Value goes beyond the menu at this quick service restaurant company

Jonathan Boyar, director of Boyar Value Group and advisor to the MAPFRE AM US Forgotten Value Fund

The key to finding value in the equity market largely involves knowing where to look. Some situations create more fertile ground for value plays than others. When industries or markets fall, it’s worth poking around for diamonds in the rough — think well-capitalized housing related companies during the housing crisis, for example. When a new leadership team takes over, it can be worth looking for underappreciated brands ripe for resuscitation.

Other times, it’s a combination of factors that add up to more upside than investors are currently giving a stock credit for. In those cases, a stock may not even look like a value play at first blush. Take Restaurant Brands International (QSR): Its current P/E ratio of 24x earnings is far from a deep value play but there is the potential for material earnings improvement. Plus, we see signs that suggest at least some of the company’s value is partially hidden — in part because investors are more familiar with the brands it owns than the company itself.

A high-profile executive with skin in the game

When Patrick Doyle arrived at Restaurant Brands as Executive Chairman in November 2022, he was coming off a high-profile turnaround of Domino’s Pizza. His arrival caught our eye because he clearly knows the quick-service restaurant industry, it seemed unlikely that job offers were in short supply, and he put $30 million of his own money into the company’s stock.
That level of confidence from an industry expert doesn’t automatically signal an upside opportunity on its own. But it does warrant a closer look.

Why and where Restaurant Brands’ value is hidden

Even if you’ve never heard of Restaurant Brands, you’ve probably heard of Burger King. If you’re Canadian or have spent any time in Canada, you’ve certainly heard of Tim Horton’s, which has a nearly ubiquitous presence selling baked goods and coffee to our northern neighbors. Restaurant Brands formed in 2014, when Burger King acquired Tim Hortons in an $11.4 billion takeover backed by the venerable Berkshire Hathaway and the Brazil-based private equity firm 3G Capital. It added Popeyes Louisiana Kitchen, a chicken-and-seafood chain, to the roster in 2017, followed by the sandwich-oriented Firehouse Subs in 2021.

Like the rest of the quick-service industry, all four brands experienced a substantial slump in sales during the COVID-19 pandemic. Bringing same-store profitability up is a key priority for Doyle. “Our success as a franchisor is going to be built on the success of the franchisees,” he told me on a recent episode of the World According to Boyar podcast. “It’s a really easy product to measure: what did they spend to build it and how much cash is it generating for them as a result of the investment they made?”

Investors’ unwarranted preconceptions about 3G Capital, which controls roughly 29% of the voting power for Restaurant Brands, may also make it difficult for investors to grasp the whole picture. 3G is well-known for aggressive cost-cutting measures informed by a zero-based budgeting system in which prior-year expenses have little to no impact on future spending decisions. This reputation for tight cost management can make it seem as if they are laser focused on improving the bottom line even if it sacrifices the long-term health of the business. This is not a fair assumption of how they approach capital allocation in our view, as zero-based budgeting scrutinizes old and new expenses alike, and allows room for resources to be directed toward the highest priorities.

Plenty of potential for upside

At Tim Horton’s, Restaurant Brands has invested in building a powerful digital presence, including the second most popular e-commerce app in Canada. Investments in store remodels and quality improvements such as the use of freshly cracked eggs and upgraded coffee brewers with water filters that produce a more consistent product from store to store have helped the brand regain market share and post double-digit comparative sales in 2021 and 2022.

“What I think Tim’s means to people, both in Canada and around the world, is that it is just a good, honest brand — it is what it is, it’s not trying to be fancy,” Doyle said. The potential to expand Tim Hortons into not just a breakfast destination but a lunch and dinner location and add stores internationally also gives it plenty of space to grow over time.

Meanwhile, the Whopper—the company's flagship burger with a fiercely loyal cohort of fans—is arguably more popular worldwide than the Burger King brand itself. Doyle is focusing the company on making the rest of the experience in the restaurant equal to its top product, work which had already begun before his arrival via the Reclaim the Flame marketing campaign. The company is investing $400 million over two years in advertising and digital enhancements, as well as remodeling, relocation, technology, and kitchen equipment.

Burger King’s international growth story is already impressive: in 2022, comparable sales were up a whopping 15.9%, versus just 2.2% in the U.S. A turnaround in the domestic market and room to grow into breakfast foods offer additional opportunities for upside.

Popeyes and Firehouse Subs, while smaller businesses, have seen solid momentum in their respective markets recently. Popeyes systemwide sales have delivered roughly 11% compound annual growth since 2017. China, the world’s largest market for chicken products, represents an attractive international growth opportunity for the brand as well. In addition to Firehouse’s growing sales numbers, the 3.5 million subscribers to the sandwich maker’s loyalty program that accounted for roughly 10% of its total transaction in 2021 make it an attractive candidate for international expansion in its own right.

A focus on attractive franchises

With ample opportunities for expansion in international markets and the growth of digital sales, even already-popular brands may have more room for growth than they initially appear to. Shifting corporate focus to investing in brands in ways that make the franchises more profitable also makes them more attractive to investors. What’s more, those investments pave the way for organic growth, especially as brands gain traction in new markets, dayparts or sales channels. Given opportunities for both domestic and international expansion, as well as opportunities to leverage digital technology across brands, this approach has the potential to unlock strong unit growth (the number of restaurant locations).

Finding reasons to take a deeper look

The fact that upside is sometimes hard to see is what makes value investing possible. With so many great companies doing so many great things, it’s sometimes hard to know where to look for opportunities that fly just under the radar. Keeping an eye out for multiple signals of potential value can help jump-start that process, helping you find the right places to dig around for signs of something that’s more than immediately meets the eye.