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Did Burger King Really Outperform McDonald's and Wendy's?

Erin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Burger sales are down at McDonald’s (NYSE: MCD) and Wendy’s (NASDAQ: WEN). But Burger King’s (NYSE: BKW) first-quarter earnings more than doubled even though revenue fell. If sales were down at the two largest burger retailers, why were they up at the third largest? The answer may come as a surprise.

Burger King earned $35.8 million, or 10 cents per share, in the first quarter, up 150% from the $14.3 million net income from the same period the previous year.

At Wendy's, the second-largest burger chain by restaurant sales volume in the United States, first-quarter overall revenue rose 1.8% to $603.7 million in the first quarter, but net income fell 83% from the year previous.

McDonald’s reported that sales were down 0.6% worldwide. There was a 0.7% increase in the U.S., but it was offset by falling sales in China and economic weakness across much of Europe.

How the King Beat the Golden Arches and a Little Girl with Pigtails

In the past few years, both McDonald’s and Wendy’s have put an emphasis on more premium foods, such as “Premium McWraps,” or flatbread grilled sandwiches, while also spotlighting value or dollar-menu items. In fact, all fast food retailers have taken this same approach of balancing out the menu with both premium and value items, including Burger King. Which again, begs the question, if sales were down at the two largest burger retailers, why were they up at Burger King? Was there something better about Burger King burgers? No. 

Burger King’s ownership has changed hands several times in the past few years. Last year, 3G Capital, a private investment firm, took the company public (again), but not without making some major business changes within the company first. The company now puts a higher emphasis on selling restaurants to franchisees. The franchise business model lowers costs to the parent company (Burger King). Restaurant revenue (food sales) for the first quarter were actually down 69% to $121.1 million, but franchise and property revenues rose 19% to $206.6 million.

Burger King's same-store sales fell 3% in North America. McDonald’s U.S. same-store sales grew by only 0.7%. Wendy’s North American same-store sales grew by only 1%.

Burger King saw an increase in booking sales from restaurants, not product/food sales. The company is not profiting off of burger sales at all.

For now the franchise model is paying off for Burger King, but how long will it sustain that success before future franchise buyers notice that burger sales/restaurant revenue is down across the board? Will people buy franchises if store sales are decreasing?

What Happened to Fast Food?

For years it was believed that fast food restaurants were ‘recession proof.’ McDonald’s barely lost a cent throughout most of the recession, just to have slowing sales for the last several months, while most people believe the recession is over. While funds were tight many people choose cheaper fast food options over fast casual or traditional restaurant choices. But now the consumers just don't go to fast food restaurants like before.

One main challenge to fast food restaurants is that the American consumer has become more health conscious, and is choosing to frequent “fast casual” restaurants, like Panera Bread (NASDAQ: PNRA) and Chipotle Mexican Grill (NYSE: CMG), which offer more salads and healthier fare. Each of the major fast food brands has turned both to value menus and more premium products to meet these challenges, but as this quarter's earnings reflect, thus far this approach has not paid off.

Wendy’s has sought to position itself as competition to the fast casual option by remodeling restaurants to include fireplaces, flat screen TV’s, and fireplaces. (As of April 30, 2013, of the companies 6,500 franchises, 86 have been remodeled.) The company's new goal is to be considered a fast casual and fast food restaurant.

The next challenge is market saturation in the North American market. There is a fast food restaurant in almost every town, if not several. With so many competitors with similar products (burgers, chicken sandwiches, and fries), it is no surprise that fast food restaurants are also losing market share to fast casual- a relative newcomer in the restaurant space.

Wendy’s operates 6,500 restaurants in the U.S. and 27 countries and U.S. territories worldwide. Burger King operates 12,600 locations worldwide, and McDonald’s has 34,000 locations. Panera Bread Company owns and franchises 1,673 bakery-cafes as of March 26, 2013. Chipotle operates 1,458 stores nationwide.

Are “Fast Casual Restaurants” the Way to Go for Investors Instead of Fast Food?

Without question, fast casual restaurants are outperforming fast food restaurants. In the same first quarter that the fast food franchises were suffering, Panera Bread saw a 17% net income increase, up to $41 million. Bakery revenue increased 12%, while franchise royalties and fees only increased 6% (as compared to Burger King’s increased franchise revenue of 19%). Same store sales were 3%, which was lower than analysts’ expectations of 4-5%.

Chipotle’s first quarter earnings reported a revenue increase of 13.4% to $726.8 million. And net income increased 22% to $76.6 million, or $2.45 per share. (Chipotle is not a franchise.) There was only a 1% increase in same store sales.

It may be time to consider that good old reliable McDonald's has reached its peak. In this changing market can McDonald's go much higher? It isn't time to sell- the stock has held strong, and the dividend continues to produce and reward stockholders. But it may not be wise to further invest in it for the future. With prices so high, American interest in fast food so low, and lack of sales in Asia and Europe, there may just not be room to grow for this giant. Look for a flat future.

As for Wendy's and its new endeavor to be more like Panera, there may be more of a future there. The company will have a few expensive quarters ahead as it spends money on remodels, but after the labor is done, it will be well-positioned against its new fast-casual competition. The stock is still cheap and inexpensive and has room to grow.

From the investor’s point of view, and the hungry American’s point of view, the restaurant of choice is in the fast casual market. Options like Panera and Chipotle offer a more hopeful future for a continued strong upward climb.

And for investors looking to spend the $1.2 million-2.2 million it takes to buy a Burger King franchise, stop and look at where Burger King is making its money before you invest. And maybe consider purchasing a Panera franchise instead, for the low, low price of $1 million-1.6 million, and positive same-store sales.

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Erin McBride has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide, Chipotle Mexican Grill, McDonald's, and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, and Panera Bread. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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