It’s strange at first glance that Bill Ackman has almost as much of his Pershing Square Capital portfolio allocated to a restaurant company as he does to Alphabet (NASDAQ:GOOGL). The latter is a perennial revenue grower with scalable software solutions while the former is typically accompanied by slim margins and more susceptible to economic swings.
What does Bill Ackman see in Restaurant Brands International (NYSE:QSR) that has earned it a top spot in his portfolio, now representing a full 14.8% allocation?
5 Reasons Why Pershing Square Holds QSR
The first thing to know about Pershing Square Capital is it manages over $10.4 billion so Bill Ackman’s 14.8% stake in Restaurant Brands International is a ginormous bet of around $1.5 billion. So, what is it that could have enticed Bill and his investment team to take such a substantial position?
At first glance it’s just not obvious. After all, a restaurant has to pay for its goods, overhead in the form of rent and utilities among other items, and labor. The revenues from food have to pay for all those costs, and typically leaves little leftover in the form of profits.
But that cursory analysis is not representative of Restaurant Brands International, which has invested heavily in digital transformation with a focus on mobile ordering, delivery partnerships, and digital loyalty programs to enhance customer experiences, create new revenue streams, and build repeat business.
Once a hungry customer is in the door, the company has invested in menu innovation to help further grow revenues by offering a range of plant-based options and locally tailored menus that cater to a variety of consumer tastes and dietary preferences.
And like McDonald’s, Restaurant Brands International operates predominantly a franchise-based model that provides a steady stream of fees and reduces operational risks. By so doing, the company can more predictable forecast revenues, margins and profitability.
It’s also succeeded in riding viral waves and popular cravings like the highly popular chicken sandwich from Popeyes. Still, other brands in its portfolio, such as Tim Hortons, have undergone significant changes to revitalize their brands, including menu revamps and store modernizations.
The combination of these factors have been instrumental in management growing abroad too, with key expansions in China and India that are expected to be pivotal for long-term growth as growing middle-classes emerge in those regions.
Put all those ingredients into the mix and you end up with a financially pie that is very intriguing.
QSR Is Much More than a Top Dividend Stock
With a predictable revenue stream from franchising, it’s not a big surprise to learn that QSR pays a handsome dividend of 3.13%, which incidentally has an 9-year consecutive growth streak.
But that’s not the only thing about the financials to jump out. For the past 11 quarters, year-over-year revenue growth has been up and now sits at $1.8 billion. Remarkably that has translated to $566 million in operating income last quarter.
Given the gross margin for the quarter sat at 41.5%, it is almost a feat of wizardry for a restaurant firm to squeeze out such a high percentage of revenues to operating income.
Cash levels sit at an impressive $1.3 billion now with long-term debt of $12.8 billion, a high but unsurprising number given the brick-and-mortar nature of the business.
Free cash flows are also impressive. Over the past five years, not a single quarter was reported with negative levered FCF.
Clearly, the company has a lot going for it but is there more to the story that caused Ackman to snap up such a large stake?
Why Did Bill Ackman Buy QSR Stock?
Among the many reasons investors have rushed into the stock, up 5.9% over the past month, is its successful track record in mergers and acquisitions that provide growth levers. So too management’s stewardship and acumen, using financial instruments to hedge against currency and commodity price fluctuations to maintain profit margins.
But one financial metric in particular stands out. So why did Bill Ackman buy QSR stock? Bill Ackman likely bought QSR stock because it has a 34.9% return on equity, suggesting it is highly profitable.
That profitability is a key sustainable advantage for the firm because it produces the cash flow needed to grow and capitalize on the opportunities of a rising middle class in Asia and India in particular.
No doubt, Pershing Square Capital is also enjoying the fruits of the regular dividend payment given that Ackman has expressed admiration for Buffett’s investing style historically, and it too leans towards income-paying stocks.
Restaurant Brands International flies in the face of the traditional food enterprise that is plagued by thin margins and susceptible to economic booms and busts.
Instead it has embraced digital loyalty programs and mobile ordering. So too has the firm followed in the proven footsteps of McDonald’s with a franchise model that leads to predictable revenues.
Alongside its revamp of some brands and riding the wave of others, like the chicken sandwich craze, QSR has succeeded in building a $21.9 billion enterprise with a sky high return on equity.
Those factors alone are perhaps enough to attract the interests of most investors but the gravy on top is the opportunity for growth from a burgeoning middle class in the East, from China to India.
All those factors combined, alongside a generous dividend, have been enough to convince Pershing Square Capital to bet a full 14.8% of their $10+ billion portfolio on QSR.
And with 31 analysts assessing fair value much higher at $77.88 per share, they are not alone in their expectations that the future will remain bright for some time for this enterprising restaurant stock.
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