Burger King’s Refranchising Strategy Leads to Lower Costs

During the first quarter of fiscal 2014, Burger King Worldwide (NYSE: BKW  )  reported a large-percentage drop in expenses, which propped up its net earnings. However, the company's top-line revenue did not grow.. The company reported a 69% rise in fiscal 2014 first-quarter earnings, mostly due to lower company-restaurant expenses. Total restaurant expenses fell 86% to $15.5 million.

Refranchising has been the main reason behind the lower costs; since 2013, the company has refranchised 360 of its restaurants. As expenses dropped, top-line revenue also fell by 26%. Same-store sales rose about 2%, which includes a 0.1% rise in the U.S. and Canada.

Company executives also credited the refranchising effort to the doubling of net income during fiscal 2013, and they expect profitability to grow further in 2014. Last year, in addition to the restaurants that were refranchised, Burger King also opened 670 new restaurants. The pace of new restaurant openings is expected to continue in 2014.

Restaurant upgrades and new food items contributed to future outlook
Sprucing up the image of its restaurants is also a major initiative for the company: in 2013, 600 remodels, or 30% of its U.S. and Canadian restaurants, were completed. Burger King plans to bump up the number of domestic restaurants remodeled to 40% by year-end 2015. Franchisees report that the remodels of their locations have raised average sales between 10% and 15%.

New menu items have also helped to increase sales; some of the items that have been introduced onto the menu include lower-fat and lower-calorie French fries, called Satisfries, and a new burger known as Big King. Burger King is focusing on adding fewer menu items that are sure to have an impact on profits.

In addition to the Big King sandwich, the company also launched a BBQ Rib sandwich during fiscal 2013's fourth quarter. In 2014, a spicy version of the company's original chicken sandwich will be added to the menu and will address the two areas of Burger King's menu that are considered to be underserved -- chicken and breakfast.

Burger King's first-quarter profit was $60.4 million, or $0.17 per share, up from $35.8 million, or $0.10 per share in fiscal 2013. Revenue, however, dropped 26% to $240.9 million, due to refranchising efforts and currency fluctuations negatively impacting results. Excluding these two components, overall revenue rose 6.9%.

Burger King's international expansion under way
The fast-food chain operator is looking to open restaurants in South Africa and other nearby countries. It is also interested in pursuing joint ventures in countries like France and India. The segments with the highest growth during the first quarter in comp-store sales and net restaurant growth were Europe, the Middle East, and Africa (EMEA) and Asia Pacific (APAC). The two regions have been delivering strong results for several quarters: EMEA comp sales growth of 4.8% represents the 13th consecutive quarter of growth, while APAC's 3.8% comp sales growth is its sixth consecutive quarter of growth.

Can changes lure customers away from the competition?
While Burger King's revenue saw a steep drop in the first quarter, the company's competitors had mixed results. McDonald's (NYSE: MCD  ) saw its total revenue rise 1% during the first quarter of fiscal 2014, while operating costs rose 2%. Net income and earnings per share sank in the single digits and were also negatively affected by currency exchange rates. The recent weakness was attributed to industry challenges and bad weather conditions.

Comp sales grew abroad but decreased in the U.S. market. The company is looking into stabilizing its business in key markets, such as the U.S., Germany, Australia, and Japan. For the second quarter of 2014, the expectation is for modest growth.

Domino's Pizza (NYSE: DPZ  ) has been growing steadily, reporting 5.4% domestic same-store sales growth for fiscal 2013. Its international division is leading the way in performance, with 6.2% full-year growth of same-store sales. Fiscal 2013 marks the 20th full year of consecutive growth in international same-store sales. Fourth-quarter diluted EPS was $0.78 per share, up by 22% over the prior period. The company also rewarded investors by raising its dividend in the fourth quarter by 25%, a similar strategy adopted by its competitors.

My Foolish conclusion
For these companies, a major source of growth is mostly abroad, and their foreign expansion will be key in staying relevant in the food space. Keeping menu items fresh and relevant to what consumers are seeking will be critical for these companies going forward. The success of their restaurants in new, emerging markets will also be important for future growth.

Of the three companies mentioned, Domino's Pizza and Burger King represent the best value, priced at about 22 times 2015 earnings, and each has a PEG ratio of approximately 1.8. These two fast-food operators have more opportunities to grow their businesses abroad than their much larger rival McDonald's.

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