Burger King's buyout of Popeyes Louisiana Kitchen (NASDAQ:PLKI) for the whopper of a price tag of $1.8 billion is a big bet on fast food as Restaurant Brands International (NYSE:QSR) will now have burgers, donuts, and fried chicken all under one roof.
While McDonald's (NYSE:MCD) pursues a strategy of showcasing healthier fare through fresher ingredients to be more like higher end "better burger" chains, Burger King's parent is seemingly taking the path laid out by rival Sonic (NASDAQ:SONC), which revels in the low-brow indulgence offered by its fast food menu. But regardless of whether a chain goes high or low, this acquisition may end up being a costly mistake for Restaurant Brands International.
Nothing on the menu looks good
Not too long ago it looked as if both extremes were smart moves. Fast casual chains like those McDonald's wanted to emulate were just about the only segment of the restaurant industry doing well, and the burger joint's own earnings finally turned positive allowing it to produce a string of higher same store sales for five consecutive quarters. At the other end, Sonic was largely outperforming the competition, putting up double-digit earnings growth rates quarter after quarter.
But industry trends began slowing last year, first with Sonic missing expectations, then with more fast casual chains producing goose eggs. And just last month McDonald's broke its streak of higher quarterly comps with a 1.3% decline as its all-day breakfast menu failed to deliver the same sales growth. The Golden Arches just announced it was going to be cutting prices on drinks as it confronts slowing industry sales trends.
There is a broad restaurant recession under way as substantial price deflation at the supermarket convinces consumers it's cheaper to buy groceries and cook at home. NPD Group noted in December that customer traffic at restaurants that had been flattening finally turned negative in the third quarter and ended the year with no quarterly growth at all. Investors shouldn't expect 2017 to be any better either.
Not so finger-licking' good?
Which is why Popeyes' acquisition by Restaurant Brands International could falter. First, a recent Bloomberg article noted the price tag being paid for the fried chicken joint translates into a multiple of six times its sales, the highest ever paid for a North American restaurant chain. While the news site thought it was still a good deal because Restaurant Brands had low debt levels, something it planned on rectifying this year anyway and the acquisition helps in that regard, it would still seem a suboptimal purchase.
Burger King's parent has not fulfilled the promise to grow internationally that it made when it purchased Canada's Tim Hortons chain in 2014 for $11.4 billion. The rationale at the time was Restaurant Brands could sell the signature combination of donuts and coffee on an international scale but today there are only 100 more Tim Hortons operating than there were back then. It's hardly expanded the chain anywhere, let alone globally, and now it will be undertaking a supposed second global expansion initiative.
Still, on its latest earnings conference call with analysts CEO Daniel Schwartz suggested a growth spurt would be coming for Burger King as "there is no reason that the Burger King brands shouldn't be growing at an accelerated pace in the U.S.," and in announcing the Popeyes deal, it said it would seek to "continue developing the brand at an increasing pace" in the U.S. and international markets.
Bulking up as industry slims down
The restaurant industry is entering a period of decline, and perhaps even one of slow or no growth. At the same time it faces the prospects of higher costs from labor and maybe commodities once more. Industry profits were previously buoyed by the collapse in commodity prices, but the Labor Dept. says consumer prices rose faster in January than forecast with the 0.6% rise the highest jump in almost four years.
And in Popeyes' recent fourth quarter earnings report, while revenues were higher than Wall Street estimates, profits missed the mark and it ended the year with comps only 1.8% higher, much lower than the near-6% growth it notched in 2015. As CEO Cheryl Bachelder acknowledged, Popeyes, like everyone else, faced "challenging market conditions."
Certainly debt is cheap now and it may a good time for a company to optimize its financial structure, but big acquisitions rarely turn out as planned and this buyout being the most expensive in the industry ever suggests a lot of risk of things going awry. With Popeyes' rate of growth slowing appreciably, Restaurant Brands International could be setting itself up for its biggest mistake yet.