Burger King (NYSE:BKW) is not an ideal investment for a long-term investor. It is lacking with regard to long term profitability, mostly due to its low quality food and high competition. It competes with restaurants such as McDonald's (MCD) and Wendy's (WEN) and is mostly indistinguishable from them. As a result, it carries no competitive advantage and can only compete on the basis of price and other forms of promotion. Long-term investors are advised to stay away from the stock.
Some important metrics to value the company:
1. Business Model: Not Ideal
The company's business model entails serving low priced burgers at its fast food chains. The food is very generic and scores low on taste. The company does add newer burgers and other products to its menu to keep customers interested, but the difference in taste or quality is at best marginal. As a result, the company often tries to undersell the competition, which is very hard.
A recent project of the company includes re-imaging the restaurants, giving them a more modern look. Such projects would cost approximately $300,000 per restaurant and are expected to increase sales by 10-15%. According to the 2012 annual report, the company would like to re-image 40% of the restaurants in the US and Canada. The capital required to re-image the restaurants will be provided by the franchisees, though corporate would assist them in seeking third-party financing. While such a step may provide a short-term boost, the increase in sales is not likely to be permanent since the food quality and the target market remain the same.
It seems unlikely that the current business model of the company would help in beating the competition in the long term. In addition, as consumers in North America become more health conscious, they are likely to prefer healthier options such as Subway, which is doing quite well. In addition, restaurants such as Burger King are not likely to find loyal customers especially when neither the food nor the ambiance is any different from the other restaurants.
Usually, it is some unique combination offered to the customer that wins their loyalty. Instead, Burger King has followed the opposite course and is completely dependent on gimmicks that make the company's long-term future hard to predict.
2. Cash Reserves: Strong
Burger King, to its credit, has strong cash reserves that inspire confidence in its ability to meet unexpected liquidity based challenges.
It has a current ratio just above 2. Working capital is close to $500 million (Current Assets of $890 million and Current Liabilities of $397 million), which is also 133% of the food costs ($382 million), so in the event of high food inflation, they might be OK. Also, according to the company, a 10% increase in food inflation would increase food costs by around $38 million. That is less than 10% of working capital, and will not have a huge impact on the company's liquidity.
3. Debt to Equity Ratio: High
The company has a bad debt to equity makeup. The debt to equity ratio is close to 2.47. The company carries around $3 billion of long-term debt. In addition, a portion of that amount ($794 million of unsecured debt is serviced at 9.875%, and $685 million of senior discount notes at 11%) is serviced at very high rates. Even though Burger King's Debt rating was recently raised by Fitch (due to an increase in Operating Income), the rating remains Mediocre at B+.
In a time of economic crisis, it is a company like this that gets into trouble. If high inflation did strike, the rise in interest rates would make it very difficult for Burger King to service its debt. Surprisingly, Burger King has decided to continue with its stock buybacks that would hurt the debt to equity ratio even further and make the company even riskier from a long-term standpoint.
4. Stock Price: Very High
The stock is too expensive. Its PE ratio is 54. Since the market expects further stock buybacks, it has made the stock very expensive. (The company recently announced a $200 million stock buyback). The EPS would rise with the completion of the stock repurchase, thus lowering the PE ratio, but not enough to make it a value stock.
Burger King has an ordinary business model that relies on constant promotion and lower prices. Such models are not sustainable over the long term and seldom increase the life of the company. Since this analysis is only concerned with the long term success of the company, it must be said with confidence that the shoddy business model makes it a "No Buy." This advice is unlikely to change with a positive change in the liquidity or the leverage numbers. Though these 2 factors might change the strategy for a short-term investor, long-term investors had better stay away from this stock.