Bill Ackman (Trades, Portfolio) made headlines in February when he revealed a short position on the market, which he eventually covered, netting over $2 billion from the trade.
Since then, Ackman has been advocating that investors buy shares of high-quality companies. The restaurant industry is one of the hardest-hit sectors of the market, which is understandable considering that the lockdown has brought the business operations of many of the companies in this industry to a standstill. Even though this is not encouraging news for investors, Ackman seems to have taken a liking to one of the leading names in this space, Restaurant Brands International Inc. QSR.
The guru has been an investor in Restaurant Brands since 2012. On May 4, Pershing Square, the hedge fund managed by Ackman, announced an increase in its stake of Restaurant Brands to 9.6% of total outstanding shares, up from 6.6% in December 2019. This increase in ownership indicates that the Guru thinks the shares are undervalued.
Business structure
The company operates under three brands: Burger King, Tim Hortons and Popeyes. The business is structured as a franchise operation, so Restaurant Brands collects royalties on sales.
This helps the company navigate difficult times better than a company that owns and operates a chain of restaurants. For instance, Restaurant Brands does not need to incur any capital expenditures to keep the stores in working condition, as this burden falls on the individual location operators. This positions the company to have a better chance of surviving the recession, even if sales decline drastically.
Both Burger King and Popeyes operate drive-throughs, which is another characteristic that will help the company during these trying times. Because of the social distancing policies implemented by governments, restaurants will not be allowed to operate at maximum capacity. However, the negative impact on the company will be limited as an uptick in delivery and drive-through sales is expected in the coming months.
Tim Hortons is also expanding into both these distribution channels as well, in light of the bleak outlook for the dine-in segment. This is a positive development for the future of this brand, as Americans still prefer drive-through eating over getting their food delivered.
Source: The Wall Street Journal
In the first-quarter earnings conference call, CEO Jose Cil said:
“In this environment, a drive-through window is a great option for so many people who want to limit physical contact. And from guests that can’t access our drive-throughs, we are rolling out new curbside pickup options on our mobile apps in North America.”
Ackman's expertise
Warren Buffett (Trades, Portfolio) famously said, “Never invest in a business that you can’t understand."
Ackman has lived by this advice for decades. The guru has a preference for investing in restaurants, and this sector accounts for the bulk of his current portfolio, as depicted below.
Source: GuruFocus
Kenneth Squire, the founder of 13D Monitor, recently evaluated Ackman’s performance in the restaurant industry and wrote:
“Pershing Square has an extensive and successful track record investing in restaurants. The firm made six previous investments in this industry and has never lost money on any of them. Of the four that were 13D filings, they have averaged a 55.22% return versus 17.57% for the S&P 500.”
This stellar track record is, in my view, sufficient proof that he has a deep understanding of the dynamics driving this industry.
Promising outlook
According to first-quarter filings, the company operates over 27,000 stores in more than 100 countries across the world. The company reported encouraging numbers for the first quarter, but the true impact of the recession will only be seen when second-quarter numbers are reported, as many countries went into lockdown in the later half of March.
Investors may assume that almost all the restaurants operated by the company are closed due to the lockdown, which is far from the truth. As confirmed by management, the majority of Restaurant Brands' restaurants are still open in the following percentages:
| Region/country | Percentage of restaurants that are open |
| The United States | 95% |
| Canada | 85% |
| Asia-Pacific | 80% |
| Europe, the Middle East, and Africa | 40% |
| Latin America | 50% |
Source: Company filings
Going by this data, I think it’s reasonable to assume that the hit to company earnings might not be as devastating as some investors fear.
Management went on to confirm that week-over-week sales are picking up in both the U.S. and Canada as some states are beginning to ease lockdown restrictions. The trend will likely continue through the end of the year.
The long-term prospects of the company will rely on its store openings and same-store sales growth. Both these factors were trending positively before the recession. For instance, in 2019, total sales grew by 8%, supported by unit growth of 5% and same-store sales growth of 3%.
In the next decade, the company plans to increase the global store count to 40,000. These new openings should help the earnings growth of Restaurant Brands as comparable sales figures are still in a growth phase.
Shares are undervalued
According to Morningstar data, Restaurant Brands shares have traded at an average earnings multiple of 34.36 in the last five years. The 20% decline in the share price this year has contracted the price-earnings ratio to just 22, which is a significant discount to the historical mean.
This alone is not an indication of a possible undervaluation. However, I believe the company can be expected to weather this recession and come out stronger in 2021, which would lead to the resumption of its growth story. Considering this outlook, I rate the stock as a undervalued.
Takeaway
Ackman is betting on Restaurant Brands to stage a recovery in the next couple of years. Sales might not decline as much as some investors believe, and if that is the case, the long-term outlook for the company could be even better than expected.
Disclosure: I do not own shares of any company mentioned in this article.
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