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For Restaurant Brands, it's ... fast food, but slow growth

By Shoeshine

Thursday 17th April 2003

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Few companies work harder than Restaurant Brands at keeping the business humming along.

So although the company put a brave face on its latest profit result managers must have been disappointed.

The company, Stock Exchange ticker RBD, listed in June 1997 when PepsiCo, the original owner of its fast food chains, was pulling in its worldwide horns.

The shares sold for $2.20, giving the company a market capitalisation of $187 million. At last week's closing price of $1.46 market cap was $135.2 million.

The 1997 bottom-line profit was $11.1 million. Last week's result came in at exactly the same figure.

The loss of market cap in the intervening six years represents investors' disenchantment with what many had hoped would be a growth stock.

The 10c dividend has stayed the same for four years running.

Nonetheless RBD still has its fans. On the Sharechat investors' online forum the thread entitled "RBD ­ growth to come?" runs to 30 pages.

Afficionados pin their faith on RBD's excellent governance and management.

A great deal of hard work and investment has gone into preserving the market share and profitability of the workhorse KFC fried chicken brand and building the Pizza Hut chain.

And the company has displayed a level-headed approach to growth opportunities.

The May 2000 acquisition of the Eagle Boys pizza chain for $28.3 million was a big one for a business of RBD's size but it has paid its way handsomely, exceeding management's earnings expectations.

The introduction of the Starbucks chain of coffee houses is also going well. Given the long-term earnings black hole Australia has proven for many a local outfit the April 2002 acquisition of 51 Pizza Hut stores in Victoria is coming right remarkably quickly.

Still, the impression remains of a company pedalling very hard to go nowhere.

The early and sustained slump below the shares' issue price will take some time to fade from the market's mind. RBD's fast food sales seem vulnerable to the fortunes of the economy and consumer confidence.

And punters are probably right to worry about fast food's long-term appeal to increasingly affluent and health-conscious consumers.

Division by division the latest result was something of a mixed bag.

The press release trumpeted second- half margin improvement across all four but the overall result was, as noted, no higher than six years ago.

KFC now accounts for 59% of group sales, down from 67% a year ago.

Annual sales fell 1.1% to $175.1 million. In 1997 they were $172.3 million.

Ebitda has been falling for three years, from $36.3 million 2001 to $30.3 million last year.

Chief executive Jim Collier acknowledged the business, while stable, had "modest" growth prospects.

The plan to arrest shrinkage involves introducing "lighter and healthier" menus ­ for example, a chicken salad being tried in the Waikato.

This sends it down the same trail as Burger King and McDonald's, which recently reported a $620 million fourth- quarter loss.

But whether people will actually go to any of those chains for such things remains to be seen.

For consumers, in Shoeshine's experience, the grease has always been half the charm.

Much of the slack KFC has given in New Zealand has been taken up by Pizza Hut, where sales, thanks largely to the Eagle Boys acquisition, have grown from $44.5 million in 1997 to $75.7 million last year.

People, it seems, are increasingly uninterested in sitting in a restaurant just to eat pizza so RBD has been replacing restaurants with "delco" outlets catering for takeaways and home delivery.

Jitters about the impending entry of Domino's Pizzas, which plans to open up to eight outlets in the three main centres later this year, are probably overdone.

Domino's isn't likely to come off best in a price war with the incumbent chains and RBD has warned it is "well prepared to use aggressive strategies to rebuff any new competitor."

RBD arguably overstated the prospects of the Starbucks chain but it has so far been a useful though modest add-on.

From a standing start in 1998 sales have climbed each year, to $22.8 million.

Earnings before interest, tax, depreciation, and amortisation (ebitda) of $2.6 million, although not as substantial as some had hoped for, are growing steadily.

The question here is how much those sales and earnings can grow in a hugely competitive sector. "Charbucks," as some would have it, hardly provides the ambience of a boutique cafe.

Somewhat inevitably the future for RBD comes down to Australia.

RBD paid $14.4 million for the Victorian pizza stores.

Sales and profits there had been declining for three years and RBD, as it likes to remind investors at every opportunity, got them for below replacement cost.

At the end of this year they were breaking even at the cashflow and ebitda levels.

Collier, a former Pizza Hut Australia manager, has the same strategy for staunching the losses as he has used in New Zealand, that is, closing restaurants and opening delcos.

He says it has already worked around the rest of Australia ­ Victoria was just lagging behind.

Analysts now expect the Victorian operation to be an earnings contributor in the 2004 or 2005 year, depending on how much RBD has to spend on restaurant-to-delco conversions.

Collier said last week the rest of Australia was a target but not until Victoria came right.

It's not clear what he means. RBD doesn't own the Pizza Hut brand in other states, so presumably it will be on the hunt for franchises that have been weakly managed and are failing.

On their track record so far Collier and his team are good at spotting those. But they'll have to find a few good ones fast if RBD is to gain a rating as a growth stock.

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