Should You Bet on the Asset-Light Strategy at Burger King?

Burger King has transformed itself into a pure-play franchiser through sales of company-owned properties, sending its profitability higher. Should investors bet on the story?

Jan 12, 2014 at 8:00AM

Ever since acquiring control of Burger King Worldwide (NYSE:BKW) in a 2010 leveraged buyout, investment firm 3G Capital has put its stamp on the company, with a focus on capital efficiency and shareholder value. Now public, Burger King has continued implementing 3G's strategy, selling off company-owned stores and concentrating its resources on product development and franchisee support. 

Despite weak sales growth for the quick-serve restaurant industry in 2013, due to sales going upstream to casual-dining-focused chains like Red Robin (NASDAQ:RRGB) in the burger arena, some investors see value at the Home of the Whopper, including investor Bill Ackman and his Pershing Square hedge fund. So, should small investors buy into the story?

What's the value?
Burger King has the No. 2 position in the quick-serve hamburger segment, with roughly 13,000 stores operating in 91 countries around the world. Unlike hamburger-chain kingpin McDonald's (NYSE:MCD), Burger King traditionally has had a majority of its locations in North America, resulting in a recent push to expand in international hotspots, like China and Brazil. The company has also been overhauling its menu for a more health-conscious crowd, adding salads, wraps, and smoothies to its beef-heavy menu.

In fiscal year 2013, Burger King has enjoyed positive systemwide sales growth, up 3.7% versus the prior-year period, although comparable-store sales growth was flat in a tough operating environment. On the upside, though, the company believes that reimaged stores in North America have been outperforming its overall store base in sales growth, providing management with a strong impetus to quickly overhaul the roughly 80% of stores that have yet to go through the upgrade process. 

More important, Burger King's operating profitability has jumped sharply in the current period, courtesy of its refranchising activities, which are providing the capital to pay down debt and embark on global growth initiatives.

Of course, Burger King's virtually 100% franchised-store strategy stands in stark contrast to McDonald's heavy mix of company-owned stores, roughly 19% of its overall store base. By its own admission, McDonald's likes to maintain a solid base of company stores in order to provide a real-world testing ground for its new marketing plans, pricing strategies, and operating methods. McDonald's also seems to have a more adept system for running its stores, reporting a store margin of 17.6% in the current year compared to just 11.6% for Burger King.

In FY 2013, McDonald's has been feeling the effects of low industry growth in the quick-serve segment, generating a revenue gain of 1.9%, below its target of 3% to 5% annual increases. Despite the limited top-line expansion, though, the company was able to maintain its profitability by leveraging efficiencies in its store-support operations, an unparalleled network that supports stores in 119 countries around the world. 

In addition, McDonald's remains a cash flow machine, generating roughly $3 billion in excess cash flow during the period, which it is returning to shareholders through dividend increases and stock repurchases.

Going upscale in burgers
Since Burger King has almost completed its multiyear refranchising initiative, expected at the end of FY 2013, the company is now relying heavily on greater productivity from its existing franchisee partners for future profit growth. Given that consumers seem to be gravitating toward casual chains for their higher-quality food and better service capabilities, according to data provider NPD Group, Burger King and its quick-serve competitors might have some tough sledding ahead. Red Robin's slow and steady ascension is emblematic of strong underlying demand for better burgers, a phenomenon that was reportedly sparked by famed French chef Daniel Boulud's creation of the $32 db Burger in 2001.(NASDAQ:RRGB)

For its part, Red Robin offers roughly 20 different gourmet burgers, including its new chef-inspired Smoke & Pepper burger, a diverse portfolio that landed the company on Zagat's Best Burger list for the fourth year in a row. Red Robin's shares were as hot as its grills in 2013, up more than 100%, due to generally favorable financial results, including a 4.2% increase in its comparable-store sales.  More important, a slight improvement in profitability is providing the capital and momentum to expand its operations and provide more competition for Burger King and the quick-serve burger chains in FY 2014.

The bottom line
Burger King has an active majority shareholder that is watching the company's bottom line, resulting in enhanced profitability and a better financial profile for the company. However, Burger King needs to continue upgrading its food offerings to avoid losing the subset of customers that see greater value from the casual-dining segment, a process that remains incomplete. As such, investors should let this burger icon's redevelopment age a bit further before contemplating a position.

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Fool contributor Robert Hanley 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.

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