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Why Aren’t Investors Shorting Restaurant Brands International Inc.?

Over the past few months, the tensions between the franchise owners of Tim Hortons restaurants and the management of Restaurant Brands International Inc. (TSX:QSR)(NYSE:QSR) have moved from the board room to the pages of Canada’s most-read newspapers. It would seem that owners are very unhappy about the tone from the top.

For those not in the know, Restaurant Brands is the franchisor responsible for Tim Hortons outlets. Given the few coast-to-coast chains that serve coffee in Canada, this issue is being taken extremely seriously.

Although many younger investors will not remember Dunkin Donuts, which were the only game in town for many years, the fact of the matter is that this could be a much bigger problem than investors realize.

If we look at shares of the company, it is difficult to understand why investors are not shorting the security. Restaurant Brands is currently trading at a trailing price-to-earnings ratio (P/E) of 77 times. There are only so many new Tim Hortons locations that can be opened before a point of saturation is reached. Investors saw this previously with Starbucks in the downtown cores.

Revenues, which were US$4,052 million in 2015, increased by only 2.3% to US$4,145.8 million in fiscal 2016. Although this increase is in line with inflation, the challenge comes when we look at the bottom line. Restaurant Brands is already a mature company; earnings per share (EPS) rose from US$0.51 in 2015 to US$0.82.

If we look further into the income statement, the gross margin calculated as (revenues – cost of goods sold (COGS) / revenues) increased from 55.3% in 2015 to 58.3% in 2016. The complaints of the franchise owners are well founded.

For a fast-service company to be able to increase the gross margin by as much as 3% in one year, there is clearly going to be a difference in the quality of products sold. This is where the franchise owners are better connected than senior management at Restaurant Brands.

By looking at the gross margins of the first quarter of 2017 vs. last year, we can see the party may soon be coming to an end. The gross margins in each quarter were a steady 57.7%, which may result in a slowing down of bottom-line earnings. Time will tell over the next few quarters.

Going forward, two of the key metrics to look at will be the change in revenues, which will signal to investors whether or not customers have decided to go elsewhere, in addition to the quarterly gross margins.

The gross margins show the percentage of revenues which account for COGS; they will either have to continue increasing upwards. or a sell-off in the share price could ensue. Investors need to remember what kind of company they are investing in.

A better (stickier) business would be a company, like a bank, that has an ongoing relationship with each customer.

Should Restaurant Brands International Inc be on your buy list?

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Iain and his team of star analysts just revealed their five top stock picks for investors to buy right now. Did Restaurant Brands International make the cut?

*returns as of 6/6/17

Fool contributor Ryan Goldsman has no position in any stocks mentioned. David Gardner owns shares of Starbucks. Tom Gardner owns shares of Starbucks. The Motley Fool owns shares of RESTAURANT BRANDS INTERNATIONAL INC and Starbucks. Starbucks is a recommendation of Stock Advisor Canada.

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