Burger King Worldwide New Coverage: $29 Trefis Price Estimate
Burger King Worldwide (NYSE:BKW) is a fast food restaurant chain, which operates in the quick service restaurant category. Founded in 1954, it has over 13,600 restaurants across 97 countries. In 2010, Burger King was acquired by 3G Capital, a Brazilian equity fund. Following a brief hiatus from the stock market, the company went public again in June 2012. Burger King is predominantly a franchised business. By December 2013, more than 99% of its restaurants were run by franchisees. While more than 50% of its restaurants are in the U.S., the company is looking to expand in international markets. Burger King’s main competition is with McDonald’s and Wendy’s in the fast food category, both of which have a larger market share in the U.S.
We have a price estimate of $28.97 for Burger King , which is about 10% above the current market price.
We have broken down the company into three divisions:
a) Franchised Royalties
Franchised Royalties, which constitute around 75% of the company’s valuation, is the most important division for Burger King. The company earns its revenues as a percentage of the franchisee sales.
With over 7,400 stores, the U.S. is the largest market for Burger King. The fast food segment in the U.S. is highly competitive and Burger King has already lost its second spot to Wendy’s in 2012. In addition, the emergence of fast casual restaurants such as Panera Bread and Chipotle Mexican Grill in recent years has only made life more difficult for Burger King. These restaurants claim to offer healthier, fresher and organic food and are rapidly gaining market share. Due to an already cramped domestic market, we expect few store additions in the U.S. in the future.
Burger King, however, plans to accelerate its expansion in the international markets. In 2012, it entered into a joint venture in China to open around 1000 stores by 2015. As part of this agreement, 104 stores were added in the country in 2013. In addition, Burger King also plans to open several hundred stores in the next few years in Russia. The company also intends to leverage its brand name to open stores in South Africa, Latin America, Singapore and Malaysia.
By December 2013, 30% of all the Burger King’s restaurants in the U.S. were on the modern “20/20” image, up from 19% at the end of 2012. Restaurants with the modern image have recorded an average sales uplift of 15-20%. As Burger King plans to remodel 40% of its stores in the U.S. by 2015, we expect a positive impact on the comparable sales growth. The growing awareness and importance of healthy consumption has snubbed the popularity of fast food. This has prompted Burger King to focus on providing healthier fast food, e.g. the launch of “Satisfries” with 40% less fat.
While the franchisee sales are expected to grow, the royalty rate could take a hit in the near term. This is because Burger King is offering limited term reductions in royalty rate, in order to expedite international expansion and restaurant renovations in the U.S. However, we expect the royalty rate to gain slightly in the long run, once the process of re-modeling is complete.
Although franchised restaurants generate lower revenue (per restaurant) compared to company-operated restaurants, they enjoy higher margins since they do not involve any operational or overhead costs. As Burger King plans to run a completely franchised business, margins are expected to hover in the range of 70-75% in the long run.
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b) Franchised Rent and Fees
In addition to royalties, Burger King earns its revenues from initial fee and rent paid by its franchisees. However, not all the stores provide rental income to Burger King. Out of 13,667 restaurants globally, the company derived rental income from only 1,845 properties in 2013, mostly in the U.S. and Europe ( vs 1,081 properties in 2011). As a result, rent revenue as a % of franchisee sales has increased in 2012 as well as in 2013.
Going forward, most of the expansion will come from international markets, where the company is expected to earn only royalties (and no rent). Therefore, the proportion of restaurants from which the company will derive rental income is expected to get lower. As a result, the rent revenue, as a percentage of franchisee sales, should decline in the coming years.
After the two-year restructuring initiated in 2010, the company’s margins have improved considerably in the last two years. Since the royalty business tends to be more profitable than the rental business, there could be a further improvement in the overall margins, due to a greater contribution from the royalty business.
c) Company-Operated Restaurants
Company-operated restaurants are owned and run by Burger King itself. By the end of 2013, there were only 52 company restaurants. Burger King plans to use these restaurants for testing new products and systems. Since the company has already adopted the franchisee model, we do not expect it to add new company-operated stores in the future. As a result, the contribution of company-operated stores to the overall valuation is negligible.
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