RBD - Restaurant Brands

[Snoopy]

Pizza Hut has been turned around with the best “Concept EBITDA” since 2006. Starbucks EBITDA was the best ever in FY2015. Both of these divisions have dragged down the overall company result in previous years. At KFC the store transformation program, begun in FY2005, is 90% completed. However, the fact that all three established divisions are performing in one year does not mean we can assume they will do so in future years. The past earnings trend just isn’t good enough. This means we cannot use the Mary Buffett ‘growth model’ to estimate the future value of this share. I propose we use the average dividend paid, expressed as a dividend yield, to value this share instead.

Discl: hold RBD, but not because Warren Buffett would approve!

A significant progression has occurred since Restaurant Brands have shifted outlook from becoming a 'domestic franchiser' to an 'international restaurant developer'. The point of failure in the 'Buffett Tests' is now the seemingly ever decreasing net profit margin. To give this some context, I have stacked up the profit margin trend against the company that develops the KFC concept in China, YunChina (YUMC). YUMC is twenty times the size of RBD and operates in a different market. Nevertheless, the underlying mode of operation, developing new outlets for the master franchise holder in the US - YUM brands - is the same. Furthermore I have calculated the Net Profit Margin for the most recent half year reporting period for RBD:

$21.853m / $445.848m = 4.9%

and added that to the trend comparison. Note that I am comparing the RBD year that ends in March with the YUMC year that ends in December. The best overlap is to consider the RBD FY2018 year ending 31st March 2018 with the YUMC year ending 31st December 2017, So this is what I have done for all years

	FY2014	FY2015	FY2016	FY2017	FY2018	HY2019
Restaurant Brands Net Profit Margin	5.7%	6.0%	6.0%	5.9%	5.3%	4.9%
YumChina Net Profit Margin	4.1%	3.7%	5.4%	7.0%	8.3%

What can explain the two apparently diverging trends? The low profitability of YUMC in FY2013 and FY2014 can be explained by a supplier food handling scandal. In FY2014 that saw a same store sales decline of up to 40% at some KFC outlets. FY2015 was a period spent rebuilding from this. So it is the FY2016, FY2017 and FY2018 net profit margins are reflective of what shareholders might expect without these adverse conditions at YumChina.

By contrast at RBD, FY2017 and FY2018 are the periods where the great overseas expansion strategy was coming into play. In AR2018 p26 and p27, CEO Russel Creedy gives a candid interview. He says that to gain the 'growth' required for the company's strategic vision, to become a billion dollar company in revenue and market capitalization, it was necessary to buy that growth by investing overseas. Yet later in that same interview he admits that:

"Our growth strategy also includes new store builds which incidentally generate the highest return in investment."

Putting the two comments together, it is clear that growth overseas where you are generally buying stores rather that building them is less profitable. Sure Taco Bell in Hawaii has a high EBITDA as a percentage of sales at concept level. But this does not include the extra interest costs incurred in funding the purchase, nor the extra more bloated corporate structure behind the scenes needed to manage it. The RBD growth strategy contrasts very greatly with YumChina who develop all their own stores from scratch.

The ROE decline at RBD mirrors a similar pattern, although there are signs it has stabilized near 20%. This is still a good figure in absolute terms, albeit well down on 30% that was regularly attainable when RBD was an NZ focussed business. Yet so great has been the drop against a background of the NZ side of the business doing well, I think questions need to be asked as to what the ROE is on the overseas side of the business, and just how far above the cost of capital are these overseas business returns?

Taken overall it looks like RBD are on a path of increasing profits, even in eps terms, but decreasing profitability.. Are there shades of Buffett's much derided management phenomenon of the 'institutional imperative' at work here? The naval analogy of the 'institutional imperative' is that our 'captains of industry' would prefer to skipper a battleship, even one with dis-functional weapons than a smaller well armed frigate.

It is possible that RBD will be able to turn their overseas investments around, with more green field KFC projects in New South Wales and a rebuild program in Hawaii that will revamp that states restaurants so that earnings double in that state. However talk that RBD will instead look to acquire more existing restaurants on the West Coast of the United States as their prime growth plan would argue against the positive overseas growth outcome. I think Warren Buffett would be waiting to see if the overseas strategy was not going to degrade the profitability of RBD too much before investing his own money in the RBD story going forwards.

SNOOPY

discl: hold RBD myself, but bought many years ago