Burger King Still Owes Whoppers of Debt
Much has changed in the half century since Burger King (BKC) sold the first flame-broiled Whopper sandwiches from a drive-up hamburger stand in Miami. What remains the same, however, is the fast-food chain's cycle of running into financial difficulties, restructuring and getting repackaged for resale. Operating results of late suggest that history is still repeating itself.
The latest reorganization could've been torn from the playbook of Gordon "Greed is Good" Gekko: A troika of private equity firms, lead by the likes of Bain Capital and Goldman Sachs Funds, orchestrated a controversial public offering in May 2006 -- but not before pocketing more than $700 million in fees and dividends. Financing this avarice was almost $1 billion in debt heaped on the balance sheet inherited by the new shareholders (and the equity funds still own a 32 percent stake, at an essential cost basis of pennies per share).
Unfortunately, like the tenth read of a well-worn novel, the story line doesn't change. Burger King, the second largest fast food burger chain in the world, has been unable to adjust to the soggy economy as well as competitors such as McDonald's (MCD). U.S. and Canada comparable sales fell 3.3 percent for the second-quarter ending December 31 due to lower levels of customer spending per transaction (resultant from value promotions liked the $1 ¼ lb. Double Cheeseburger promotion).
Restaurant margins in the all-important North American markets (more than 60 percent of store locations) improved 160 basis points to 14.4 percent in the latest period -- but a review of operating results suggests these alleged "operational efficiencies" are temporary, driven by lower commodity costs, from dairy to wheat to fuel.
Management is looking to enhance restaurant profitability by introducing higher-margin products. Good luck to BK as it tries to wean cost-conscious customers from their "value meals," of which 62 percent pick-up their food via the drive-thu window.
A first-test comes mid-April, when BK plans to raise the price of its popular $1 Double Cheeseburger to $1.19, likely to be followed by a similar hike in the sales price of the signature $1 Whopper Jr. sandwich.
Morning snacking has been growing in popularity, as noted in consultant NPD Group's 23rd annual Eating Patterns in America . Another tell that trouble is brewing at BK was chief executive John Chidsey's admission on the second-quarter 2010 conference call that the company has had little success in growing breakfast share among quick service restaurant (QSR) competitors, from McDonald's to Dunkin Donuts.
Looking to blunt the success of McDonald's new McCafé line of lattes and cappuccinos, and make inroads of its own with the drive-to-work crowd, BK is adding Seattle's Best Coffee to its branded beverage platform and breakfast menu. Part of the Starbucks (SBUX) family, the Seattle's Best agreement calls for the freshly-brewed premium coffee to be marketed in the approximately 7,250 BK restaurants across the United States by September 2010. Whether this less-known Starbucks brand proves any tastier for profits or traffic compared to the retiring "BK Joe" coffee brand remains to be seen.
Last September, Fitch Rating affirmed its stable BB long-term rating on Burger King's debt paper, anticipating that "weak top line growth would result in [only] modest additional deterioration in leverage ratios over the near term."
I disagree with that assessment and believe events will implicate further negative revisions in debt ratings:
- Burger King remains a highly leveraged company within the very competitive QSR industry. At December 31, net working capital was a negative 87 million; total debt wiped out stockholder equity of $1.06 billion; and, after shedding intangibles, the book value of $8.06 per share dropped to a worthless share-net loss of 63 cents.
- Burger King had liquidity of only $259.4 million, which included $119.5 million available on its secured revolver due June 2011, and owes millions in franchisee lease guarantees and pension costs.
- Burger King's bank facility subjects the company to various financial restrictions, including a maximum leverage ratio of 3.0 times EBITDA. At year-ending 2009, coverage was about 2.7 times EBITDA, leaving little wiggle room under this covenant.
The health of BK's franchise operators is significantly improved over the last down cycle (2003). In fact, the financials of BK's biggest U.S. franchisees -- Carrols Corp. (314 stores), Strategic Restaurants Acquisition Company (267), and Heartland Food Corp. (258) -- appear relatively sound, according to a review of available public records. The analysis also suggests, however, that some operators are funding other restaurant holdings (non-burger) with their BK operating profits, with BK unable to exercise much influence.
Contrary to most restaurant analysts, I don't expect gains in operating margins to be sustainable. Increasing its menu prices should help to mitigate rising commodity prices, but not enough to offset traffic lost as QSR customers look to dine elsewhere (resulting in comparable same-store sales declines). The occurrence of unforeseen events, such as food-borne illnesses or another flu pandemic could also cripple BK's attempted recovery.
With a turnaround in discretionary consumer spending still a distant hope and close to $1 billion in term loans maturing in the next two years, BK needs to smell the sizzle of fresh greens -- not the stench of stale cash flow -- or dance through yet another restructuring with its creditors.
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