Burger King: The King’s Report Disappoints

Burger King Holdings, Inc. (BKC) reported earnings last week that blew management’s guidance out of the water. Revenues for the quarter came in at $646 million which is a 9% increase over last year. Earnings growth saw the effect of a leveraged operating structure with EPS at $0.37 – good for a 28% increase. The numbers were well above the levels management had guided the street to expect, and yet the stock traded sharply lower. What gives?!?

The issue at stake causing the stock price to decline appears to be one of management credibility. Burger King has developed the habit of offering guidance that is unmistakably conservative, only to finish the period significantly above this artificially low hurdle. While the “under promise – over deliver” approach often works well from a customer service standpoint, it can backfire when dealing with an investing public. The reason is that at some point investors simply don’t listen to the guidance. Management expectations are so far removed from reality that they no longer become helpful. In short, Burger King appears to be entering a stage where management simply lacks credibility.

Looking into the report, it appears that while revenue growth was relatively strong for such a large company, the margins took a significant hit as expense increases outpaced revenue growth. Specifically, restaurant margin decreased by 170 basis points to 13.1% for the fourth quarter. Full year (the company’s fiscal year end is June 30) margins were a bit better at 14.3% but that only goes to show that the fourth quarter saw this metric rapidly decreasing from levels seen earlier in the year.

Commenting on the margin issue, management stated that commodity costs have played a major role in this contraction. However, the good news is that management believes that commodity costs have peaked and that is part of the rosy story it is painting for fiscal 2009. If you believe that commodity prices have peaked, this may be a legitimate story. However, the jury is still out and I would have a hard time committing my clients' hard earned capital into a story based on this assumption.

Capital expenditures were significantly higher for 2008 and expected to remain at current levels for 2009. This is a result of the company reimaging quite a few of its stores in order to present a more attractive store front. While necessary, this move will continue to pressure margins and keep the balance sheet relatively leveraged. A purchase of 72 stores in Nebraska and Iowa from a franchisee will also keep a good bit of the company’s capital tied up.

In short, the growth story for Burger King may be old news. The company is large enough that even international expansion cannot move the needle significantly. Margins should remain under pressure and uncertainty with the overall economy make a purchase difficult to rationalize. Since the multiple is not extremely high, I find it also hard to rationalize a short position so I feel it is necessary to manage risk and stay on the sidelines for the time being.

BKC Notes

FD: Author does not have a position in BKC.

Comments

[bizonly:]

totally wrong perspective on bkc news-

buying back franchise restaurants will provide stronger yield than paying debt
would expect 2 year old public company expanding internationally
to be conservative with estimates
misconstrue impact of lower margin=this company collects 90%
royalty-has less pressure than somebody like jbx or sonc
take advantage of dip-this is a cash generating machine

2008 Aug 25 09:13 AM

[Francorp:]

BK has had some major management problems, who has ever been into a Burger King and felt that they received good customer service. The brand is old and deflated and it seems like every marketing idea they come up with pales in comparison to McDonald's. They need to rework something, I'm surprised this ship is still sailing at all.

2008 Aug 27 06:25 PM

[Anonomous C...:]

Hello, I'm a crew member at a local Burger King in my area, and I'm having some problems at my store. There's a manager that I work with that treats the crew rather poorly to put it mildly. Most are kids who just take the abuse, and get written up with no one to stand up for them. I however am an adult. Instead of using respect and teamwork to motivate her crew, she offers free-meals (which she's not supposed to do) and when something doesn't go her way, to 'motivate' them she threatens to take away their 'free-meal' privelages, which she shouldn't be offering in the first place. She is taking advantage of those with low-income. I call that extortion.

Unfortunately there is more... The way she talks to the crew is LESS than professional. I am a closer and recently hired, so i'm kinda new. I was washing dishes and discussing closing procedures with another crew, which I thought to be acceptable as 'teamwork', when she comes barging out of the blue, and unexpected SCREAMING at us to, "shut-up, and get back to work or I'll take away your free-meal priveladges." I was stunned. I've never had a boss that treated me like a child like this before. Even if I were at fault, or got carried in conversation, it didn't warrent all that. It really bothered me. Enough that I tried to bring my concern to her. I asked her when it was just us two working together so that the rest of the store could not hear us, so it would be discreet, "Is there another way you could have made your point across without treating us like we were 12?" She went boligerant after that, and our 'private conversation' was no longer 'just between us' but rather the whole store. She carried on, and insulted me by telling me how slow I was at filtering the fryers. The filter machine was acting up, making it very difficult to complete the task. Now the machine doesn't work at all, and our supervisor needs to call a repair man. Furthermore she said, "Maybe your not cut out for this job." I would have let this go, or even second-guessed myself, being new and all, that I may have been the one that had done something wrong, if this was an isolated incident... To my suprise, I am not the only one.

Another member of our crew went to the hospital for anxiety after a shift with her, and another crew man the next day refused a 'write-up' from her because she felt she was being singled out and picked on. Also it became known to me that the District Manager had to transfer her 3 or 4 times to diffrent stores because no one got along with her. My supervisor and hiring manager don't get along with her either. To the point where the DM was called in to 'councel' my hiring manager and the manager of topic, to just get them to talk to each other.

This woman is not only wasting company money with her free meal bribes but using it as extortion to her crew, but she is also a company liability, for any of my fellow crewman has enough evidence to sue for Mental Dirress.

Oh and if this is not enough, she openly says to other crewman when I'm not working the same shift as her, that "I'm a worthless crew member, not worth the payroll." When the crewmember with this information came to me with this, he was standing in front of my hiring manager, and my hiring manager confirmed it and advised that I should definatly speak to our supervisor regaurding this 'bad manager.'

Honestly, I'm not sure what I should do. I shouldn't have to 'feel' this way about a job, and feel like i'm being laughed at behind the scenes, as a person in position of authority mocks me and it always getting back to me. How anyone could do this is beyond me. I just wanted a job cause times are tough, I didn't sign up to be abused. It's not worth the pay, but I need it right now. Should I just quit? Then again, why should I have to? I didnt' do anything wrong... But when I go back to work, she singles me out and has me do 1 task over and over and over. 'Taking me by the hand, and critiquing sarcasticly.'

What do I do?

-3164

2008 Sep 20 12:33 PM

[Sharon Bohanan:]

My name is Sharon Bohanan and we often stop in to the areaa Burger Kings. Recently we stopped into Burger King Durant OK and after we ordered our food I noticed them take it out of the cooler, microwave it and then give it to us. This week we visited the Burger King DeQueen AR and when I ordered I specifically told the clerk that I did not want my food microwaved. I told her that it was my belief that Microwaves cause cancer and being a cancer survivor, I just didn't want mine microwaved. I stood at the counter and wated the cook take the food from a cooler and stick it in the microwave. When the clerk didn't say anything to the cook, I told the clerk I wanted my money back and she kept trying to argue with me that it wasn't being microwaved. Overhearing the conversation the cook just wrapped the burger up cold and sent it out to us.
If this is Burger Kings policy then thats okay with me, I can just take my business elsewhere. I do know there are others who feel the same way about microwaved food who will probably not shop at BK either. It just seems funny to me that BK advertises they have flame broiled patties when it may have been flame broiled some time ago and has been sitting in a cooler. But for a clerk to argue with me about what I'd already seen with my own eyes, that is not acceptable to me. If you think my comment is trivial, then wait until you get cancer and see if you don't start looking at possible causes in a different light. Thanks. You may respond to me at [e-mail]

Apr 16 11:43 PM