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david milstead

There are "story stocks," companies whose shares are propelled forward by an easy-to-understand, compelling narrative. Many times, however, the story unravels, the shareholders get burned, and we get to look back at the few who pointed to the red flags well ahead of the denouement.

Restaurant Brands International Inc. is, I submit, one of these stocks – and I will say this even as, or perhaps especially because, it hit a new 52-week high this week on extraordinarily high price-to-earnings multiples.

Here's the narrative: Formerly known as Burger King, the company took on its generic moniker when it acquired Canadian treasure Tim Hortons in 2014. The well-regarded Brazilian firm 3G Capital, which had Warren Buffett's imprimatur as an investment partner, already controlled Burger King. The 3G magic would cut costs at Timmies while taking the brand global in an "asset light" model where much of the capital costs fell on the franchisees, rather than the company.

Read more: Inside the brutal transformation of Tim Hortons

Rinse, lather, repeat: Earlier this year, Restaurant Brands said it would buy Popeyes Louisiana Kitchen Inc. The chain already has more than 2,000 restaurants, but about three-quarters are in the U.S. Investors who know that KFC is the biggest fast-food chain in China are salivating at the prospects for Restaurant Brands International to take Popeyes, yes, international.

In continuing to pile in to the company's stock, however, investors are disregarding warning signs that have been present for quite some time, and seem to be intensifying. In an example of being right too early looking like being wrong, I've been negative on Burger King since 2012, its Bill Ackman-backed IPO date, and continued my beef in 2014 when it announced the Tims deal. The core of my concern: The company's plans to push costs to franchisees, and whether the stores really would perform as well as promised.

At the time of the Tims acquisition, Carrols Restaurant Group Inc., a Syracuse, N.Y.-based, NYSE-listed company that owned 560 Burger Kings, had just posted its 10th money-losing quarter in a row. "Ultimately, owning a Burger King restaurant has to be a profitable, rewarding venture," I wrote. "Right now, the franchisees are paying big bucks in hopes that better sales will follow. If it doesn't work out, owning Burger King stock will be similarly unappetizing."

Thanks to the amazing work of my colleague Marina Strauss, we have come to learn that Tim Hortons franchisees are now having a similar, perhaps even worse, experience. As Ms. Strauss has detailed, franchisees have alleged that the quality of goods they are required to buy from the franchisor have declined even as their prices have gone up, and the company's aggressive cost-cutting has left them without adequate staff support and with frequent product shortages. The situation has prompted the franchisees to form the Great White North Franchisee Association to better advocate for themselves.

Now, an influential U.S. investment letter has drawn on Ms. Strauss's coverage and synthesized it with other financial commentary to produce a bear case on Restaurant Brands International. Grant's Interest Rate Observer published its "Rumblings from the great white north" article after the markets closed Wednesday, and it may have contributed to the stock's tick down Thursday; the shares fell more than 2.5 per cent in early trading before bouncing back, closing up 25 cents, at $82.90.

"What are the chances of Warren Buffett being wrong? The chances of Buffett being wrong in the elevated company of 3G Capital, Bill Ackman and Mr. Market himself? High, we are about to contend," Grant's says. "The bearish story on Restaurant Brands hinges on the franchisees: on their profits, or lack thereof, and on their complaints (especially the complaints of the Hortons franchisees)."

Those complaints of the Hortons franchisees, which make up a significant portion of the Grant's article, are well-known to Globe readers. What's worth bringing out from the Grant's analysis, in addition, is that Carrols, the aforementioned Burger King franchisee, had a negative 0.6-per-cent operating margin in the first quarter of 2017, down from 5.6 per cent in 2015's second quarter. Its adjusted EBITDA fell by half over that time.

Carrols's CEO blamed "a higher level of promotional activity," which I can confirm: The latest Burger King U.S. coupon flyer promises "over $110 in savings," with a buy one, get one free deal on Whoppers that will allow the user to get two of the sandwiches for less than $5 in most markets. Another coupon offers two chicken sandwiches and two small fries for $4.99.

Despite such promotions, U.S. same-store sales at Burger King fell by 2.2 per cent in the first quarter. Same-store sales, revenue at locations open at least a year, is a vitally important metric for assessing restaurants and retailers; Grant's notes Restaurant Brands International has scaled back disclosure to only show the numbers in each chain's most important region, which makes it difficult to assess progress at a company whose selling points supposedly include global expansion.

There are additional points. Grant's notes that Restaurant Brands International shares trade at 37.9 times trailing "adjusted earnings," or 42.9 times trailing earnings that are actually calculated according to generally accepted accounting principles.

The Popeye's deal has pushed the company's net debt to $12-billion, more than six times trailing EBITDA, adjusted for the transactions.

And the company continues to benefit from using the Canadian tax system. In its tax footnote in its annual report, it claims that nearly 90 per cent of its pretax profit is earned in Canada, which Grant's notes "is impossible to square" with the segment disclosure that Tims provides an already-ample 55 per cent of adjusted EBITDA. While the trend in the U.S. seems not to be to crack down on corporate taxpayers, this aggressive posture places Restaurant Brands International more at risk than others, it would seem.

At last month's Berkshire Hathaway annual meeting, Mr. Buffett was asked about 3G Capital's methods; he defended them, with his sidekick Charlie Munger adding, according to Grant's, "We don't see any moral fault with 3G." Grant's, by contrast, says it would be preferable to own a business where the owners were "in the service of preserving and improving the brand rather than – inadvertently, through shortsighted fixation on the bottom line – debasing it."

Investors can see, if they choose to look, all the cracks in the foundation. If Restaurant Brands International keeps announcing new deals that cover up the erosion of its existing business, maybe they can keep the party going for its shareholders. It is a journey I do not recommend, however, because some day the story might change.