Restaurant Brands NZ (NZSE:RBD, Financial) (ASX:RBD, Financial) (RTBRF, Financial), together with its subsidiaries, operates quick service and takeaway restaurants in New Zealand, Australia, California, Hawaii, Saipan and Guam. The company is a corporate franchisee of the KFC, Pizza Hut, Carl’s Jr. and Taco Bell brands in New Zealand; the KFC and Taco Bell brands in Australia and California; and the Taco Bell and Pizza Hut brands in Hawaii, Guam and Saipan.
Below is a geographical breakdown of where the company earns its money:
As of December 2021, Restaurant Brands NZ had 359 locations. It is controlled by Mexican private equity investor Finaccess Capital SA de CV, which has a controlling stake in the company after acquiring three quarters of the company’s shares.
Since it's a corporate franchisee, there's not really any case that can be made for the company innovating, developing new products, etc. However, we can make a case based on value and reversion to the mean. Let's take a look at why I believe Restaurant Brands NZ has the potential to triple going forward.
Owner's earnings
I came across this company when looking for companies which have consistently grown their free cash flow and owner's earnings over long periods, but which have seen their stock price fall significantly below the trendline due to temporary issues. I believe this makes the stock a good candidate for a reversion to the mean strategy.
Restaurant Brands NZ's owner's earnings per share has increased by 13% per year on a compounded annual basis in the last 10 years (which includes the pandemic period).
Owner's earnings is a cash flow concept popularized by Warren Buffett (Trades, Portfolio) in his 1986 Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) company letter to shareholders. At that time, companies were not required to produce a cash flow statement, nor was stock based compensation recorded as a big non-cash expense. Buffet explained owner's earnings as follows:
"Owner's Earnings = (a) Net Income plus (b) depreciation, depletion, amortization, and other non-cash charges minus (c) average annual maintenance capital expenditures."
Historical operating results and growth
As can be seen from the table below, the company has produced very good results over the 10-year and five-year periods but has suffered in the one-year period because of the whiplash effect of Covid, mainly due to inflation and labor shortages. This can be seen in the earnings per share line as 10-year growth is 6.4% per year while one-year growth declined almost 40%. I believe this to be temporary issue, and the company's earnings should return to trend in the next couple of years. Management said that it was mitigating the impact of inflationary pressures by cutting costs and increasing prices. The CPI increased 7.2% annually in the September 2022 quarter in New Zealand.
| Growth Rates (Per Share) | Annual (Year End) | |||||
| Fiscal Period | 10-Year | 5-Year | 1-Year | 19-Feb | 20-Dec | 21-Dec |
| Revenue | 11.40% | 15.90% | 6.00% | 824.92 | 892.36 | 1,068.25 |
| EPS without NRI | 6.40% | 8.40% | -39.60% | 0.288 | 0.248 | 0.416 |
| EBIT | - | - | -318.20% | 56.23 | 51.44 | 72.63 |
| EBITDA | 10.30% | 19.40% | -56.90% | 88.58 | 119.5 | 157.79 |
| Free Cash Flow | 14.30% | 9.00% | -56.80% | 34.33 | 51.31 | 40.92 |
| Dividends | - | - | - | 0.18 | ||
| Book Value | 17.00% | 19.40% | 4.30% | 1.8 | 1.85 | 2.32 |
| Price (Total Return) | 9.70% | -3.50% | -58.90% | 8.79 | 11.55 | 13.8 |
One New Zealand dollar is currently around $0.64. The New Zealand dollar has declined substantially vs. the greenback over the last couple of years, but I expect it to rebound as global inflation eases.
Balance sheet and debt
Restaurant Brands NZ's balance sheet is quite strong with total debt of NZ$291 million and equity of NZ$282 million. The company had to take on debt to survive the lockdowns during the pandemic. While GuruFocus is giving the company a low financial strength rating of 2 out of 10, I don't believe it's as bad as all that because most of the company's debt being considered is actually long-term lease liabilities for its restaurant real estate. Total long-term debt is only about NZ$196 million when excluding these lease obligations. Total bank debt at the end of the half year was $290.6 million compared to $246.9 million at the previous year's end. Given the company's 2021 operating profit of about NZ$102 million, this is not onerous at all.
In terms of loans, Restaurant Brands NZ has renewed its current bank lending facilities, the majority of which were due to expire in April 2023. Restaurant Brands NZ has bi-lateral committed bank debt facilities totaling approximately NZ$370 million. The facilities are split between NZD, USD and AUD tranches with a mix of four and five year tenors. The lending facilities are on similar terms to Restaurant Brands NZ's previous banking arrangements and will be used to repay existing facilities and for general corporate purposes.
Summing up, the debt position and balance sheet are solid in my view.
Dividends
Restaurant Brands NZ's current dividend yield is 5.75%. The dividend was suspended during the beginning of the pandemic but has now been reinstated. Historical earnings and dividend information for the company is listed below (the currency is NZD). For non-resident foreign shareholders, dividends paid are subject to a 30% non-resident withholding tax to the extent they are not fully imputed.
| Feb 2018 | Feb 2019 | Dec 2019 | Dec 2020 | Dec 2021 | |
| Earnings per share (full year) | 28.8c | 28.8c | 24.1c | 24.6c | 41.6c |
| Ordinary dividend per share | 28.0c | - | - | - | 32.0c |
Recent results
Restaurant Brands NZ's total sales for the third quarter ended Sept. 30, 2022 increased to NZ$322.2 million (up 32.3% over the equivalent period last year), as sales recovered from the impacts of the Covid-19 restrictions in New Zealand and Australia.
Worldwide inflationary pressures have continued from last quarter, with the company still experiencing significant cost inflation across all regions. The company continues to implement price increases where possible in response to these increased costs.
Total year to date sales reached NZ$907.1 million (an increase of 15.7% on the prior year). Total sales were supported by the inclusion of 20 new stores (to 372 stores in total), lower levels of Covid-19 disruption and the strengthening U.S. and Australian dollars over the prior year.
Valuation
The company has not released full-year 2022 results as of yet. In its interim report for 2022, the company noted that "the continued impact of inflation as well as the rolling issues with Covid-19 makes it difficult to provide firm profit guidance; however the reported net profit after taxation for the 2022 year is expected to be in the range of $32-37 million." This puts the forward price-earnings ratio at about 18, which is lower than its 10-year median price-earnings ratio of 25.
The GF Value chart, an intrinsic value estimate from GuruFocus that uses the stock's historical price multiples, past returns and estimates of future business performance, rates the stock as a "value trap." However, after looking at the company in detail, I think it's undervalued, not a value trap.
The share price was over NZ$15 before the pandemic struck. I expect the price to not only get back to that level but to exceed it in the next three to five years.
Conclusion
I think Restaurant Brands NZ is undervalued based on a reversion to the mean analysis. Past results have shown that the company has the ability to compound capital, as shown by the growth of its revenue, free cash flow and owners earnings. The company pays a solid dividend of well over 5%, which has now been restored.
The company's stock has been sold down by investors because of what I think are temporary issues like inflation and labor shortages, which should eventually be brought under control. In addition, I believe the New Zealand dollar to be undervalued compared to the U.S. Dollar. I think the closing in NZD value to USD value could provide further upside to the stock.
The company has recently installed a new CEO and chief financial officer to galvanize results in the pandemic recovery. I am reasonably sure that the private equity owners will be putting the pedal to metal to accelerate earnings because right now, the stock is far below the amount they paid for it in 2019.
