Goodbye pizza. Hello coffee, doughnuts, burgers and fried chicken.
Back in May, I wrote that I was losing my appetite for Pizza Pizza Royalty Corp.’s (PZA) shares and would be watching the company’s performance closely.
Hurt by the proliferation of third-party food delivery apps, growing competition from U.S. pizza chains Domino’s Pizza Inc. and Papa John’s International Inc. and a highly promotional fast-food marketplace, Pizza Pizza had reported a string of weak results and the company’s stock had taken a hit.
Well, since then things have only gotten worse.
Earlier this month, the company reported that same-store sales skidded 3.3 per cent in the three months ended June 30 – the fourth consecutive quarterly drop for this key measure. The company’s Pizza 73 chain in Western Canada has been hit especially hard, with same-store sales falling for 11 quarters in a row.
In my model Yield Hog Dividend Growth Portfolio, I focus on companies that raise their dividends regularly, but Pizza Pizza is in no position to do that now. The company last hiked its dividend more than two years ago and, in the second quarter, its payout ratio spiked to 110 per cent, up from 104 per cent in the same period a year earlier.
In light of the company’s deteriorating performance and poor dividend growth prospects, I’ve decided to take my lumps and sell the 200 Pizza Pizza shares in my model portfolio. (Disclosure: I’ve also sold the stock personally.)
I’m using the proceeds – plus most of the cash in my model portfolio – to purchase 45 shares of Restaurant Brands International Inc. (QSR). The owner of Tim Hortons, Burger King and the Popeyes fried chicken chain not only offers superior diversification, but its dividend has been rising steadily and will almost certainly continue to increase.
I also believe Restaurant Brands’ share price has much better long-term growth potential, which should more than make up for the fact that Restaurant Brands’ yield of about 3 per cent is less than half of Pizza Pizza’s yield of more than 8 per cent.
To be sure, Restaurant Brands (whose shares I also own personally) has faced its share of struggles, particularly at Tim Hortons where sales have weakened amid a feud between the company and a group of franchisees. However, Tim Hortons’ same-store sales stabilized in the second quarter, and analysts expect sales to accelerate soon thanks to initiatives including the recent launch of all-day breakfast.
“The outlook for Tim’s Canada is improving, and it is certainly possible we have seen the bottom,” CIBC World Markets analyst Mark Petrie said in a recent note. Store renovations, improved marketing, investments in mobile ordering and the launch of a loyalty program this fall should also give sales a lift, he said.
Restaurant Brands’ other chains, meanwhile, have been putting up solid results. Burger King’s same-store sales rose 1.8 per cent in the second quarter and Popeyes’ same-store sales jumped 2.9 per cent.
What’s more, all three chains are opening restaurants internationally, which is a major source of growth. In July, for instance, Tim Hortons announced an agreement with private equity firm Cartesian Capital Group to open more than 1,500 locations in China over the next 10 years. Cartesian also holds the master franchise rights in China for Burger King, which has grown to more than 900 stores in that country from less than 60 when Cartesian first partnered with Restaurant Brands in 2012.
“The Tim's/China announcement is ambitious, but if the company can even attain half the 1,500 targeted stores over the next decade, we would deem that a success,” Mr. Petrie said.
Mr. Petrie is one of 10 analysts with a buy or equivalent rating on Restaurant Brands. There are five holds and no sells, and the average 12-month price target is US$73.33, according to Thomson Reuters. The shares closed Tuesday at US$58.72 on the New York Stock Exchange and at C$76 on the Toronto Stock Exchange.
David Palmer of RBC Capital Markets, who rates the stock “outperform,” said in a note that Restaurant Brands is in a position to deliver long-term revenue growth of 6 per cent – roughly 2 per cent from same-store sales growth and 4 per cent from franchised restaurant development – which would translate into annual earnings per share growth in the mid-teens.
On the surface, the shares may not look especially cheap – they trade at about 20 times estimated 2019 earnings of US$2.88 a share. But that’s actually a reasonable price-to-earnings multiple for a company with expected double-digit earnings growth.
I have no idea what Restaurant Brands’ share price will do in the short run, but over the long run I expect that it will produce some tasty capital gains – and plenty of delicious dividend increases along the way.