Morgan Stanley's Drive-Thru Pair Trade: Buy Restaurant Brands International, Sell Jack In The Box

A plethora of quick service restaurant chains have undergone a refranchising process in the last five years, with company-owned stores being sold to franchisees, Morgan Stanley said in a sector-wide industry report. Now that the process has mostly come to an end, the sell-side firm has become incrementally more positive on Restaurant Brands International Inc QSR and less positive on Jack in the Box Inc. JACK

The Analysts

A team of analysts led by John Glass upgraded Restaurant Brands' stock rating from Equal-Weight to Overweight with a price target lifted from $69 to $71. The analysts downgraded Jack in the Box's stock rating from Overweight to Equal-Weight with a price target lowered from $106 to $95.

QSR: Bear Case Scenario Nothing To Fear

QSR, the parent company of Burger King, Tim Hortons and Popeyes Louisiana Kitchen, is the "single most dislocated" stock versus the general restaurant industry based on multiple valuation metrics, including free cash flow yield, Glass said in the upgrade note.

The company has the potential to return more than 40 percent of its market cap to investors over the next three years, partially aided by one of the highest dividend yields in the group at more than 3 percent, according to Morgan Stanley. 

Investors do have reason to be concerned with Tim Horton's slow sales, as the iconic Canadian coffee brand accounts for 50 percent of total earnings, Glass said. But a "bear case stress test" — in which EBITDA remains flat for two years and total capital expenditure rises to $100 million — QSR would still notch $2.90 in free cash flow per share, the analyst said. Under this scenario, Restaurant Brands' stock valuation "wouldn't be that much lower" than it is now, he said. 

Related Link: Why Restaurant Brands Could Be A Great Growth Stock

Jack In The Box: Debate Might Be Over

The bull-bear debate for Jack in the Box is mostly based on the restaurant operator's free cash flow outlook after it divested Qdoba for $305 million, Glass said.

The debate could be over, as the hamburger chain provided sufficient "clues" in terms of G&A, leverage targets, capex commentary, tax rates and other metrics to "provide a reasonable" free cash flow per share estimate of $5.70 in calendar year 2019, according to Morgan Stanley. 

Jack in the Box's stock warrants a 6-percent target free cash flow yield on an estimated $5.75 per share in free cash flow, which equates to a $95 price target, the analyst said.

Under a bull case scenario, Jack in the Box's free cash flow per share could come in at $6.25, but the figure is based on better cost reductions and stronger sales — a scenario which may not be feasible to assume based on current expectations for only "modest growth," Glass said. 

Price Action

Shares of Restaurant Brands were trading higher by 1.7 percent Monday morning, while shares of Jack in the Box were lower by 0.55 percent. 

Related Link:

Wedbush Develops An Appetite For Jack In The Box

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