After a previous attempt by turnaround companies to re-energize Burger King (BKW), the latest try may prove successful.
3G Capital, a private equity firm, bought the fast-food giant in October 2010 for $3.3 billion. At the time, the company was struggling, not unlike eight years before when it was bought by a group of private equity funds and returned to the New York Stock Exchange in 2006.
Return to the Market
After spending 20 months as a private company, 3G put Burger King back on the public market in June 2012. After falling to #3 in the fast-food industry behind McDonald's (NYSE:MCD) and Wendy's (NYSE:WEN) last year, Burger King seems to be gaining market share.
Burger King recently reported a robust 2012. The company finished fiscal 2012 with earnings per share of 33 cents per share, or $117.7 million, up from 25 cents per share, or $88.1 million, a year earlier. This despite a 16% drop in revenue for the year to $1.97 billion.
It re-franchised 871 restaurants, bringing the system to about 97% franchised. This is considered a positive move, as a more franchise-centered business model generates revenue mostly from royalties from franchisees, thus minimizing its exposure to overhead costs and maintenance fees.
The move helped reduce Burger King's costs substantially during the fourth quarter. Total operating costs fell 40% to $292.6 million. The re-franchising was also primarily responsible for the revenue decrease.
Also helping the company reduce costs was the refinancing of $1.9 billion of debt, which lowered its annual interest expense by $25 million.
Growth and Change
During the fourth quarter, Burger King reported adjusted earnings of 14 cents per share, or $48.6 million. Adjusting for one-time costs, earnings came in at 23 cents per share, topping analyst consensus of 15 cents per share on the same basis. Revenue came in at $404.5 million, also exceeding the forecast of $375.3 million.
Burger King also grew by 485 restaurants for the year, about 4% in physical growth. It accelerated its international growth as well seven development agreements in key growth markets.
In 2012, the company re-imaged approximately 600 restaurants in the U.S. and Canada, giving a modern look to an additional 19% of the region. Burger King also launched what it called its largest menu update ever in the region.
Perhaps the most telling indicator of the company's prospects is its robust increase in same-store sales. While much of the industry is experiencing no movement or even declines in same-store sales, Burger King grew in this category by 2.7% globally last year, and 3.7% in the U.S. McDonald's, on the other hand, grew same-store sales by only 0.1% globally and 0.3% in the U.S.
Burger King's performance has rewarded investors thus far. Since its June re-appearance on the New York Stock Exchange, BK shares have grown 25% to just over $18 a share. Burger King even managed to eke out a $0.04 per share dividend in the fourth quarter.
Fundamentally, Burger King doesn't particularly shine in contrast to its primary competitors. It exhibits average growth rates for its industry as well as average margins. Its management effectiveness ratios are comparably low; its most recent return on equity was 10%, return on assets was 2% and return on investments was 2.8%,
One of the black marks on the company's balance sheet is its debt-to-equity ratio. It currently has only $546 million in cash, and 5.5 times as much debt at just over $3 billion.
Cash flow is also a potential concern. Over the past 12 months, Burger King generated $154.2 million cash while it booked net income of $117.7 million. That means it turned 7.8% of its revenue into free cash flow. However, as one market watcher pointed out, a lot of the company's cash flow is not coming from favorable sources like net income and adjustments for non-cash expenses.
About 38.6% of cash flow comes from non-favorable sources, such as changes in taxes payable, tax benefits from stock options, and asset sales, among others. Within the questionable cash flow reported in the last 12 months, other operating activities (which can include deferred income taxes, pension charges, and other one-off items) provided the biggest boost, at 19.7% of cash flow from operations. Overall, the biggest drag on free cash flow came from capital expenditures, which consumed 31.3% of cash from operations.
Some are also worried about Burger King's ability to compete in the space of value menus and $1 offerings, which is becoming a major driver of revenue for fast food chains due to the overall economy. In the fourth quarter, McDonald's added a Grilled Onion Cheddar Burger to its Dollar Menu. Wendy's added new items to its 99 cents menu, as well as a tiered pricing system that goes up to $2 per item.
Burger King is late to this segment, and thus far its only value item is a limited time Junior Whopper for $1.28.
Though BK grew its business last year with revamped menu offerings, including a chicken parmesan sandwich, sweet potato curly fries, smoothies and gingerbread desserts, 2013 appears to be a year in which low-cost food is what will bring in customers. This will, of course, squeeze margins for the entire industry. But given Burger King's cash and debt position, it could impact them even more. And that's assuming the company can produce a menu to compete with the highly touted offerings by McDonald's and Wendy's.
Burger King also just announced a partnership with Seattle's Best Coffee to carry the brew in their restaurants and adding 10 new coffee drinks to its menu.
Burger King is also going where no fast-food restaurant has gone before: to people's homes. The chain has been test-marketing its BKDelivers program at nearly 40 stores in five states, and in a handful of international locations.
While Burger King still has a way to go to become the true king of the fast-food industry, it certainly appears to be heading in that direction.
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Business relationship disclosure: This article was written by an analyst at Catalyst Investments.