The world's largest ketchup supplier -- Heinz -- will no longer supply ketchup to the world's largest quick-service restaurant by sales , McDonald's (NYSE:MCD). This is because Bernardo Hees, the Vice Chairman of Burger King Worldwide (NYSE:BKW), has taken over as the CEO of Heinz. This ends four decades of association between the two giants and indicates how intense the burger wars could get in the future, as Burger King is no longer content with playing second fiddle to McDonald's.
Burger King's new strategy
Burger King has an ambitious plan to take McDonald's head on while also competing with Wendy's (NASDAQ:WEN). The loss of Heinz could be the beginning of more trouble for McDonald's. Burger King has a more holistic approach to growth than its peer and it is also migrating to a franchise-based business model. The franchise model is less capital intensive, involves lower risk, and provides a steady stream of cash flow all at the same time.
McDonald's and Wendy's both follow the franchise model themselves and Burger King is now joining the fray with an eye on expansion. Burger King had transitioned to a 99% franchised model by the end of the second quarter, which is why its short-term results have taken a hit.
During the third quarter, Burger King reported systemwide comparable sales, or comps, growth of 0.9%. Net revenue declined 39.6%, but this should not be surprising as the company is transitioning. It has refranchised 519 company-owned restaurants in the last twelve months.
On the back of positive comps, Burger King's system-wide sales increased 4.9% versus a 3.6% gain in the same quarter a year earlier. Excluding the impact of refranchising and currency movements, revenue increased by 8.1% year-over-year due to net restaurant growth and positive comparable sales growth. Burger King's total restaurant count stood at 13,259 versus 12,667 in the same quarter of the previous year. Adjusted diluted earnings per share increased 31.6% to $0.23 per share .
Tapping more markets
Going forward, Burger King is stepping into the lucrative Indian market through a joint venture with Everstone Group, which will be the master franchisee for the country . The joint venture will also allow Everstone to have Burger King's sub-franchise rights throughout the country. This will be an important growth driver going forward because the middle-income population in India is expected to grow ten-fold by 2025 .
The company has also inked a deal with Groupe Olivier Bertrand in France for expanding into France with a network of 250 restaurants. Lately, it has also taken steps to expand into key markets like Russia, China, Mexico, Central America, South Africa, the Nordic countries, Singapore, Malaysia, Korea, and Vietnam to boost its business.
Burger King operates in over 13,000 locations , serving more than 11 million guests daily. This is way behind McDonald's, which has 35,000 locations that serve 69 million visitors per day. Burger King has a lot of runway ahead of it and it could give McDonald's a run for its money with its new business model, putting further pressure on the Golden Arches.
McDonald's is slowing down
McDonald's third-quarter report was not very good as the company reported comps growth of 0.9% versus 1.9% in the year-ago period. The decline was due to weaker consumer spending as a result of macro-economic headwinds. Revenue increased 2% to $7.32 billion and missed the consensus estimate.
Comps were down 1.4% in the Middle East and Africa, while weak performances in Australia, Japan, and China also contributed to the poor results. Going forward, the company is focusing more on locally relevant items, and it is expanding its breakfast line-up as well.
For the fourth quarter, McDonald's expects global comps to remain consistent with the recently reported quarter. Late last month, McDonald's unveiled its new pricing strategy. It changed the dollar menu to the Dollar Menu and More. In my opinion, going forward this could be a catalyst that could lead McDonald's to break out from its recent weakness.
What about Wendy's?
Wendy's has been following a completely different path for growth. It is focusing on an "Image Activation" plan, which focuses on modernizing restaurants and enhancing the customer experience. Driven by this strategy, comps at Wendy's company-owned restaurants in North America grew 3.2% while franchised units saw a 3.1% jump in the previous quarter. The growth in comps was due to new menu offerings like the Pretzel Bacon Cheeseburger, along with brand transformation initiatives .
On the back of comps growth, Wendy's total revenue grew 0.7% year-over-year to $640.8 million, which missed the consensus estimate. Adjusted earnings per share came in at $0.06, beating the consensus estimate by 33.3%.
Wendy's expects average comps at company-operated restaurants in North America to increase 2% versus the prior guidance of 2%-3% for 2013. As a part of its brand revitalization and portfolio optimization plan, it is focused on franchising about 425 company-operated restaurants in 13 U.S. markets, and this is expected to be completed by the second quarter of 2014.
Making a choice
However, Wendy's isn't a good pick considering its expensive P/E ratio of 88, way above the industry-average P/E ratio of 36. In comparison, Burger King trades at a much more reasonable valuation of 35 times earnings.
Given that Burger King is transitioning to a new business model, investors could consider putting their money in this stock. In addition, it also pays out a dividend that yields 1.30%. While this might not be as attractive as McDonald's yield of 3.40%, it should be remembered that McDonald's is now a mature company and its comps growth has been slowing down. Burger King's comps could go up once it completes its transition to a franchise-based business model.
That's why investors looking for growth at a reasonable price in this space should definitely consider Burger King for their portfolios.
Amal Singh has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and McDonald's. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.