Morgan Stanley: As Refranchising Dies Down, What's Next For Fast Food Restaurants?

The quick service restaurant industry has benefited in recent years from a "wave of refranchising" in which company-owned stores were sold to franchisees, Morgan Stanley said in an industrywide report. The top question in investors' minds is, according to the sell-side firm: what's next?

The Analysts

Morgan Stanley's John Glass, Christopher Carril, and Brian Harbour analyzed the eight largest all or nearly all-franchised restaurant stocks.

The Thesis

After a refranchising trend in the quick service restaurant industry over the past five years, now is the time to "look beyond the refranchising event itself" to identify which restaurant operators still boast catalysts, the analysts said.

Morgan Stanley measured the group of stocks on three different metrics: free cash flow yields, return of cash to shareholders, and income purity.

Here's a summary of the firm's findings. 

Free Cash Flow Yields

The most undervalued company on a free cash flow basis is Restaurant Brands International Inc QSR, the analysts said. 

Sonic Corporation SONC is "by far" the cheapest on this metric, but has had the most disappointing sales results over the past six quarters, according to Morgan Stanley. 

Return Of Cash

Both QSR and Jack in the Box Inc. JACK can return more than 40 percent of their market cap to shareholders over the next three years, the report said. 

Wendys Co WEN and Domino's Pizza, Inc. DPZ rank third and fourth, respectively, in terms of having the greater potential upside to existing capital return estimates.

Income Purity

Sonic, Yum! Brands, Inc.YUM and Dunkin Brands Group IncDNKN boast the "purest" franchise income stream, as 80 percent of reported EBITDA comes from royalty and fee income, the analyst said. 

This metric is not "easily visible" in reported results and doesn't factor as much in valuation, according to Morgan Stanley. 

Related Links:

Buy The Weakness in Yum China Shares, Says Morgan Stanley Analyst

Wendy's 'Intriguing' 2020 Outlook Overshadowed By Valuation Concerns, Oppenheimer Says