Restaurant Manufacturers: Franchisee Struggles May Hamper Outcomes (QSR)

Regardless of inventory market turmoil in 2022, Restaurant Manufacturers (NYSE:QSR) shares have elevated almost 12% year-to-date as the corporate’s franchisor enterprise mannequin has produced steady outcomes. Going ahead the corporate sees alternative for continued unit development in its much less mature Tim Horton’s and Popeye’s manufacturers.

Whereas the Restaurant Manufacturers’s franchise enterprise mannequin has to date been insulated from inflationary stress, some franchisees are struggling. Whereas this is not a trigger for panic (but), wanting forward continued stress on franchisee economics might current issues (explored beneath) sooner or later.

Buying and selling at 22x 2023e EPS, Restaurant Manufacturers shares seem to cost in regular development going ahead. I see draw back threat if inflation persists and franchisee economics deteriorate additional.

Present Outcomes are Sturdy

For the third quarter of 2022, QSR has reported stable outcomes with income up and EBITDA growing (reported EBITDA was up 6%, 9% excluding the affect of Russia). Inflation has result in menu value will increase at Burger King, Tim Horton’s, Popeye’s, and Firehouse which has result in system-wide development in income and EBITDA.

As a franchisor, Restaurant Manufacturers costs franchisees a share of income (round 5%) so rising costs have bolstered its prime line as system-wide comparable gross sales have elevated 9% (whereas items have expanded extra reasonably).

Whereas system-wide gross sales have been up 9%, Burger King US has been a laggard with only a 4% enhance. Whereas menu value will increase have bolstered the highest line, transaction volumes have declined. Burger King prospects are usually lower-income and have been disproportionately impacted by inflationary stress. Whereas inflationary stress has proven a slight unfavourable affect (to date) on Restaurant Manufacturers, the identical can’t be stated for its franchisees.

However QSR’s largest US Burger King franchisee is not doing so effectively…

Whereas Restaurant Manufacturers outcomes have been resilient within the face of inflationary stress, the identical can’t be stated for its franchisees. As proven above, on its 3Q22 earnings name, Restaurant Manufacturers vaguely acknowledged that inflation is negatively impacting franchisee economics however did not get into the affect by model (Popeye’s, Burger King, Tim Horton’s) the magnitude of EBITDA declines. Thankfully, Restaurant Manufacturers’ largest US Burger King franchisee Carrols Restaurant Group (TAST) is publicly traded and provides a glimpse into simply how tough issues have develop into for franchisees.

Carrols operates over 1,000 US Burger King Eating places within the US (Carrols represents 14% of complete US Burger King eating places). Whereas Carrols’ top-line has elevated (and franchise charges paid to QSR have elevated) on account of value will increase, as proven beneath, the corporate has seen profitability evaporate as prices, significantly labor, have elevated at a quicker charge. By way of the primary 9 months, Adjusted EBITDA has fallen 40% year-over-year and the corporate has been working at a loss throughout 2022:

You will need to word that not solely is Carrols Burger King’s largest US franchisee however traditionally Carrols has been one in every of its greatest operators by way of long-term similar retailer gross sales efficiency. If Carrols is struggling it’s doubtless that smaller franchisees are going through related (if not higher) difficulties.

Additional, as proven beneath, Carrols carries a big debt load with web debt to trailing 12 month Adjusted EBITDA of almost 9x. Whereas we do not have visibility into the operational efficiency and monetary place of QSR’s different franchisees, I think that many are experiencing profitability challenges (given inflationary stress) and a few could also be encountering even higher steadiness sheet pressure.

Additional, as proven beneath, Carrols carries a big debt load with web debt to trailing 12 month Adjusted EBITDA of almost 9x. Whereas we do not have visibility into the operational efficiency and monetary place of QSR’s different franchisees, I think that many are experiencing profitability challenges (given inflationary stress) and a few could also be encountering even higher steadiness sheet pressure. The dramatic deterioration in outcomes has triggered Carrols share value to fall 75% prior to now 18 months.

How would possibly Franchisee Struggles affect Restaurant Manufacturers?

Ought to inflationary stress on franchisees persist, this might have unfavourable impacts on Restaurant Manufacturers. Whereas within the brief run, Restaurant Manufacturers can report steady outcomes no matter the underlying profitability of its eating places, within the long-term QSR’s success is inextricably linked to its franchisees. If circumstances stay tough or worsen, I anticipate we might see the next affect on Restaurant Manufacturers:

• Offering help to franchisees – this might take many kinds together with: momentary suspension of franchise charges, guaranteeing franchisee debt, or loans to franchisees. These impacts would negatively affect income or doubtlessly require capital (loans) from QSR.
• Closure of loss-making places – whereas restaurant closures are an ongoing actuality for franchisors (offset by opening), the big enhance in inflation and corresponding collapse in profitability might result in a lot bigger than regular restaurant closures would cut back franchise charges paid to QSR.
• QSR could should take over struggling places – ought to this happen, QSR would develop into the proprietor of those eating places (moderately than a franchisor). If QSR turns into the proprietor of extra eating places, it’s topic to inferior economics as moderately than clipping franchise charges it might bear the complete burden of restaurant possession. This might injury working profitability and likewise lead buyers to put a decrease P/E a number of on the enterprise.

Valuation & Conclusion

At 22x 2023e EPS, Restaurant Manufacturers inventory is priced for continued regular development in EPS. Whereas it’s doable that inflation will subside and franchisee profitability will rebound, I see draw back to Restaurant Manufacturers EPS and P/E a number of ought to franchisee difficulties develop into acute (both through restaurant closures or franchisee help). It’s tough to quantify exactly how franchisee struggles will affect QSR’s EPS given we do not know the extent of franchisee difficulties and/or how the corporate would search to mitigate these points. As an illustration offering mortgage ensures or precise loans would not essentially affect EPS whereas restaurant closures (and lack of franchise charges) would have a direct affect.

That stated, I feel the P/E a number of (presently a 15-20% premium to the broader market) might revert to a market a number of (~18x) or worse if buyers develop into extra involved about franchisee well being. Assuming a 5% decline in EPS and bearing in mind a decrease P/E a number of recommend 20-25% draw back.

Editor’s Observe: This text covers a number of microcap shares. Please concentrate on the dangers related to these shares.