Is Restaurant Brands International’s Carrols Buy a Slam-Dunk Win for QSR Stock?

Will Ashworth - Barchart - Wed Jan 17, 9:23AM CST

Restaurant Brands International (QSR), the parent of Burger King, announced on Tuesday that it would pay $9.55 a share for all of the stock in Carrols Restaurant Group (TAST) that it doesn't already own.

The transaction gives Carrols an enterprise value of $1 billion. That’s a premium of 23.1% to Carrols’ 30-day volume-weighted average price as of Jan. 12. It is Burger King's largest US franchisee.

“This acquisition is an exciting accelerator to our Reclaim the Flame plan that is focused on relentlessly pursuing a better experience for our Guests,” stated Tom Curtis, President of Burger King U.S. and Canada.

“We are going to rapidly remodel these restaurants over the next five years or so and put them back into the hands of motivated, local franchisees to create amazing experiences for our Guests.”

There is no question about the motivation behind Restaurant Brands’ acquisition of Carrols. It's in a race to remodel its Burger King footprint so it can better keep up with McDonald's (MCD) and others in the QSR (quick-service restaurant) space.

While on paper, the transaction makes sense, RBI stock fell on the news. There’s a reason why investors reacted negatively to the news. It’s no slam dunk. Here’s why.

What Restaurant Brands Gains From Carrols

Carrols operates 1,022 Burger King locations and 60 Popeyes locations in 23 states, accounting for 15% of the total Burger King footprint in the U.S. As its President stated above, it will take five years to remodel 600 restaurants for $500 million. About 80% of the locations will be refranchised over the next 5-7 years, with Restaurant Brands keeping around 200 for its company-owned locations.

ABC News reported that Carrols’s restaurants have historically done better than other U.S. Burger King locations. Buying this many locations -- it has approximately 6,813 in the U.S. -- accelerates its renovation timetable.

“We need pretty much every Burger King all across the country to be modern, convenient and competitive with all of the other concepts out there that have new and modern buildings,” ABC News reported Restaurant Brands CEO Joshua Kobza’s comments from its August 2023 conference call.

TD Cowen investment bank analyst Andrew Charles estimates that 40% of the entire footprint has been renovated and modernized, with another 10% currently underway. Carrols would bump that up to 60%.

Carrols generated $1.85 billion in restaurant sales in the trailing 12 months ending October 2023, with an adjusted EBITDA of $142 million and a 7.7% EBITDA margin. By comparison, the Golden Arches EBITDA margin is about 6x larger.

In 2022, Restaurant Brands’ EBITDA was $2.38 billion. Carrols adds 6% to the company’s annual EBITDA. Even if it can double Carrols’ EBITDA, it’s a drop in the bucket for RBI.

And that’s a big if.

What It Loses With Acquisition

RBI will pay for Carrols with cash on the balance sheet and a term loan. As of Sept. 30, 2023, it had $1.3 billion in cash, so conceivably, it could pay for the entire purchase without dipping into debt.

But that’s not its modus operandi. It loves debt.

“RBI expects the transaction to be approximately neutral to Adjusted Earnings per Share. Net leverage giving effect to the transaction will increase minimally and the Company will remain on track to reach its previously stated net leverage target of mid-four times by the end of 2024,” stated its press release.

So, as of Q3 2023, its net leverage was 6.2x, based on net debt of $13.13 billion and $2.11 billion in EBITDA. However, it will likely finish the year with $600 million in adjusted EBITDA in Q4 2023, which brings the net leverage down to 5.1x.

With the net leverage moving slightly higher in 2024 -- let’s say to 5.3x -- it will either have to increase adjusted EBITDA by nearly 30% to $3.28 billion or lower its net debt by 30% to $10.2 billion. It hasn’t had net debt this low since 2016.

Over the past five years, QSR stock gained just 32%, less than McDonald’s, Domino’s Pizza (DPZ), and the S&P 500.

I’ve long believed its balance sheet is holding its share price back. Nothing changes with this acquisition. It might accelerate the Burger King remodel, but it doesn’t guarantee it will make a difference in the QSR arena. There are better buys in the restaurant space.

The Carrols buy is anything but a slam-dunk for QSR stock. Of course, Restaurant Brands Executive Chairman Patrick Doyle had to do something to take investors’ eyes off the fact he was Canada’s top-compensated executive in 2023.

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On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.