Burger King's turnaround in danger
Posted
Sep 04 2008, 02:11 PM
by
Anthony Mirhaydari
Rating:
Burger King has made brilliant progress with its turnaround following a leveraged buyout in 2002 and IPO in 2006. Recent economic weakness helped, as quick-service restaurants took advantage of newfound frugality and curtailed visits to sit-down restaurants.
But now, even $1.39 meals wrapped in tortillas and jovial marketing campaigns can't stop the next phase of our consumer-led recession from striking the world's second-largest fast-food chain. The company's 18 consecutive quarters of global same-store sales growth looks especially vulnerable as new menu items fail to compensate for reduced traffic.
UBS analyst David Palmer notes that the downward trend has already started, driven initially by drops in discretionary income and consumer sentiment. His channel checks indicate that fast food sales have slowed over the last few weeks as the tax rebate checks pass into memory. The next stage, driven by joblessness, is ready to begin.
According to David, 25 years of data has demonstrated a meaningful relationship between the unemployment rate and the number of meals eaten away from home. UBS economists expect the unemployment rate to average 6.4% in 2009, up from 5.7% in July. Besides the obvious hit to income, the unemployed simply find themselves at home more often.
All of this will have an outsized impact on Burger King because of a lower average unit volume compared to its peers. The average store currently generates $1.2 million in sales; management has been aiming for $1.5 million. Margins, which are already suffering, will fall further as overhead is further deleveraged by a sales slowdown.
Recently released fourth-quarter data had margins falling nearly 2% in spite of same-store sales growth of 5.3% -- which included a 2.4% price increase taken in May.
Burger King launched a number of new products and positioned its eponymous figurehead as a "reverse pickpocket" for adding the Cheesy Bacon BK Wrapper and Spicy Chicken BK Wrapper to the chain’s Value Menu. Now it's considering drastic measures like shrinking the Whopper Jr. hamburger. Besides food, transportation, and packaging costs, a company-wide remodeling initiative has weighed on results.
Company forecasts placing next year's earnings growth between 12% and 15%, or $1.54 and $1.59 per share, assumes store profitability remains flat and same-store sales grow upwards of 4% during this difficult period. In my mind, that's too hopeful. Bank of America analyst Joseph Buckley agrees, noting that that could be a "difficult task" with food prices expected to rise 7% in 2009.
Any downward revision could break the sentiment stalemate keeping the entire quick-service sector range bound. The bulls are looking at names like Burger King as early plays on the inevitable recovery; Bears continue to focus on the industry's challenges. For now, shares continue to trade near two-month lows.
(Disclosure: I don’t control a position in any of the companies mentioned)
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