Valuecruncher places a mid-point valuation of $1.04 per share with a sensitivity range of $0.90 to $1.19 per share for Restaurant Brands (RBD). This is considerably higher than the current market price of $0.84. RBD has traded consistently below $1.00 since late March 2007 following CEO Vicki Salmon’s resignation. Six months later the position is yet to be filled.

RBD Summary

RBD is effectively a management company, they operate 236 concept stores (at 21 May 2007) under the KFC (87), Pizza Hut (103) and Starbucks (46) brands throughout New Zealand. RBD pays license and royalty fees to Yum! Brands (KFC and Pizza Hut) and Starbucks Corp for the right to operate the brands in New Zealand. RBD is in the process of exiting their Pizza Hut operations in Victoria, Australia.

KFC

The KFC brand generates approximately 62% of RBD’s revenues ($182.7 million) and has been the primary driver of RBD’s growth with 7.1% growth in same store sales in the 2007 financial year. The growth in KFC sales has been driven by a revised menu and refurbishment of approximately 21 stores. The refurbishment of the KFC stores is a key driver of RBD’s capital expenditure and is expected to continue over the next financial year. KFC generates the highest EBITDA margins (17.1% before general and administrative expenses) of the three RBD concepts.

Starbucks

Starbucks stores represent the smallest portion of RBD’s operations providing 11% ($31.3 million) of New Zealand revenues in the 2007 financial year. Starbucks revenues are grew 12.2% with 3 new stores added in the 2007 financial year, with same store revenues growing at 3.2%. In the 2007 financial year Starbucks generated $3.6 million EBITDA before general and administrative expenses.

Pizza Hut

Pizza Hut represents approximately 27% ($79.7 million) of RBD’s revenue. The Pizza Hut segment has experienced declining revenues and EBITDA over the last 2 years. RBD have undertaken a review of the Pizza Hut operations and are in the process of implementing a new strategy. The new strategy includes closing 15 “Red Roof” dine-in stores to focus on takeout and delivery stores and introducing new non-pizza menu items. A key issue facing Pizza Hut operations is staff turnover; in 2007 staff turnover was 77% with management turnover of 40%. The fast-food industry experiences relatively high staff turnover but lowering these levels must be a focus for RBD.

Valuation Assumptions

Valuecruncher’s valuation of $1.04 is based on an annualised revenue growth of 3.4% over the next 3 years. The growth rate reflects the negative growth of the Pizza Hut segment offsetting the recent strong performance of the KFC brand. EBIT margins are forecast to increase to 6.8%, this is consistent with historic levels. Valuecruncher has applied a terminal growth rate of 2.5%. Valuecruncher has used a cost of capital of 12% to RBD, this is higher than the 11.1% listed in the latest PWC Cost of Capital report reflecting the uncertainty surrounding the Pizza Hut operations.

Conclusion

The Valuecruncher valuation is considerably higher than the recent trading range of RBD. The Valuecruncher valuation assumes that the restructuring of the Pizza Hut operations is successful. The key uncertainty facing RBD is how they will address the issues with their Pizza Hut division; they have exited their Australian operations and are restructuring the New Zealand operations. The inability to turn around the Pizza Hut operations will have a negative value impact. The recent performance of the KFC brand and in particular the refurbished stores has been strong it is important to consider that this growth is being driven by significant capital expenditure. RBD’s priority should be to appoint a CEO and executing the results of the strategic review.

The RBD business model has a number of fundamental issues:

1. As a management company they are required to pay a license and royalty fees for the right to do business. The royalty fees are typically based on revenues so RBD are required to pay royalties on loss making operations. The license fees are a function of stores operated so these costs are not mitigated by scale.
2. The quick-service take-out restaurant industry is extremely competitive, particularly the pizza sector. Pizza Hut is constantly competing on price for market share. RBD is paying royalties to operate a brand that is producing a product that can be regarded as a commodity. Pizza Hut is competing directly with Domino’s at the low cost end of the market and indirectly with all other quick-service take-out providers.
3. Increases in the minimum wage and the pressure to abolish youth rates will impact on RBD’s profitability.
4. The quick-service take-out restaurant industry is under pressure to address the health/obesity issues associated with their products.

Valuecruncher Valuation Report - Restaurant Brands - 20070905

Valuecruncher has placed a value of $1.43 per Restaurant Brands share, with a range of $0.77 to $2.12.  The current share price is $1.09, which is in the lower range of the Valuecruncher range.

Revenue Growth

Revenue growth remained flat in the 05/06 period (0.122%), partially due to the unsuccessful operation in Victoria Australia.  In previous years, growth has been closer to 3% (2.06% and 3.61% in the 03/04 and 04/05 periods, respectively). We have forecasted revenues growth to remain flat for the 06/07 period, and increasing back to 3% (also the terminal growth) in the 07/08 and 08/09 periods.

EBIT Margin

The EBIT margin for 2006 was also hampered by the unsuccessful division, sitting at 2.89%, compared with margins of 6.52%, 4.78% and 5.99% for years 03, 04, and 05, respectively.  We have forecasted margins to return to 4% for 2007, 5% for 2008 and 6% for 2009 due to the sale of the Victoria division.  Without this division, it is likely that margins will return to historical margins.

Terminal Growth

Terminal growth has been set at 3%

Discount Rate (WACC)

The discount rate used is 11%.

Commentary

With the sale of the unsuccessful Victoria, Australia section of the business it is likely that revenue growth and EBIT margins will improve, as management concentrate on the New Zealand divisions. The estimate that Valuecruncher has come up with takes into account these possible improvements. Valuecruncher can see why Restaurant Brands is a potential private equity target.  Other market analysts share the same opinion.

http://www.stuff.co.nz/stuff/dailynews/0,2106,3884205a6405,00.html

Restaurant Brands Valuation