Restaurant Brands International’s Cash Flow Increases The Safety Of Its Dividend Yield

Recap from December’s Picks

On a price return basis, the Safest Dividend Yields Model Portfolio (+3.4%) outperformed the S&P 500 (-2.4%) by 5.8% from December 22, 2021 through January 18, 2022. On a total return basis, the Model Portfolio (+3.5%) outperformed the S&P 500 (-2.4%) by 5.9% over the same time. The best performing large cap stock was up 15% and the best performing small cap stock was up 6%. Overall, 18 out of the 20 Safest Dividend Yield stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from December 22, 2021 through January 18, 2022.

This Model Portfolio only includes stocks that earn an attractive or very attractive rating, have positive free cash flow and economic earnings, and offer a dividend yield greater than 3%. Companies with strong free cash flow provide higher quality and safer dividend yields because I know they have the cash to support the dividend. I think this portfolio provides a uniquely well-screened group of stocks that can help clients outperform.

Featured Stock for January: Restaurant Brands International Inc.

Restaurant Brands International (QSR) is the featured stock in January’s Safest Dividend Yields Model Portfolio.

After its acquisition of Tim Hortons and prior to the COVID-19 pandemic, Restaurant Brands International grew revenue and net operating profit after-tax (NOPAT) by 8% and 12% compounded annually, respectively, from 2015 to 2019. Restaurant Brands International’s NOPAT margins have risen from 26% in 2015 to 28% over the trailing twelve months (TTM). Return on invested capital (ROIC) has risen from 5% to 8% over the same time.

Figure 1: Restaurant Brands International’s NOPAT Since 2015

Free Cash Flow Exceeds Dividend Payments

Restaurant Brands International’s business generates significant free cash flow (FCF) to support its dividend payment. The company has paid dividends every year since 2014 and increased its dividend from $0.62/share in 2016 to $2.08/share in 2020. The current regular quarterly dividend, when annualized, provides a 3.9% dividend yield.

Since 2016, Restaurant Brands International’s cumulative FCF easily exceeds its regular dividend payments. From 2016 to 2020, Restaurant Brands International generated $6.7 billion (39% of current market cap) in FCF while paying $3.8 billion in dividends, per Figure 2. Over the TTM, the firm generated $1.5 billion in FCF and paid $973 million in dividends.

Figure 2: Restaurant Brands International’s FCF vs. Dividends Since 2016

Companies with strong FCF provide higher quality dividend yields because I know the firm has the cash to support its dividend. On the other hand, dividends from companies with low or negative FCF cannot be trusted as much because the company may not be able to sustain paying dividends.

Restaurant Brands International Is Undervalued

At its current price of $55/share, Restaurant Brands International has a price-to-economic book value (PEBV) ratio of 0.7. This ratio means the market expects Restaurant Brands International’s NOPAT to permanently decline by 30%. This expectation seems overly pessimistic given that Restaurant Brands International grew NOPAT by 12% compounded annually from 2015 to 2019 before the pandemic and has seen a rebound in profits over the TTM.

Even if Restaurant Brands International maintains its TTM NOPAT margin of 28% (vs. 5-year average of 32%) and the company’s NOPAT grows by just 3% compounded annually over the next decade, the stock is worth $77/share today – a 40% upside. See the math behind this reverse DCF scenario. In this scenario, Restaurant Brands International’s NOPAT in 2030 is just 4% above 2019 levels. Should the company grow NOPAT more in line with historical growth rates, the stock has even more upside.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in Restaurant Brands International’s 10-K and 10-Qs:

Income Statement: I made $1.3 billion in adjustments with a net effect of removing $821 million in non-operating expenses (17% of revenue). See all adjustments made to Restaurant Brands International’s income statement here.

Balance Sheet: I made $5.4 billion in adjustments to calculate invested capital with a net decrease of $766 million. The most notable adjustment was $2.8 billion (12% of reported net assets) in deferred tax assets. See all adjustments made to Restaurant Brands International’s balance sheet here.

Valuation: I made $18.6 billion in adjustments with a net effect of decreasing shareholder value by $15.2 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $1.7 billion in excess cash. This adjustment represents 10% of Restaurant Brands International’s market value. See all adjustments to Restaurant Brands International’s valuation here.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.