggests a shift in new unit development targets, with North America as much in focus, as international locations. Importantly, the group is garnering significant interest from master franchisees from across the globe, specifically from those based in Brazil, Spain, the Philippines, the U.K., Mexico, the Middle East, and India. With respect to Burger King international, development plans are somewhat delayed as China and Russia, where most of the foreign new units were to be launched, are currently unaccessible, due to the zero-COVID policy in China and the war in Ukraine. Burger King U.S.’s footprint growth targets are likely to revert to historical levels, once regulatory delays, and supply-chain bottle necks disappear.

Considering that QSR’s brands enjoy amongst the best unit economics within their industry, we are glad that their accelerated new unit development plans are on track, for the most part.

Balance Sheet Remains Strong. At the end of F2Q2022, the company had a cash and cash equivalents balance of ~$838 million and long-term debt of ~$12.9 billion on its balance sheet. QSR’s debt to EBITDA ratio at the end of the period was 5.4x, below the prior quarter’s figure, and inline with associated covenants. QSR can borrow an additional ~$998 million to fund operations under a revolving credit facility, it has available. Given its funding position, we believe that the company has sufficient resources to fund operations and execute on its accelerated new unit development strategy for the year. QSR declared a dividend of $0.54/share for the second quarter.

Bottom Line

QSR is clearly on a roll. Its Tim Hortons’ business is firing on all cylinders, with more juice upcoming based on the roll-out of Phase 2 of the turnaround initiative. The firm’s international business, on the whole, is outperforming. QSR along with its franchisees is solidly behind investing heavily in Burger King U.S. to ensure that the business recaptures and then accrues market share from the competition. Based on strong franchisee interest (as QSR is 100% franchisee driven) new unit development has been at record levels, with pipelines across all four brands, planned many years into the future. Overall, given business dynamics, QSR at the present moment, appears invincible. Therefore, we believe that investors that build positions at current levels, are likely to be rewarded handsomely, as the stock breaks-out over the next couple of years.