John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
Shares of Restaurant Brands International Inc. have cooled off considerably after the owner of Tim Hortons and Burger King made a sizzling debut with investors.
The shares began trading in December at $41 on the Toronto Stock Exchange (they're also listed on the New York Stock Exchange) and zoomed to $56.61 by early March, for a gain of 38 per cent. Since then, however, it's been largely downhill.
I sold my shares in Tim Hortons around the time the merger with Burger King was announced (read my column here tgam.ca/EEmF). But with Restaurant Brands well off its highs – and a full quarter of earnings under the company's belt – today we'll take another look at the shares.
Growing – but still tiny – dividend
One reason I sold my Tim Hortons shares was that the combined company, with about $12-billion (U.S.) of debt initially, was probably going to be more concerned with paying interest than dividends. That turned out to be true: The shares currently yield just 1 per cent, which isn't enough to get me interested as a dividend investor. On an encouraging note, the company boosted its dividend by 11 per cent when it announced first-quarter results in April – to 10 cents (U.S.) a quarter from 9 cents. That's a step in the right direction, but it would take years of similar increases before Restaurant Brands is paying out meaningful amounts of cash. As a dividend growth investor, I like to see a relatively high initial yield combined with regular and substantial dividend increases.
Impressive results so far ...
If you've been to Tim Hortons lately, you may have noticed that the chain has been raising prices for everything from coffee to sandwiches. This – along with new product launches and more aggressive advertising – helped the chain to achieve a blowout first quarter. Tim Hortons' same-store sales soared 5.3 per cent – the best performance in three years – while Burger King's same-store growth was the highest in seven years at 4.6 per cent. I had long believed that some of Tim Hortons' menu items were underpriced, so charging more was a quick and easy way to boost same-store sales. But in an intensely competitive fast-food market, there's a limit to how much consumers will tolerate. For Restaurant Brands, maintaining such strong sales momentum could be a challenge in coming years.
... but rich valuation
Even after the recent drop in the stock price, Restaurant Brands is trading at about 40 times estimated 2015 earnings and 35 times 2016 estimates. Those are lofty price-to-earnings multiples that imply strong growth in the company's bottom line over the next couple of years. Even with the stellar management and legendary cost cutting of Restaurant Brands' owner 3G Capital, however, delivering results that live up to the optimistic expectations built into the share price won't be a slam dunk. We've already seen investors temper their enthusiasm, as illustrated by the stock's pullback from its recent high.
The bullish case
Restaurant Brands still has plenty of fans. Analyst Stephen Boland at Vancouver-based Odlum Brown says 3G has an "outstanding track record" that included turning around Burger King's fortunes by focusing on franchising.
"Burger King is now essentially a franchisor that collects royalties from store owners. Franchising is an attractive business model with minimal capital requirements, robust cash flows and a high return on equity," he said in a note. By adding Tim Hortons to the mix and aiming to accelerate the Canadian chain's U.S. and international expansion, "this could be the early days of a large, global company with multiple restaurant banners," he said.
Others say the high P/E paints an incomplete picture. Effie Wolle, chief investment officer with Toronto-based GFI Investment Counsel, which owns Restaurant Brands shares, said the company is trading at a more reasonable "low 20s" on a multiple of estimated 2015 free cash flow. With cash flow expected to rise steadily through a combination of cost cutting and sales growth, the stock's multiple based on 2017 estimates is in the "high teens." "When everything is right about an investment … our logic is that paying up slightly on a multiple of cash flow is well worth it," he said.
Closing thoughts
Restaurant Brands could well turn out to be a great long-term investment. But I'm staying on the sidelines for now given the stock's low dividend yield, high valuation, elevated debt levels and uncertain growth trajectory.