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Sorry Warren: 3 Reasons I’m Bearish on This Favourite Buffett Stock

It’s no secret that Warren Buffett loves the franchise business. Berkshire Hathaway, his holding company, has heavily invested in the sector over the years.

Buffett’s largest restaurant investment today is in Restaurant Brands International (TSX:QSR)(NYSE:QSR), the parent company of approximately 18,000 Burger King restaurants, 5,000 Tim Hortons locations, and, most recently, 3,100 Popeyes chicken joints. Together, these three chains do more than US$30 billion in sales each year.

It’s easy to see why Buffett was attracted to the investment. It’s a colossus. Today, Berkshire’s stake in the company stands at a hair over 8.4 million shares, an investment worth some US$550 million. The position was previously worth several billion, but Buffett took his profits when given the opportunity to do so on the preferred share part of the investment.

It isn’t very often I can say this, but I don’t agree with Warren Buffett here. I think an investment made in Restaurant Brands today will underperform the market going forward. Here are three reasons why.

Crummy innovation

I’m not very impressed with recent new products coming from both Burger King and Tim Hortons.

Let’s start with Tim Hortons, a chain I believe has been going downhill for years now. Recent product innovations include a deep-fried chicken burger (despite not having a deep fryer in any of its restaurants) as well as a Beyond Meat burger and breakfast sandwich with a vegetarian sausage option.

The most successful fast-food joints are emphasizing fresh ingredients and quality products because customers are demanding good food. Tim Hortons responds to this trend by releasing a microwaved chicken sandwich and a lacklustre attempt at a hamburger. Nobody goes to Tim’s for a burger. There are a million good hamburger places out there, and Tim Hortons will never be one of them.

Then there’s Burger King, which is pushing various chicken products. The company identified chicken as a long-term growth area and has responded accordingly. But the products are chicken strips, popcorn chicken, and a spicy chicken sandwich. Yawn. It’s time for some real innovation.

Cheap head office

Many investors are choosing to ignore the recent issues between disgruntled Tim Hortons franchisees and head office, saying they’re a few rogue owners who miss the good ol’ days.

I disagree completely. It takes guts to risk your livelihood challenging head office. This wasn’t a decision taken lightly. And I guarantee for every vocal complainer, there are dozens more grumbling quietly behind the scenes.

3G, the Brazilian-based majority shareholder of QSR, is notorious for cutting expenses to the bone. This is a dangerous path to take over the long term, and I believe it will ultimately lead to dissatisfaction at the store level. The golden rule in a franchise business is, you must keep your franchisees happy. After all, they’re the ones who are talking to customers all day.

Slowing comps

The issues I’m mentioning are beginning to show up in same-store sales, which is perhaps the most important metric in the whole restaurant industry.

In the first quarter, the company reported overall sales growth of 6.4%, which a solid number. But that was driven almost entirely by new restaurants opening rather than growth at existing locations.

Results are more bleak once we look a little deeper. Burger King’s comparable sales growth wasn’t bad, coming in at 2.2%. But Popeyes only saw same-store sales growth of 0.6%, while Tim Hortons saw a marginal decrease in same-store sales with that number declining by 0.6% in the quarter.

Burger King is the only part of the business that’s performing well, and some analysts say that’s because of aggressive discounting — a strategy that is making franchisees unhappy.

The bottom line

I don’t want to argue that Restaurant Brands is a poor company or anything that extreme, because it’s still a behemoth in the industry with the potential to acquire more brands. I just don’t like the company’s operations. The company needs some fresh new ideas, not the same old stuff.

Until it does, I’d much rather stick with this restaurant stock.

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Fool contributor Nelson Smith owns shares of Berkshire Hathaway (B shares). The Motley Fool owns shares of Berkshire Hathaway (B shares) and RESTAURANT BRANDS INTERNATIONAL INC and has the following options: short October 2019 $82 calls on RESTAURANT BRANDS INTERNATIONAL INC, short January 2021 $200 puts on Berkshire Hathaway (B shares), and long January 2021 $200 calls on Berkshire Hathaway (B shares).

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