QSR (QSR, Financial)’s total shareholder return declined 1% during the third quarter and by 7% year to date. Despite the stock’s performance, overall results remain strong, as free cash flow per share growth has increased more than 30% this year due to a combination of positive same-store stores growth, strong net unit growth and a substantial benefit from last year’s refinancing of high-cost preferred stock. We attribute the weakness in the company’s share price to investor concerns regarding the ongoing slowdown in same-store sales at Tim Hortons, which were flat in 2017 and have not yet shown a meaningful improvement in 2018.
We remain confident that QSR can return Tim Hortons to a healthy level of same-store sales growth over time. Earlier this year, QSR replaced the prior management at Tim Hortons with the same team that had previously improved same-store sales results at Burger King several years ago. The company also announced a new operational plan, entitled “Winning Together,” which incorporates a variety of initiatives including menu innovation, enhanced marketing, store re-imaging, and investments in digital technology. While Tim Hortons’ management has just started to implement some of these new initiatives, same-store sales growth this quarter improved from the first two quarters of this year. We expect continued improvement as the new management team implements more of the recently announced initiatives.
While the market is focused on near-term same-store sales results at Tim Hortons (to an excessive extent in our view), we believe it is overlooking the sizeable long-term unit growth opportunity at each of QSR’s brands:
- Burger King’s fast growing international business is still much smaller than competitor McDonald’s, which has more than three times the numbers of international stores.
- Tim Hortons’ U.S. business is a fraction of the size of Dunkin’s, which has almost ten times the number of U.S. stores. In addition, Tim Hortons is beginning to expand internationally, including a recent franchise agreement to add 1,500 stores in China (~30% of the current store count), which we believe highlights the power of the brand’s overseas potential.
- Popeyes has a small store count compared to KFC, which has close to eight times the number of total stores.
Moreover, QSR’s deep network of global franchisee partners who have successfully opened stores under one of the company’s brands provides an advantage in accelerating unit growth for other brands in QSR’s portfolio. The company’s ability to continue to close the current store count gap with each of its brand’s closest peers should allow it to maintain its current 6% net unit growth rate for many years to come. We believe that QSR’s unit-growth potential underpins a long-term earnings growth rate in the mid-teens, and should allow the company to maintain strong earnings growth even during a period of weaker same-store sales results.
Despite the high-quality nature of QSR’s capital -light business model and its significant long-term growth potential, the company’s shares trade at only 19 times our estimate of next year’s free cash flow per share. The current multiple is one of the lowest since our initial investment in the company and is significantly below that of its capital-light peers, such as McDonald’s, Yum! and Dunkin, which have lower unit-growth potential and trade at an average of 24 times analyst estimates of next year’s free cash flow per share. As QSR continues to make progress on same-store sales growth at Tim Hortons and maintains its high level of unit growth, we believe the company’s share price will appreciate significantly from current levels. Management appears to share our view of the company’s undervaluation as the company recently repurchased $560 million of common stock.
From Bill Ackman (Trades, Portfolio)'s third-quarter 2018 Pershing Square shareholder letter.
