Restaurant Brands International (NYSE:QSR) has an unassuming corporate name, but most people are familiar with its underlying brands, which include Burger King, Tim Hortons, and Popeyes. Burger King and Popeyes have been shooting the lights out recently in terms of performance. In 2019, Popeyes launched its infamous chicken sandwich, which caught fire on social media. Burger King has done well on the back of the hit Impossible Whopper burger and a well-executed international expansion.
However, Tim Hortons has not shared in the success and has been a drain on the company's financial performance. Should investors expect the company's overall performance to improve in 2020?
Burger King and Popeyes overshadowed by Tim Hortons' weakness
Restaurant Brands International is a franchisor, which means the company manages marketing and franchisee relationships, while the actual restaurants are owned by independent operators. The company makes money by collecting a sales royalty from franchisees of around 5% of the restaurant's net sales.
The franchise model is used by several other national restaurant concepts, including McDonald's and Yum! Brands. This model works well because the parent company doesn't need to invest capital in underlying stores or purchase raw materials to sell. In other words, franchisor businesses earn high profit margins and are not capital intensive -- a powerful financial combination.
In order for a franchisor like Restaurant Brands International to do well, it needs its franchisees to open more restaurants and increase sales at existing locations. As we can see from the table below, there has been robust store growth across the company. Burger King grew store count by roughly 6% in each of the last two years, while Popeyes grew store count by roughly 7% per year.
|Net Restaurant Growth||FY 2019||FY 2018|
What's driving the restaurant count growth? For Burger King and Tim Hortons, it has been an aggressive international expansion. Over the past 10 years, Burger King has opened more than 5,000 net new units outside of the United States and has plans to continue its aggressive pace. Tim Hortons is primarily a Canadian coffee and breakfast brand, but has been opening new locations around the world to capitalize on the global growth in coffee consumption. Popeyes still has a lot of room to grow in North America, where KFC (owned by Yum! Brands) has double the number of locations.
When it comes to improving sales at existing locations, the table below shows that Burger King and Popeyes have excelled, while Tim Hortons has struggled. Popeyes had a blowout 2019 with its new chicken sandwich. Burger King's Impossible Whopper also resonated with customers. However, Tim Hortons saw its comp sales decline due to increased competition in Canada from other chains launching breakfast menus.
|Comparable restaurant sales||Q4 2019||Q4 2018||FY 2019||FY 2018|
Two out of three success stories should average out well, but unfortunately Tim Hortons accounts for nearly half of Restaurant Brands' total sales and earnings before interest, taxes, depreciation, and amortization (EBITDA), which means that poor results at that one brand set the overall tone of the company's financial performance.
The problem with Tim Hortons
The fact that Tim Hortons is a larger contributor to Restaurant Brands' financial performance may be a little surprising. After all, Tim Hortons only had 4,932 locations at the end of 2019, compared to 18,838 Burger King locations.
What's driving the outsized importance of Tim Hortons is a different franchise structure. Restaurant Brands not only manages the Tim Hortons brand; it also manages its supply chain. In addition to paying royalties on net sales, franchisees must also purchase their raw materials directly from Restaurant Brands International. Therefore, if Tim Hortons sees sales decline, Restaurant Brands will receive lower sales royalties and also sell fewer raw materials. Burger King and Popeyes franchisees purchase raw materials from third-party suppliers.
The Tim Hortons franchise model has other challenges, as well. Managing the supply chain is a laborious function and requires the company to invest capital in distribution facilities and inventory. This translates into lower margins for the Tim Hortons segment.
There are also potential conflicts of interest with a franchisor managing the supply chain, because it is not incentivized to source from lower-cost vendors. If Restaurant Brands sources higher-cost raw materials, then the Tim Hortons restaurants will likely need to sell items at higher cost, increasing the franchisor's royalty on top-line sales. This conflict has played out publicly in the past, with franchisees angrily calling for a better structure. The franchisee relationship seems to be healthy today.
Is a turnaround in the cards?
To stem the lackluster performance at Tim Hortons, management has boosted the brand's loyalty program by launching an improved Tim Hortons mobile app and offering aggressive promotions and discounts. These new programs were launched during the summer of 2019 and have not yet resulted in much of a turnaround; however, the company is quite focused on the Tim Hortons brand and will continue investing in its success.
It is unfortunate that the recent sales decline at Tim Hortons has overshadowed an impressive run at both Burger King and Popeyes. Investors may be attracted to Restaurant Brands International due to the ownership of these two fast-growing restaurant brands, but they should come in with the knowledge that Tim Hortons is the more important segment, for better or worse.