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Stock Analyst Note

As we gear up for the release of first-quarter earnings, our top picks in the restaurant industry remain wide-moat McDonald's and wide-moat Starbucks, trading at 14% and 19% discounts to our $312 and $105 fair value estimates, respectively. While industry traffic has been depressed for two years, both brands boast strong digital platforms that allow them to defend transaction frequency without indiscriminate national discounting, and both benefit from scale-driven cost advantages that should allow them to meet the needs of the increasingly value-sensitive consumer without sacrificing financial performance. These are the two most important factors, in our view, that will distinguish the best and worst performers in our industry coverage over the coming years. The industry looks fairly priced in aggregate, trading at a 3% premium to our market-cap weighted fair value estimates. The aggregate figure masks a very bimodal return distribution: Brands like narrow-moat Wingstop (up 108% annually) and wide-moat Chipotle (74%)—which boast strong unit economics and have taken material industry transaction share—have materially outperformed brands like no-moat Wendy's (down 9%) and narrow-moat Papa John's (down 17%), which have not. Those top-performing brands are fully priced, trading at material premiums to our intrinsic valuation (163% and 52%, respectively), suggestive of meaningful execution risk.
Stock Analyst Note

While narrow-moat Restaurant Brand International's fourth-quarter earnings offered several key moving pieces, we believe investors' key takeaway should be that improving store-level profitability, a growing digital business, and traffic improvements across brands provide a firmer base than we'd expected from which to drive long-term systemwide sales growth. We expect to lift our 10-year systemwide sales compound annual growth rate projection to 6.1% from 5.5% after digesting results, leading to a high-single-digit percentage increase to our CAD 93 and USD 71 fair value estimates. That will leave shares trading in a range we'd consider fairly valued after a 3%-4% decline in Feb. 13 intraday trading.
Stock Analyst Note

Narrow-moat Restaurant Brands International announced the planned acquisition of its largest U.S. Burger King franchisee, Carrols Restaurant Group, in a move that we expect to prove slightly value accretive. The purchase should accelerate RBI's "Reclaim the Flame" Burger King turnaround initiative, and the acquisition price appears reasonable at a 23% premium to Carrols' 30-day volume-weighted average price. More importantly, at a 13.8% restaurant margin in the third quarter of 2023, we estimate that RBI is paying just 4 times store-level EBITDA for 1,022 Burger King restaurants (and 60 Popeyes restaurants) that outperform the broader U.S. system in both average unit sales and store-level profitability. We expect that it should receive roughly 6 times EBITDA when it refranchises those stores, which would yield an industry-average midteens cash return on investment for prospective franchisees. That said, shares fell 3% during intraday trading, likely attributable to uncertainty regarding a definitional uptick in cash flow volatility tied to owning stores and the firm's ability to manage a store base roughly 6 times as large as its current 175-unit footprint. While we view the market reaction as unnecessarily harsh, we continue to view shares as slightly expensive, trading at a modest premium to our CAD 93 and USD 71 fair value estimates.
Stock Analyst Note

As we survey the U.S. restaurant landscape looking toward 2024, the largest, chained restaurants with durable cost advantages look best positioned to outperform. We expect industry growth to remain low—just 1.3% annually in real terms through 2025, versus a long-term average of 2.5%. The sharp slowdown is predominantly attributable to slowing consumption spending, with pressured U.S. consumers already limiting restaurants’ ability to further increase prices and likely driving an uptick in industry promotional activity.
Stock Analyst Note

Narrow-moat Restaurant Brands International posted OK third-quarter earnings results, with $1.84 billion in sales and $0.79 in diluted EPS narrowly missing our $1.87 billion and $0.83 estimates. While development remains a near-term challenge—the firm expects 4% unit growth in 2023 and 5% in 2024, with the latter falling a bit below our preprint 5.5% estimate—we view this as a cyclical rather than structural factor, largely attributable to a handful of geopolitical issues and elevated interest rates. While shares traded down on the report (falling 4%-5%) as the firm missed consensus sales expectations, we remain optimistic regarding its long-term prospects and expect to increase our $70 and CAD 95 intrinsic valuations by a low-single-digit percentage as we balance time value, stronger-than-anticipated Burger King results, and slower near-term development. Shares look modestly undervalued.
Stock Analyst Note

The restaurant industry looks cheap to us for the first time since fall 2022, with the recent market correction creating a buying opportunity for long-term investors. Our coverage trades at a 7% cap-weighted discount to our intrinsic valuations, with wide-moat companies like Yum Brands, Starbucks, and McDonald's looking unusually alluring, each trading at a 10%-12% discount to our respective $139, $103, and $285 fair value estimates. We recognize that slowing same-store sales pose a near-term risk, but believe that large, quick-service operators with scale-driven cost advantages and strong digital touchpoints look poised to capture market share in this dynamic environment. Restaurants are more resilient than many investors realize, with companies that outperform on the basis of "value for the money" like McDonald's and wide-moat Chipotle even posting comparable-store sales growth over the course of the 2007-09 downturn. While we expect consumer spending to slow in 2024, we continue to maintain that the U.S. will avoid an outright recession and believe that investors seeking consumer cyclical exposure would do well to consider turning toward the restaurant industry at current prices.
Stock Analyst Note

Restaurant Brands International delivered strong second-quarter results, including $1.78 billion in sales (up 8.2%) and $0.85 in adjusted EPS that handily surpassed our respective $1.73 billion and $0.72 estimates. As a result, we plan to lift our $67/CAD 92 fair value estimates by low-single-digit percentages. However, shares appear a tad overvalued, and as such, we’d suggest investors await a more compelling entry point.
Stock Analyst Note

Restaurant stocks look expensive as we take the industry's pulse, with names in our coverage trading at a market-cap-weighted 10% premium to our intrinsic valuations. While demand has held up nicely to date, we're seeing weak spots, with persistent declines in traffic and items per check suggesting price-conscious consumers and a more challenging pricing environment to come. Nominal same-store sales growth remains healthy, up around 5.7% industrywide over the past three months (RMS data), but traffic (down 1.4%) and items per check (down 3.7%) remain points of concern. We expect slowing sales momentum into the first half of 2024, resulting in a more promotional environment for the industry and a three- to four-year route to normalized restaurant-level profitability. The industry's bargain bin looks sparse, but we see modest upside in Wendy's and Starbucks shares, which trade at 6% and 2% discounts to our $23 and $104 fair value estimates, respectively.
Company Report

In aggregate, Restaurant Brands International appears to be taking adequate steps to meet the changing demands of its customers. Recent investments, including footprint reimaging, a renewed emphasis on loyalty programs, and proprietary e-commerce pages represent a few of the efforts likely to shore up the brands' competitive positions, and we anticipate that similar investments will simply become a cost of doing business going forward. The firm's recent attention to operational excellence is cogent, if perhaps too late, and RBI has prudently carved out an enviable foothold in international markets through a robust network of master franchise partnerships.
Stock Analyst Note

Narrow-moat Restaurant Brands International, or RBI, posted solid first-quarter earnings, with every brand but Tim Hortons Canada seeing acceleration in sales momentum relative to the comparable 2019 period. While the near-term restaurant macroenvironment provides plenty of reasons for trepidation, we derive cautious optimism from modest early signs of improvement at Burger King U.S. and RBI's growing Tim Hortons and Popeyes international businesses. On balance, the quarter clocked in largely in line with our expectations, and we expect to raise our $65 fair value estimate by a low-single-digit percentage, consistent with time value.
Stock Analyst Note

The restaurant industry has proven surprisingly resilient despite stout macroeconomic headwinds, but between normalizing consumer spending patterns, a widening value gap with the grocery channel, and early signs of price sensitivity, we believe that 2023 is shaping up to be challenging. Despite early indications of a strong first quarter, we continue to expect a softer second half of the year, limiting near-term margin recovery as restaurants are reluctant to outprice their core customer. To this effect, traffic and items per check have declined in each of the past 10 months industrywide—through February 2023—and we continue to view exclusively price-driven comparable store sales growth as a tenuous long-term strategy. We sport a carb-heavy value menu in the industry, with wide-moat Domino's and narrow-moat Toast representing our top picks, trading at 16% and 18% discounts to our $397 and $21.50 fair value estimates, respectively.
Stock Analyst Note

We believe that prudent adoption of digital ordering, restaurant software, and loyalty programs can yield meaningful benefits for the restaurateurs we cover as well as for astute investors who can identify today's digital leaders. We expect investments in technology to pave the way for food-service establishments to gain share from the grocery channel, settling just north of 55% of U.S. consumer food spending, ahead of our prior 50% estimate, as technology-driven cost savings enable restaurateurs to narrow the value gap with the cheaper grocery channel. The largest chains in our coverage are poised to disproportionately benefit from technology adoption; we forecast their share of total restaurant sales to grow by 200 basis points over the next five years, with wide-moat firms like Chipotle, Starbucks, and Domino's looking particularly well positioned. Investors looking for immediate-term opportunities should consider Domino's and narrow-moat Toast, which trade at roughly 16% and 17% discounts to our $397 and $21.50 intrinsic valuations, though we'd remain eager buyers of leaders like Chipotle and Starbucks at prices below our $1,550 and $103 fair value estimates.
Company Report

In aggregate, Restaurant Brands International appears to be taking adequate steps to meet the changing demands of its customers. Recent investments, including footprint reimaging, a renewed emphasis on loyalty programs, and proprietary e-commerce pages represent a few of the efforts likely to shore up the brands' competitive positions, and we anticipate that similar investments will simply become a cost of doing business going forward. The firm's recent attention to operational excellence is cogent, if perhaps too late, and RBI has prudently carved out an enviable foothold in international markets through a robust network of master franchise partnerships.
Stock Analyst Note

Recently appointed chair Patrick Doyle's first impact was felt at Restaurant Brands International with the announced departure of CEO Jose Cil, whose unit development pedigree was overshadowed by declining four-wall profitability at the firm's largest brands during his four-year tenure. Doyle, who as CEO spearheaded Domino's tremendous run in the 2010s, appears to be driving RBI's priorities toward operational excellence and heightened attention to franchisee profitability, replicating the playbook from his time leading the pizza chain. Cil will be replaced by Joshua Kobza, who has been with Restaurant Brands as both COO and CFO over the past 10 years. We see no reason to change our Standard Capital Allocation Rating in the immediate term.
Stock Analyst Note

We expect sluggish sales growth to represent the key issue for the restaurant industry in 2023, following a year of investor concern regarding inflated input costs and margin compression. Though we see modest upside in wide-moat Domino's and view wide-moat Chipotle shares as fairly valued, the industry trades at a 5% market-cap weighted premium to our fair value estimates, suggesting that current entry prices are less than salient.
Company Report

The long-term equilibrium in the quick-service restaurant space remains fluid, but all signs point to permanent changes for operators, with customers favoring those brands that offer seamless omnichannel access, personalization, and robust off-premises channels. In our view, Restaurant Brands International is taking adequate steps to meet the changing demands of its restaurant customers. Recent investments, including footprint reimaging, a renewed emphasis on loyalty programs, and proprietary e-commerce landing pages represent a few of the efforts likely to shore up the brands' competitive positions, though we anticipate that similar investments will simply become a cost of doing business going forward.

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