Buffett Tests Overall Conclusion [perspective 2018]
Quote:
Originally Posted by
Snoopy
Pizza Hut has been turned around with the best “Concept EBITDA” since 2006. Starbucks EBITDA was the best ever in FY2015. Both of these divisions have dragged down the overall company result in previous years. At KFC the store transformation program, begun in FY2005, is 90% completed. However, the fact that all three established divisions are performing in one year does not mean we can assume they will do so in future years. The past earnings trend just isn’t good enough. This means we cannot use the Mary Buffett ‘growth model’ to estimate the future value of this share. I propose we use the average dividend paid, expressed as a dividend yield, to value this share instead.
Discl: hold RBD, but not because Warren Buffett would approve!
A significant progression has occurred since Restaurant Brands have shifted outlook from becoming a 'domestic franchiser' to an 'international restaurant developer'. The point of failure in the 'Buffett Tests' is now the seemingly ever decreasing net profit margin. To give this some context, I have stacked up the profit margin trend against the company that develops the KFC concept in China, YunChina (YUMC). YUMC is twenty times the size of RBD and operates in a different market. Nevertheless, the underlying mode of operation, developing new outlets for the master franchise holder in the US - YUM brands - is the same. Furthermore I have calculated the Net Profit Margin for the most recent half year reporting period for RBD:
$21.853m / $445.848m = 4.9%
and added that to the trend comparison. Note that I am comparing the RBD year that ends in March with the YUMC year that ends in December. The best overlap is to consider the RBD FY2018 year ending 31st March 2018 with the YUMC year ending 31st December 2017, So this is what I have done for all years
|
FY2014 |
FY2015 |
FY2016 |
FY2017 |
FY2018 |
HY2019 |
Restaurant Brands Net Profit Margin |
5.7% |
6.0% |
6.0% |
5.9% |
5.3% |
4.9% |
YumChina Net Profit Margin |
4.1% |
3.7% |
5.4% |
7.0% |
8.3% |
|
What can explain the two apparently diverging trends? The low profitability of YUMC in FY2013 and FY2014 can be explained by a supplier food handling scandal. In FY2014 that saw a same store sales decline of up to 40% at some KFC outlets. FY2015 was a period spent rebuilding from this. So it is the FY2016, FY2017 and FY2018 net profit margins are reflective of what shareholders might expect without these adverse conditions at YumChina.
By contrast at RBD, FY2017 and FY2018 are the periods where the great overseas expansion strategy was coming into play. In AR2018 p26 and p27, CEO Russel Creedy gives a candid interview. He says that to gain the 'growth' required for the company's strategic vision, to become a billion dollar company in revenue and market capitalization, it was necessary to buy that growth by investing overseas. Yet later in that same interview he admits that:
"Our growth strategy also includes new store builds which incidentally generate the highest return in investment."
Putting the two comments together, it is clear that growth overseas where you are generally buying stores rather that building them is less profitable. Sure Taco Bell in Hawaii has a high EBITDA as a percentage of sales at concept level. But this does not include the extra interest costs incurred in funding the purchase, nor the extra more bloated corporate structure behind the scenes needed to manage it. The RBD growth strategy contrasts very greatly with YumChina who develop all their own stores from scratch.
The ROE decline at RBD mirrors a similar pattern, although there are signs it has stabilized near 20%. This is still a good figure in absolute terms, albeit well down on 30% that was regularly attainable when RBD was an NZ focussed business. Yet so great has been the drop against a background of the NZ side of the business doing well, I think questions need to be asked as to what the ROE is on the overseas side of the business, and just how far above the cost of capital are these overseas business returns?
Taken overall it looks like RBD are on a path of increasing profits, even in eps terms, but decreasing profitability.. Are there shades of Buffett's much derided management phenomenon of the 'institutional imperative' at work here? The naval analogy of the 'institutional imperative' is that our 'captains of industry' would prefer to skipper a battleship, even one with dis-functional weapons than a smaller well armed frigate.
It is possible that RBD will be able to turn their overseas investments around, with more green field KFC projects in New South Wales and a rebuild program in Hawaii that will revamp that states restaurants so that earnings double in that state. However talk that RBD will instead look to acquire more existing restaurants on the West Coast of the United States as their prime growth plan would argue against the positive overseas growth outcome. I think Warren Buffett would be waiting to see if the overseas strategy was not going to degrade the profitability of RBD too much before investing his own money in the RBD story going forwards.
SNOOPY
discl: hold RBD myself, but bought many years ago
Capitalised Dividend Valuation: HY2019 Perspective
Quote:
Originally Posted by
Snoopy
Dividends paid in the calendar years below were as follows:
2011:: 7.0c, 10.0c
2012:: 6.5c, 9.5c
2013:: 6.5c, 9.5c
2014:: 6.5c, 10.0c
2015:: 7.5c, 10.0c
The average annual dividend 16.6 cps is fully imputed. 16.6c is equivalent to a gross yield of :
16.6c / (1-0.28) = 23.1c.
Current term deposit rates are around 4%. I would want a return two percentage points better than this to allow for the greater income volatility risk of share such as this. So my June 2015 valuation for RBD is:
23.1/ 0.06 = $3.84
Should term deposit interest rates fall to 3.5% my valuation would increase to:
23.1/0.055 = $4.20
With RBD trading at up to $4.40, the company is now overvalued. However, any share can be expected to be overvalued for extended periods. Furthermore, the overvaluation is not great. If the Carl Juniors growth story takes off (i.e. my modelling is too conservative), then RBD may not be overvalued. In the absence of a better retail/food investment, I will continue to hold.
Dividends paid in the financial years below were as follows:
FY2014:: 9.5c, 6.5c
FY2015:: 10.0c, 7.5c
FY2016:: 11.5c, 8.5c
FY2017:: 12.5c, 9.5c
FY2018:: 13.5c, 10.5c
HY2019: 18.0c
The average annual dividend 20.6 cps fully imputed. 20.6c is equivalent to a gross yield of :
20.6c / (1-0.28) = 30.0c.
Current term deposit rates are around 3.5%. I would want a return two percentage points better than this to allow for the greater income volatility risk of share such as this. So my January 2019 valuation for RBD is:
30.0 / 0.055 = $5.45
This valuation is strictly from an 'income' perspective. With the share trading at $7.60 just prior to the 'Global Valar SI' takeover offer, this shows that there was a considerable growth premium built into the share price before the Mexicans came along. At an offer price of $8.90, there is now a huge growth premium built in. A premium I would suggest that can only be satisfied with a sustained push into Pacific rim markets.
SNOOPY
ROE for Overseas Venture Returns [FY2018 Perspective]
Quote:
Originally Posted by
Snoopy
The ROE decline at RBD mirrors a similar pattern, although there are signs it has stabilized near 20%. This is still a good figure in absolute terms, albeit well down on 30% that was regularly attainable when RBD was an NZ focussed business. Yet so great has been the drop against a background of the NZ side of the business doing well, I think questions need to be asked as to what the ROE is on the overseas side of the business, and just how far above the cost of capital are these overseas business returns?
Having posed the above question, I think rather than speculating on what the answer might be, I should 'do the maths' and find out.
From the Buffettology Workbook, p149
"We take the per share amount of earnings retained by a business for a certain period of time then compare it to any increase in per share earnings that occurred during the same period"
In this instance the 'per share earnings retained' has been supplemented by a whole lot of new capital raised with the October 2016 cash issue. So in my judgement it is best to use the change in shareholders equity from the reporting date before the cash issue (EOFY2016) to the end of FY2018. FY2018 was the first full year of operation that included the Hawaiian and most (42) of the Australian KFC acquisition (18 more KFC stores were acquired over FY2018).
|
EOFY2016 |
Change |
EOFY2018 |
Normalised Earnings {A} |
$24.207m |
|
$40.361m |
No. of Shares {B} |
102.871m |
|
123.629m |
eps {A}/{B} |
23.53c |
+9.12c {D} |
32.65c |
Owner Equity {C} |
$75.617m |
|
$210,608m |
Owner Equity per share {C}/{B} |
74c |
+96c {E} |
$1.70 |
Return on Incremental Equity / Share {D}/{E} |
|
+9.5% |
|
The above should not be too much of a surprise. If the overseas operations are now roughly the size of the NZ business, the ROE before overseas acquisitions was 30% and the ROE after overseas acquisitions was 20%, then it would take a figure that low to bring the average ROE down to 20%. I would also argue that not all of that new capital has been in use all of the time (the capital raised one quarter of the way through the study period and gradually deployed over it).
I don't know what the generally accepted value of the cost of capital of RBD is these days. But I would guess that 9.5% 'plus a bit' is still above it. I suppose what this means is that real underlying growth for RBD will be much slower going forwards compared to the recent past.
SNOOPY