Burger King’s Q2 Earnings: Revenues Decline As Breakfast Battle Intensifies; International Expansion To Accelerate

Burger King Worldwide (NYSE:BKW) beat its EPS guidance by $0.02 when it released its second quarter earnings report on August 1. ^[1] Burger King managed to deliver yet another quarter with positive comparable store sales, as the global comparable sales for the second quarter were nearly 1%, driven by strong sales in all four regions. The highlight of this quarter was the positive 0.4% growth in comparable sales in the U.S. and Canada, which saw flat same store sales in the first quarter due to adverse weather conditions. In these regions, the company’s strategy to launch fewer but more eye-catching menu items proved fruitful.

The reported net income increased by almost 19.4% to $75.1 million from last year’s figure of $62.9 million, whereas the total reported revenues declined yet again by nearly 6% to reach $261.2 million due to a decrease in company-operated restaurant revenues by 65%, primarily driven by net re-franchising of 360 company-owned restaurants during 2013 and increased competition. Neglecting the impact of the global re-franchising transactions and currency movements, the system-wide sales increased 5.4% year-over-year due to accelerated restaurant growth and strong global same-store sales growth. ((Burger King Worldwide: Q2 2014 earnings call transcript))

The major fast food restaurants are struggling with increased competition from fast-casual restaurant chains. Moreover, the battle for the breakfast market is getting fiercer with every company focusing on introducing new innovative menu items to attract customers. On the other hand, the company has accelerated its refranchising initiative and expanding internationally to compete global brands such as McDonald’s (NYSE:MCD) and Dunkin’ Brands (NASDAQ: DNKN).

We have a price estimate of $28 for Burger King, which is about 5% above the current market price.

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Fully Franchised Model Drives Top Line Growth

Burger King re-franchised almost all of its company-operated restaurants during 2013, bringing its business model to nearly 99% franchised, and leaving only 52 company-operated restaurants by the end of the second quarter. The advantage of the franchised model is that the company does not have to incur operating costs and can enjoy the royalties paid by the franchises.

During the three months period ended June 30, franchise and property revenue rose 7.7% year-over-year, primarily due to:

• Accelerated net restaurants growth of 682 stores worldwide during the trailing 12-month period, which led to $9.8 million increase in franchise royalties.
• Increase of $7.2 million in franchise fees.

On the other hand, the franchise and property expenses were relatively unchanged in comparison to the same period last year. The margins for this type of model are very high, as the company’s EBITDA margins for the franchise restaurants touched 69% in 2013. The company’s adjusted EBITDA margins rose to 70% in the second quarter as compared to 58.4% in Q2 of 2013.

With the company’s plan to expand further in lucrative and developing markets, these margins might further grow. Trefis estimates the margins for this segment to widen up to 71% by the end of 2014. ^[2]

Highly Competitive Environment Drags Net Sales

• Breakfast Battle Intensifies

In the fast food industry, Burger King competes against big brands such as  McDonald’s(NYSE:MCD), Wendy’s, Yum! Brands, Dunkin’ Brands (NASDAQ: DNKN) and Starbucks (NASDAQ: SBUX). ^[3] According to NPD report, in 2013, guest traffic during breakfast hours rose 3%, whereas traffic during lunch and dinner declined by 1%. ^[4]

McDonald’s dominates the breakfast segment with over 25% of the market share. However, the gradual entry of brands such as Taco Bell, Dunkin’ Donuts and Burger King has put McDonald’s on the defensive. Earlier this year, Burger King rolled out burgers such as the Chicken Big King in addition to sausage biscuit, Cinnabon and its Seattle’s Best Coffee. ^[5] This new addition is helping the company to build its position in the fried chicken segment, a segment which has not been given too much attention in the past.

On the international front, Burger King continues to introduce new ‘Whopper’ menus such as Hash Brown Whopper in Korea and Mexican Whopper in Spain. Burger King’s Orange Freeze – a frozen beverage is getting popular among the customers. In addition to that, the new value menu has helped the company to stay ahead in the industry. These premium products are gaining popularity and helping the company to sustain in this tough competitive environment.

Most of the fast food chains have started selling coffee to drive revenues through their breakfast segment. Burger King started serving the Starbuck’s owned Seattle’s Best coffee to compete against McDonald’s McCafe. ^[6] With coffee being the core beverage in the breakfast menu, Burger King plans on expanding this segment to match the brand appeal of McDonald’s McCafe and Starbuck’s coffee.

• Fast-Casual Segment Stealing Market Share

The fast casual restaurants such as Chipotle Mexican Grill (NYSE:CMG) and Panera Bread, have started stealing some market share of leading fast food restaurants for the last couple of years and has generated considerable industry attention. According to Technomic’s 2014 Top 500 chain restaurant report, sales for fast-casual chains rose 11% and store count rose 8% in 2013.

Even though fast-casual restaurants lag their fast food counterparts in overall revenues and value, they are closing the gap every quarter. However, when it comes to healthier options and quality of food, fast-casual restaurants have an edge over all other restaurant segments. Moreover, people with higher disposable income are inclined more towards high quality and fresh food, even if it is expensive by a few bucks. This has led to a decrease in customer traffic gradually. Burger King took several measures such as new innovative menu additions in order to appeal to the health conscious customer base and the re-modelling of its various stores for more seating space and an inviting ambiance.

International Expansion: Key to Future Growth

The company’s major focus is on expanding its brand presence around the globe. In the second quarter, the company accelerated its expansion plans with net 131 new openings and 682 net new stores in trailing 12-month period, making it one of the fastest growing Quick Service Restaurant (QSR) in the industry. At the end of the second quarter, the company’s total store count reached 13,808. Although the re-franchising led to a decrease in overall revenues, it was more than offset by a greater reduction in expenses, leading to a widening of the adjusted EBITDA margin by 11.6 percentage points.

Burger King believes that South Africa is one of the markets with the best-in-class growth. The company opened 10 new restaurants there over the past six months and plans to expand into the rest of sub-Saharan Africa. ^[7] Moreover, the company opened a new restaurant in Marseille, France and considers it to be one of the top grossing store in EMEA region. Similarly, the company has high expectations from potential markets like India, where it plans to open its first restaurants in the coming few months. ^[8]

• Expansion Scope

The company believes that markets such as France and India have a lot of growth potential. In these countries, fast food hamburger industry has been performing well over the last decade. Big brands such as McDonald’s, Starbucks and Dunkin’ Donuts have already penetrated these markets and are performing very well. McDonald’s first opened a store in India in 1996 and currently has more than 250 outlets, most of which are concentrated in metropolitan cities, whereas it has nearly 1,300 store in France. ((List of countries with McDonald’s restaurants))

In India, people with higher disposable income constitute a wide range of population. This middle section of the society is the target area for these fast food joints. With its brand appeal and its innovative tempting value meals, the company will find it comparatively easy to penetrate the market and might attract customers in huge numbers. Moreover, in a developing nation like India, the concept of fast-casual dining is not so prominent, unlike in the U.S. This is an added advantage for a fast food chain, as the fast food segment have been facing huge competition from fast casual segment in the more developed markets.

Burger King returned to France when it opened its brand new store at the Marseilles airport in 2012.((Burger King returns to France)) This was followed by another restaurant near Reims. Following its success in these stores, the company announced that it will open 350-400 restaurants throughout this burger loving country.

In the third and fourth quarters, the company plans to further expand internationally, with more focus on the Asia-Pacific region.

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1. Burger King Worldwide: Q2 earnings result [↩]
2. Burger King: 10-K report FY 2013 [↩]
3. Top 50 QSR brands [↩]
4. NPD: Breakfast restaurant visits grow [↩]
5. Burger King battles McDonald’s over breakfast with burgers [↩]
6. Burger King serves Seattle Best Coffee [↩]
7. Burger King in sub-Saharan Africa [↩]
8. Burger King coming soon in India [↩]