Restaurant Brands Q1: Doing More With Less

| About: Restaurant Brands (QSR)
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Restaurant Brands reports Q1 2016 Results.

Same-store sales were strong (but the outlook is more muted).

Cost reductions at Tim Horton’s proved to be a key driver of earnings growth.

Restaurant Brands Q1: Doing More With Less

Restaurant Brands (NYSE:QSR) or "RBI" reported Q1 2016 results on April 28th, 2016. The quarter continues to demonstrates the ability of management to not only improve operational efficiency but to growth overall systemwide sales as well. While both brands continue to deliver good same-store sales growth, Burger King ("BK") is in the midst of a very promotional competitive environment. Fortunately, operational improvements and new product introduction at Tim Hortons ("TH") are resonating well will customers.

This report will review Q1 2016 results, compare sales to key competitors, and offer some takeaways for investors.

Quarterly Review

Over last several quarters at RBI, revenue has faced the headwind of a rising U.S. dollar - or more specifically, a declining Canadian dollar, which impacted the translation of sales at TH. As a result, total revenue declined 1.6% despite global systemwide sales increasing 7.9% and 10% at TH and BK, respectively. Adjusted EBITDA increased 22.9% and the EBITDA margin increased from 38% to 44.5%.

Management did a great job reducing costs y/y. Cost of Goods Sold declined 10% and G&A declined 25% while, as mentioned, systemwide sales increased at both brands. Much of this can be attributed to success at TH, which did much of the heavy lifting in the quarter

At TH, same-store sales increased 5.6% - 5.6% in Canada and 5.8% in the U.S. Both geographies benefited from new products such as the croissant breakfast sandwich and grilled wraps and ongoing strength in beverages. International same-store sales growth accelerated to 6.8% from 0.6% last year. TH Adj. EBITDA increased 35% y/y.

Management attributed cost reductions to three factors (in no particular order): a) growing retail business, which delivers a higher margin; b) transitioning some restaurants partially owned by TH to a normal franchise agreement, which eliminates lower performing stores from the financial statements; and c) cost reductions in the supply chain business.

At BK, same-store sales increased 4.6% and Adjusted EBITDA increased ~10%. The domestic business is working through an intensely promotional environment - the "burger wars". While items like Grilled Dogs helps differentiate the brand, it seems management must keep returning to value-focused bundles in order to compete and drive check/ traffic.

As a result, management gave a cautious outlook - sales had slowed in April. This was later confirmed by other quick-serve restaurants. That said, one quarter does not make or break an investment thesis and BK has weathered a variety of slowdowns during its turnaround. This remains a very clever marketing team.

Accelerating Expansion

On the conference call, management highlighted their intention to accelerate unit growth at both bands throughout the year. TH has a pipeline of potential units that is growing slowly but methodically - new agreements in Ohio and Indiana suggest management is being very selective building the foundation for future growth.

At BK, the unit-expansion story is a bit more interesting. We know that new development agreements in Spain, Germany and Italy along with the conversion of Quick restaurants in France will add to international growth. Domestically, however, it appears management is setting up for a potential unit expansion. In March, the WSJ noted management's intentions to accelerate growth of BK brand in the U.S.

Alex Macedo, the president of Burger King North America, said in an interview that he sees the potential to add thousands of new Burger Kings in the U.S. in the next five years.

This would be surprising as RBI had been shedding underperforming stores - in Q1 net restaurant growth in U.S. and Canada was negative 26. Arguably, BK has a much more compelling proposition for potential franchisees today than a few years ago. First, AUVs have grown to ~$1.3 million and the menu rationalized. Second, a successful modernization program demonstrates the brand is resonating with consumers. Third, domestic franchisees are earning an incredible 20% operating margins - stores are more profitable than ever.

If successful, this would provide another lever to support top-line sales momentum.

Refinancing Opportunity

The final point that deserves some attention is the opportunity for RBI to refinance preferred equity into debt. In early April, an analysis by RBC Capital Markets indicated this could save RBI about $0.35 per share in 2018. Through a combination of debt repurchased and borrowing at a lower rate, RBI would increase interest expense by ~$100 million while eliminating $270 million preferred dividend.

In my view, we'll need to see either a substantial increase in EBITDA to support another $2.5-$3 billion in debt (i.e. the value of the preferred equity) or significant debt repayment from now until 2018.

Relative to Peers

TH continues to deliver good sales growth relative to its peers Starbuck's (NASDAQ:SBUX), Dunkin' Donuts (NASDAQ:DNKN) and Panera Bread (NASDAQ:PNRA).

Likewise, BK is holding its own as it battles through the burger wars against McDonald's (NYSE:MCD) and Wendy's (NYSE:WEN).

Investment Takeaways

Here are 4 key investment takeaways:

  • In my view, the quarter continues to highlight that this is more than just a cost-cutting story. Sales growth is good and the unit expansion opportunity represents a long runway.
  • With Debt/ EBITDA at ~4.5x, I'll be looking to see that management reduces debt throughout the year. While EBITDA is growing nicely, I'd love to see debt start declining consistently.
  • The domestic BK unit growth story would be a new lever; most analysts had expected BK units to slow and TH to pick-up the baton.
  • The cost reductions at TH were very impressive - RBI continues to show they can do more with less. Amazingly, they've only owned the business for less than 18 months.

Disclosure: I am/we are long QSR, DNKN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.