Pass on Freshii Inc.: Buy Restaurant Brands International Inc. Instead

One of the most important things a new IPO can do is to deliver a solid first earnings report; Freshii Inc. (TSX: FRII) did just that March 22, setting the stage for the future appreciation of its stock. You’d be surprised how many freshly minted IPOs stumble out of the gate — a lot.

So, the fact that Freshii announced 34 net new openings in its fourth quarter ended December 25, 2016, the most in any three-month period in its history, along with 7.7% same-store sales growth, the 15th consecutive quarter of positive same-store sales growth, shareholders ought to be excited about the future.

That being said, if you don’t own Freshii stock and are considering buying, don’t. Buy Restaurant Brands International Inc. (TSX: QSR)(NYSE: QSR) instead.

Why? Earnings, that’s why. Restaurant Brands has them; Freshii needs more of them. It’s that simple.

One of the best investment books I’ve ever read is Robert Hagstrom’s 1994 classic, The Warren Buffett Way, which examines the investment strategies of the Oracle of Omaha.

One of the financial tenets covered in the book is the “One-Dollar Premise,” which requires that a public company create one dollar of market value for every dollar of retained earnings using Berkshire Hathaway Inc. equity holdings such as Washington Post and Coca-Cola as examples.

Of course, in those examples, Hagstrom was using 10 years of data; Restaurant Brands has only been a public company since December 15, 2014. Nonetheless, there’s enough data to evaluate how it’s progressing under the leadership of CEO Daniel Schwartz.

The company had retained earnings of US$231 million on December 31, 2014; on December 31, 2016, they were US$445.7 million. On December 31, 2014, Restaurant Brands had a market cap of US$7.9 billion; on December 30, 2016, it had a market cap of US$11.2 billion.

So, in the span of two years, Restaurant Brands created US$7.40 of market value for every US$1 in retained earnings, easily meeting the One-Dollar Premise.

What has Freshii done? Actually, it has done quite a bit.

It managed to produce a profit of US$1.6 million in fiscal 2016 and free cash flow of US$4.5 million compared to a US$1.7 million loss and negative free cash flow of US$3.1 million a year earlier. If you look at Freshii’s financial statements, you’ll see that it shows a much higher free cash flow number than I do — US$6.9 million and US$4.2 million in 2016 and 2015, respectively — because it defines free cash flow as pro forma adjusted EBITDA minus capital expenditures, wheres I used the traditional cash from operations minus capital expenditures.

Either way, it’s headed in the right direction.

Unfortunately, Freshii paid a dividend to existing shareholders prior to the IPO of US$7.3 million as well as a US$4 million return of capital, increasing its deficit to US$12.9 million at the end of 2016.

While that’s likely to shrink in the coming quarters given its asset-light business model, I still think it makes Restaurant Brands the more attractive stock. Check back with me in a year’s time. My opinion might change.