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Stock Analysis & Ideas

Can Restaurant Brands Stock Almost Double from Here?

Story Highlights

As the parent company of four well-known brands, QSR is able to generate a high amount of free cash flow. As a result, both analysts and a single-stage DCF model suggest that the company is undervalued.

Restaurant Brands International (QSR) (TSE: QSR) is a holding company that operates quick-service restaurants. It operates through the following segments: Tim Hortons, Burger King, Popeyes, and Firehouse Subs.

All four segments are strong brand names that are well known throughout North America, allowing the company to create shareholder value. As a result, QSR is currently trading at an attractive valuation.

QSR Creates Value for Shareholders

Great companies often have great management teams that can effectively allocate capital to profitable projects. In order to get a good picture of management’s effectiveness, investors can simply look at the numbers. A metric I like to look at is the economic spread, which is defined as follows:

Economic Spread = Return on Invested Capital – Weighted Average Cost of Capital

The idea is very simple; if the return on invested capital is greater than the cost of that same capital, then the company is creating value for its shareholders through well-thought-out projects. Otherwise, the company is destroying value and would be better off simply investing money into risk-free bonds.

For Restaurant Brands, the economic spread is as follows:

Economic Spread = 9.2% – 7.9%

Economic Spread = 1.3%

As a result, the company is creating value for its shareholders, implying that management is efficiently allocating capital.

Is Restaurant Brands Undervalued?

To value Restaurant Brands, I will use a single-stage DCF model because its free cash flow per share has remained relatively flat over the past several years. Although free cash flow has grown on an absolute basis, so has the number of shares outstanding.

For the terminal growth rate, I will use the 30-year U.S. Treasury yield as a proxy for expected long-term GDP growth.

My calculation is as follows:

Fair Value = FCF per share / (Discount Rate – Terminal Growth)

$88.62 = $5.14 / (0.09 – 0.032)

As a result, I estimate that the fair value of Restaurant Brands is approximately $88.62 under current market conditions. With the share price near $48, the stock appears undervalued.

Risks of Investing in Restaurant Brands

To measure Restaurant Brands’ risk, I will first check if financial leverage is an issue. I do this by looking at its debt-to-free-cash-flow ratio. Currently, this number stands at 9.1x.

Overall, I don’t believe that debt is currently a material risk for the company because its interest coverage ratio is 3.9x (calculated as EBIT divided by interest expense).

However, there are other risks associated with Restaurant Brands. According to Tipranks’ Risk Analysis, the company has disclosed 30 risks in its most recent earnings report. The highest amount of risk came from the Legal & Regulatory category.

The total number of risks has decreased over time, as shown in the picture below.

Analyst Recommendations

Restaurant Brands has a Moderate Buy consensus rating based on eight Buys, eight Holds, and two Sells assigned in the past three months. The average Restaurant Brands price target of $62.40 implies 30.6% upside potential.

Final Thoughts

As the parent company of four well-known brands, QSR is able to generate a significant amount of free cash flow. As a result, both analysts and a single-stage DCF model suggest that the company is undervalued.

Disclosure

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