WEEKLY STOCK COMMENT: RESTAURANT BRANDS
Roy Davidson, 8 March 2018
Restaurant Brands (RBD) is one of New Zealand’s major fast food franchise operators. The company operates the KFC, Pizza Hut, Carl’s Jr. and Starbucks brands along with providing support to New Zealand’s independent franchisees. The company recently acquired a number of KFC stores in Australia, closely followed by the operations of Taco Bell and Pizza Hut in Hawaii.
The KFC business is the flagship brand of the RBD stable. The business accounts for more than 70% of group earnings and has been the most successful business for RBD to date. We see the KFC business providing stable and visible earnings, and with capital expenditure requirements declining, we expect free cash flow to steadily improve in the future, enabling the business to invest in its growth areas. KFC has continued to evolve its product offering to keep pace with its competition where necessary. A number of different offers (some limited time) have helped to evolve its menu towards market demands. One of the key changes has been to shift a greater level of sales (30-35% of total) to burgers. While this does dilute the differentiated offering to its peers of fried chicken, burgers are higher margin.
In early 2016, RBD moved into Australia through the acquisition of 42 KFC stores in New South Wales, making RBD the largest independent franchisee in the state. The Australian KFC market is highly fragmented with a number of operators, as compared to New Zealand where RBD is the sole franchisee. Since the initial entry into Australia, RBD has acquired a further 15 stores from a number of vendors, in line with its strategy ambition of growing its Australian footprint (which now sits around 60 stores). In another, more opportunistic acquisition, RBD recently acquired Pacific Island Restaurants, a vehicle with the exclusive rights to Taco Bell and Pizza Hut stores across Hawaii, Guam and Saipan. RBD has secured exclusive rights to the locations as well as the potential to introduce further brands (i.e KFC). The cash flow profile is attractive, and there is a store refurbishment angle, similar to that successfully executed across the KFC network in New Zealand, which should drive earnings growth.
RBD continues to rationalise store numbers for both its Pizza Hut and Starbucks brands. We think this is a positive long-term strategy as the company will retain the higher turnover stores which are more suited to the RBD model. The company has reduced the number of Pizza Hut stores and more are now operated by independent franchisees. The Starbucks brand also reduced its store numbers slightly. These measures reduce total sales for the respective brands, however, more importantly, they help RBD to release capital which is then re-deployed into higher growth opportunities.
RBD has a solid track record, capable management and offers a growing earnings profile. The core New Zealand KFC franchise provides strong free cash flow, helping to support the company's growth aspirations in international markets.
Risks to RBD include: 1) acquisition risk, 2) changing consumer tastes, 3) increased competition.