Burger King -- which now operates as an independent brand under Restaurant Brands International Inc. (NYSE:QSR), along with Tim Hortons-- has been one of the best-performing food stocks over the last three years. While market darling Chipotle has risen an impressive 67% since June 2012, Burger King has nearly tripled.
The rally hasn't been loved. In fact, Burger King has been a favorite target of short-sellers since it reentered the public markets nearly three years ago.
Certainly, Burger King bears may be betting against the company for a variety of different reasons, but there's one point in particular that's haunted the fast food giant -- skeptics argue that Burger King's strong performance is nothing more than a well-orchestrated bout of financial engineering that, ultimately, is doomed to fail.
As a Restaurant Brands shareholder, I'm not particularly partial to that argument. Still, there's an indicator less confident investors can watch: the performance of Carrols Restaurant Group (NASDAQ:TAST) -- an important Burger King franchisee.
3G's Burger King strategy
Before diving into Carrols and why Restaurant Brands investors should pay attention to it, it's worth going over investment firm 3G Capital's Burger King strategy and why it's attracted a fair amount of skepticism over the past few years.
3G Capital took Burger King private in 2010. It brought it back to the public markets in 2012, but for all intents and purposes, still owned and controlled the company, as it retained a 71% ownership stake. Its young CEO, Daniel Schwartz, was given his position not because of an impressive resume filled with a lifetime of fast food management experience, but because he had previously worked for 3G as an analyst.
Since taking control, 3G has undertaken an aggressive cost-cutting and growth strategy, slashing expenses, testing out new menu items, and most notably, offloading corporate-owned stores. Before going private, Burger King owned about one-tenth of its restaurants; today, it owns only a handful.
The recent merger with Tim Hortons under Restaurant Brands International diluted 3G's ownership stake, but the private equity firm still owns a controlling interest (51%). And like Burger King, almost all of Tim Hortons' locations are owned by franchisees.
There are a number of benefits to the fully franchised model: It allows for rapid growth, it insulates Restaurant Brands from various commodity costs, and it provides more productive stores, as local entrepreneurs are (at least in theory) more knowledgeable and better incentivized than corporate managers.
But it obscures the true performance of Burger King and limits the ability of the corporation to meaningfully control its restaurants and its products. (For this reason, Chipotle avoids franchising entirely.)
If the bears are right, management is more interested in siphoning money from Burger King than in building a strong brand. The recent performance of Burger King may simply be a short-term byproduct of a shift to franchising and could eventually come back to haunt shareholders.
Carrols is a large, publicly traded Burger King franchisee
There's no reason to believe 3G isn't in it for the long haul, and the fully franchised model makes sense for a mature, fast food business. Still, if you believe Restaurant Brands is merely the byproduct of a private equity pump-and-dump, the performance of Carrols Restaurant Group should provide a warning signal to sell before the tide has turned.
Carrols is a publicly traded Burger King franchisee. In total, it owns about 675 Burger King restaurants across 15 states. If the Burger King concept is unraveling, it should show up in Carrols earnings.
So far, its earnings have been solid. Carrols shares are up more than 45% since Burger King returned to the public markets, roughly in line with the performance of the S&P 500. Most recently, Carrols reported a strong third quarter: Comparable sales rose 3.3%, and Carrols raised its guidance for all of 2014.
To be fair, it's certainly not a perfect indicator, and there are several major limitations.
Although Carrols is a relatively large franchisee, it owns less than 5% of Burger King's total restaurant base, and the stores it does own are located mostly in the eastern portion of the United States. As a franchisee, it's subject to commodity costs, and operating issues that may be specific to its stores. Most significantly, it doesn't own any Tim Hortons, which is now just as important to Restaurant Brands as Burger King. This effect may intensify over time, as indicators suggests Restaurant Brands could soon add another concept or two to its portfolio.
It's not perfect, but it may work
That said, I still think Restaurant Brands shareholders should keep an eye on Carrols. It isn't a perfect indicator -- far from it -- but if Carrols' performance takes a sharp turn for the worse, it may suggest larger problems for Restaurant Brands.
Until that happens, I'll be holding on to my Restaurant Brands shares.
Sam Mattera owns shares of Restaurant Brands International. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. 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.