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It seems that at just about every intersection in America you will find a quick-service restaurant competing for your fast food dollar.
The competition is vicious as the saturation point for these types of restaurants has nearly reached its peak. There are a whole slew of restaurants in this category ranging from burger joints to vegetarian fare and from budget eateries to pricier higher-quality dining.
Each restaurateur tries to find a niche that he can exploit where he can make diners and shareholders happy. The burger niche is where all competitors were spawned and is still the one that garners the most attention.
The players in this arena are household names not only in America but worldwide – McDonald's (NYSE: MCD), Wendy's (NYSE: WEN) and Burger King (NYSE: BKE).
I'm going to focus on Burger King, its business strategy and how it hopes to differentiate itself from its competitors.
Burger King is the number two burger chain in the world with 13,000 restaurants in 86 countries. This is far behind dominant McDonald's and its 34,000 global locations. However, in the U.S., Burger King's situation is disconcerting as it has lost its second place slot to Wendy's with its 6,500 restaurants.
In 2010, Burger King was acquired by Brazilian private equity firm – 3G Capital. After a hiatus from the public markets, 3G Capital took Burger King public again in June of 2012.
When Burger King was first acquired it had a number of issues on its plate that included declining sales, lack of expansion and the same-old menu items. Basically, the company had no vision or dexterity to solve these problems.
Since 3G Capital's acquisition, Burger King has shown signs of new life and seems to have a plan to 'right the ship'. However, is it enough?
The plan can be summarized in one word – "Remodel". Burger King is remodeling its menu items, its stores and the way it does business.
Remodeling the Menu
Menu options are of immense importance in the burger world. Two things come into play with regard to the menu – the distinctiveness of the food and the price. The former is meant to appeal to a broader consumer base who may want more than a burger and the latter is to get the foot traffic walking through the door in the expectation that they will order the premium menu items.
Burger King has had to play "ketchup" to McDonald's and Wendy's with both of these issues. While the quick-serve restaurant industry is barely growing, McDonald's has managed to increase market share even though its sales in the U.S. have dropped by 1.2%.
Burger King has been slow to respond, but it is becoming more aggressive by offering promotions such as the very popular Whopper Jr. for $1.29 and the "2 for $5" promotion where a guest can chose two premium sandwiches for $5.
But McDonald's is willing to take a hit in profits for an increase in market share and Burger King would be hard pressed to maintain its own profit margins in the face of McDonald's aggressive undertaking.
To combat the issue of decreasing market share, Burger King is attempting to roll out new menu items that appeal to a broader dining customer base.
Burger King recently began to offer wraps, specialty salads and smoothies. It has even entered into partnership with Seattle's Best Coffee for customers in need of a latte.
All this is well and good, but it doesn't distinguish itself from its competitors who offer similar type fare and it doesn't get people interested or excited about the dining experience. Even Wendy's has established a bit of a niche for itself by carrying items on its menu that could be considered "healthier".
It's no wonder that for the first quarter Burger King's revenue dropped a whopping 42% to $327.7 million where its U.S. and Canada same-store sales declined 3%.
Remodeling the Restaurants
The next "Remodel" comes in the literal sense – Burger King is remodeling its restaurants. The Company stores are in need of a facelift and a more modern look especially in light of the competition like Wendy's who is busy putting flat screen TVs and fireplaces in its restaurants.
Thus far Burger King has refurbished 600 restaurants in the U.S. and Canada and hopes to have 40% of its restaurants re-done by the end of 2015. The remodeled restaurants have yielded positive results as sales have gone up 10-15% at these locations.
Undertaking such a project is costly. It requires an average of $275,000 per store for the upgrades all of which is provided by the franchisee. In order to persuade the franchisees to undergo this expense Burger King has assisted them in finding third-party financing and has granted discounts on their annual franchisee fees.
The jury is out on whether the increase in sales will last due to the remodeling of stores. After all, a change in scenery doesn't necessarily change the food or the customer demographic.
Remodeling its Operations
Lastly, the way it does business and the relationship it has with each individual restaurant is undergoing "remodeling". Burger King is no longer looking to collect sales revenue from the restaurants rather it is looking to collect franchise fees.
The company is on a mission to sell all its corporate owned restaurants to franchisees and essentially book revenues as franchise fees.
Evidence of this can be seen with the Burger King's most recently reported quarter. Restaurant revenues were down drastically (on the surface) by 69% to $121 million but its franchise and property revenues were up 19% to $206.6 million.
In fact, even though in the recently reported quarter where same-store sales were down the company managed to grow its adjusted earnings per share from $0.11 to $0.17 primarily due to its move towards an all franchisee model and the reduction of overhead costs.
Since the acquisition by 3G Capital the company has grown its franchise owned stores to 97% and plans to reach 100% by the end of 2013.
The looming question is: Will new franchise owners be willing pay the big startup and franchise fees in an industry that is slumbering and where same-store sales are on the decline?
This question is especially significant as Burger King looks to aggressively expand abroad. It is entering into large franchise contracts and joint ventures all over the world.
Burger King is increasing its presence in Russia and Turkey. It has big plans for China and expects to open 1,000 restaurants within the next few years.
The company also is very excited about its plans in South Africa (also as a foothold into the rest of growing Africa) as it has teamed up with hotel and casino giant, Grand Parade Investments, for the start of 12 new restaurants in Cape Town.
After the Burger King Remodel
Burger King's share price is up nearly 30% since it returned to the New York Stock Exchange in June of 2012.
By comparison McDonald's has gained 10% in that time period. And on a slightly different note and for comparison's sake Burger King has a high trailing PE ratio of 50 while McDonald's trailing PE is 18.
What I have outlined for Burger King does sway me a bit more towards the SELL side. The overall outlook for the Company, much like some of the menu items, is somewhat bland.
With the general environment for the fast food sector in the doldrums I probably wouldn't look to invest in this area today.
But if you were tempted to so in order to diversify your portfolio globally I would look at the industry leader who is taking market share, McDonald's, before looking at Burger King.
David recently made a buy, sell or hold recommendation on the genesis of the food chain, the fertilizer company Mosaic.
[Editor's Note: If you have a stock you would like to see us analyze in a future issue, leave us a note in the comments below and we'll add it to our list.]
About the Author: David Mamos brings nearly 15 years of analytical experience to the table with a background ranging from big-picture fundamental analysis to highly technical trading decisions. He began his career working as a financial advisor with Royal Alliance in 2001 and helped clients with portfolio management as well as buy-sell decisions before transitioning to the development, implementation and execution of trading strategies for aggressive investors.