Why Burger King Is Set for Greatness

Burger King Worldwide (BKW.DL) may not be everyone's cup of tea. At first glance, the company looks expensive compared it its competitors, especially burger-behemoth McDonald's (MCD 1.32%).

However, Burger King has many qualities that make it stand out from its peers. In particular, the company's cash generation and profit margin, which are second to none in the sector. So, let's take a look at why I believe Burger King is set for greatness.

Debt
The first thing to point out about Burger King is its debt, which at first glance appears to have grown to worrying levels. The company's debt-to-equity ratio stood at 218% at the end of the third quarter, while its debt-to-asset ratio was a more reasonable 53%.

Burger King is extremely cash generative, however. The company generated $306 million in cash during the first nine months of this year with no additional debt or stock issuance -- around 180% of net income. This resulted in the company's cash pile growing to $764 million at the end of the third quarter, up 58% year-over-year and up by $110 million from the second quarter. The company's net-debt-to-asset ratio also dropped to 40%; down from 43% at the end of the second quarter.

Moreover, it is likely that the company could generate more cash by refinancing its debt. At the end of the second quarter, Burger King had $3.048 billion in long- and short-term debt on its balance sheet. Interest payments for the quarter were $48 million, or $191 million annualized, indicating an average interest rate of 6.3%. With the insatiable demand for corporate debt in the markets at the moment and continuation of loose monetary policy, it's likely that Burger King could refinance this debt at lower rates.

Expansion, sale, and leaseback
My second point surrounds the company's sale and leaseback plan coupled with its goal of changing all of its restaurants to a franchise model. At the end of the fiscal second quarter, 99.4% of Burger King restaurants worldwide were franchises. However, the company finally franchised its remaining 19 company-owned stores within Spain, completing its global franchise initiative.

Additionally, 133 (net) new restaurants opened during the third quarter, taking the total of new restaurants opened this year to 592. I should also mention Burger King's recent expansion into France, where the company plans to create 1,200 jobs in the first year alone.

Thanks to this franchising model the company has been able to achieve such a high level of cash flow, as noted above.

Wendy's is following in Burger King's footsteps
Like Burger King, The Wendy's Company (WEN 2.39%) is also changing its business model to a franchise-based structure. This means that the company is selling off company-owned restaurants to franchisees to ensure a more predictable cash flow and higher margins. The company plans to complete the sale of 425 company-operated restaurants by the second quarter of 2014.

This indicates that Wendy's investors could see the company's earnings and margins rocket higher over the next few quarters.

What's the company worth?
All of these factors highlight the big changes that are going on at the company to drive profits and investor returns. It's Burger King's valuation that really attracts me to the company, though. Look at how the company has grown year over year to the end of the second quarter in comparison to its larger peer: McDonald's (EBIT represents earnings before interest and taxes.) 

Burger King's growth compared to McDonald's is highly impressive. In particular, while Burger King's sales have declined due to franchising, ultimately, this has translated into rapid earnings-per-share and margin growth, far outpacing that of McDonald's. Actually, looking at these numbers alone, it would appear as if McDonald's is struggling to grow despite its size and marketing initiatives designed to drive sales.

Nevertheless, investors are paying a premium for Burger King's growth as the company trades at a trailing-12-month P/E of 34. In comparison, McDonald's trades at a trailing-12-month P/E of 18. That being said, we know that Burger King is highly cash generative, so we should use the the price-to-cash-flow ratio, or P/CF to get a more accurate view of the company's valuation considering its cash generation.

Using this metric, we can see that Burger King trades at a P/CF ratio of 10 compared to McDonald's ratio of 38. So, based on cash flows, Burger King is cheaper than its international burger-behemoth peer McDonald's

Foolish summary
While Burger King is not the largest fast-food company around, it has a huge scope for growth. Most importantly, Burger King's cash generation is almost second to none, and the company should be able to use this to its advantage in the future either through increasing shareholder returns or acquiring competitors. This makes the company look cheap on a cash-flow basis and as cash is king in business, I would rather choose 'The King' over Ronald McDonald.