Sector financial performance:

This company, who primarily franchises and operates quick service restaurants –hamburger, has been grouped into quick service restaurants sector in food service industry.

It seems that the slowing down traffic was the major reason contributing to slowing down increase in comparable sales of fast-service restaurants between 2015 and 2017. Data indicates that the average increase in comparable sales all across this sector went down from around 5% of 2015 to around 1% of 2017 except the Mexican restaurants, which presents consistent 5-6% increase in comparable sales during this period. (Hamburger-QSR went down from 5% to 1%; chicken-QSR down from 4% to 2%; sandwich-QSR down from 4% to -2%; pizza-QSR down from 4% to 0%). Correspondingly, accompanied with declining sales, the traffic has been down for most of companies in this sector since 2015. For example, our data indicates that the average decrease in traffic of hamburger restaurants was 2% and 1% in 2016 and 2017.

Since 2017, it seems that traffic all across this industry has continued to decline but present signals of slowing down. Traffic in Mexican restaurant started to decrease in 2018 following the trend seen frequently in other types of QSR before 2017.  Comps turned into negative range and were down largely in Pizza sector in 2018, which, with sandwich companies present the worst decline among QSR sector in the past two years. Comps in chicken related QSR restaurants seem least impacted by generally slowing down in traffic all across industry probably due to relatively stronger demand and thus the ability to raise price. Decreasing Hamburgers’ comps seem to be hitting the bottoms as traffic rebounds and price rises.

It seems that the impacts from decrease in traffic have been offset partially by raising menu price/products mix. This is probably why we are seeing positive growth in their comparable sales from many restaurants while decrease in traffic.

For under-performed companies in this industry, franchising their company-operated restaurants obviously has been a better business strategy in dealing with decreasing sales and cash flow. However, all industry has been suffering from general decline in sales. Data indicates that the average cash flow/share of companies in this sector has been declining since 2017.

Our data indicate that, while slowing down comparable sales, there are general improvements in companies’ gross margins in the past several years benefiting from shifting of revenue to re-franchising, rising menu price, and decreasing commodity costs.

Different types of food styles present different gross margins depending on how easy/difficult they can find franchisees for their restaurant concepts. It seems that chicken-QSR demonstrates the best abilities to franchise their concept and thus present the highest average sector gross margin (average 47%). Hamburger QSR then follows, which presents average 36% gross margin. The typical gross margin for Mexican and pizza QSR is around 17% with a low proportion of franchised revenue. Sandwich sector presents the lowest gross margin of about 13%.

Correspondingly, chicken-QSR presents, according our data, the highest operating margin of average 30% with a SG&A as percentage of sales of 16%. Hamburger-QSR has an average 22% operating margin with a SG&A as percentage of sales of 13%. Mexican and Pizza -QSR has an average 8-9% operating margin with a SG&A as percentage of sales of 8-9%.

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Company performance:

It seems that, based on comparable data, the demand for products of this company has started to take off in 2016/17 as indicated by the fact that the increase in guest counts has turned into positive number (2% in 2017)  form about -4% in 2015 when this company was still able to raise price ( average check size growth by above 3% annually). It is particularly obvious in the performance of US restaurants, the comparable sales of which increased from about -2% of 2014 to 3.6% of 2017 attributable largely to increasing traffic. We have seen improvement in all other area including area other than US and China/Hong Kong. However, the improvement in traffic in 2017 seems to not be able to continue in the first half of 2018 as indicated by almost flat growth in traffic during this period.

For the first six months of Fiscal 2018 compared with 2017(ended 20180630) 

Comparable data (owned and franchised, excluding currency):

Growth in comparable sales                                      Growth in guest counts

Company: 4.7% (4% for 2Q)                                     0.2%

US: 2.7% (2.6% for 2Q)                                            -0.3%

Other than US: 6.3% (4.9 for 2Q)

China and Hong Kong: 3.5% (2.4% for 2Q)

Fiscal 2017 compared with 2016

Comparable data (owned and franchised, excluding currency):

Growth in comparable sales                                      Growth in guest counts

Company: 5.3%                                                         1.9%

US: 3.6%                                                                    1.0%

Other than US: 5.3%                                                  2.3%

China and Hong Kong: 5.3%                                     1.8%

Fiscal 2016 compared with 2015

Comparable data (owned and franchised, excluding currency):

Growth in comparable sales                                      Growth in guest counts

Company: 3.8%                                                         -0.3%

US: 1.7%                                                                   -2.1%

Other than US: 3.4%                                                 1.5%

China and Hong Kong: 2.8%                                    -0.8%

Fiscal 2015 compared with 2014

Comparable data (owned and franchised, excluding currency):

Growth in comparable sales                                      Growth in guest counts

Company: 1.5%                                                          -2.3%

US: 0.5%                                                                    -3%

Other than US: 3.4%                                                 1%

China and Hong Kong: 1.8%                                    -2.2%

Fiscal 2014 compared with 2013

Comparable data (owned and franchised, excluding currency):

Growth in comparable sales                                      Growth in guest counts

Company: -1%                                                               -3.6%

US: -2.1%                                                                       -4.1%

Other than US: 0.8%                                                      -1.2%

China and Hong Kong: -2.8%                                        -2.9%

Its gross margin (including company-operating and franchising expenses) went up from about 38% to 46% between 2014 and 2017 as a result of revenue’s shifting to higher margin’s franchising business, which has been consistent with its strategy’s goal. Its SG&A as percentage of sales has been around 10% and its operating margin went up to about 37% in 2017. As shifting of  sales to franchising continued in 2018, we have seen continuing improvement in gross margin (50% for 2018) and operating margin (39% for 2018).  Therefore, while sales continued to decline as a result of franchising, cash flow has been increasing during the period due to improved margins.

Stock price

This stock currently has an enterprise price/EBI ratio of 29. We think that its stock is being relatively undervalued compared with its peers and considering that it is one of few hamburger restaurants with positive growth in traffic in US market.