Why This Stock Is Unsustainably High
Adrian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Shares of Burger King Worldwide (NYSE: BKW) have had an amazing year so far.
In the past 12 months, their price increased almost 40%, making this stock the best performing fast food & franchise model investment. The amazing rally has caused Burger King's market capitalization to reached $7.37 billion, but this valuation may be too high to be sustainable. To begin with, Burger King's current P/E Ratio is 52.50, while McDonald's (NYSE: MCD) PE is only 18.15, Yum! Brands (NYSE: YUM) PE is 22.8 and even Chipotle Mexican Grill (NYSE: CMG) PE is 39.8.
Looking at the relatively high PE of Burger King, I can't help but wonder: is this sustainable? I have noticed some worrying signals about this restaurant stock that suggest following this stock from the sidelines.
Market share is in danger
This industry is a zero-sum game. In order to increase market share, a player must steal market share from another player. Judging from the latest earnings call (April 26th, 2013), Burger King is not winning the game. The earnings call included a $200 million share repurchase program, which made more than one investor go long the stock. But if you take a closer look, specially at the revenue figures, you will find plenty of signals that Burger King's market share is in danger:
- U.S. and Canada comparable sales experienced negative growth in the first quarter (-3%).
- Latin America Countries comparable sales fell 1.3%, "due to weaker performance in Mexico and Puerto Rico, partially offset by positive results in Brazil, Argentina, and Venezuela".
- Asia Pacific comparable sales increased by 2.7%, "driven by positive results in Australia and Korea but partially offset by weakness in Japan and New Zealand."
- Europe and the Middle East delivered comparable sales growth of 0.8%.
Overall, global comparable sales growth fell 1.4%. Organic revenue (excluding the impact of foreign currencies movements) fell 2.1% and, what is more worrying:
"Total revenues decreased 42.5% to $327.7 million, compared to $569.9 million in the prior year period due to global refranchising transactions and negative comparable sales growth, partially offset by net restaurant growth and favorable FX impact". (Source: Burger King Investors Relations)
Nothing can stop McDonald's from expanding
One of the main reasons behind the decrease in revenue of Burger King is McDonald's, the main competitor both nationally and internationally. McDonald's has more resources than Burger King, and despite being the world's biggest restaurant chain, recently posted 1% revenue growth.
How is this possible? Unlike Burger King, McDonald's has strong competitive advantages. To begin with, it is easier for McDonald's to negotiate more favorable lease terms with landlords and developers, due to its scale of operations. Furthermore, McDonald's owns 45% of the land and about 70% of the buildings for its restaurants, as of 2012. Unlike Burger king, McDonald's is full of assets, from land to hamburgers that can be recognized by most people in the world.
Also notice that McDonald's is introducing new products at a faster pace than most of its competitors, including Burger King. And I'm not only talking about new hamburgers. McDonald's new products show that the firm is searching for new customers, who are not traditionally associated with "fast food". For example, the McCafe specialty coffee menu is designed to appeal coffee lovers with tight budgets, a common pattern in recessions. This, combined with re-imaging efforts and free wireless Internet access, keeps bringing more and more customers to McDonald's, while Burger King's sales have remained constant (the graphic plots sales at company owned restaurants, but it is a decent proxy for overall sales).
Burger King needs a special hamburger
The company's business model is all about providing cheap burgers. This is a very weak model, considering how fierce competition is in the world of fast food chains. Therefore, in order to add strength to its fundamentals, Burger King needs to add new hamburgers on a constant basis. This helps to keep customers interested.
The problem is that Burger King has not offered anything unique for quite a while. Let me illustrate this point with a recent example. According to a recent note on Yahoo! Finance Blogs, Burger King's summer menu for this year is basically its traditional set of offerings, spiced up. Some repeat items that were popular last summer include sweet-potato fries and a Carolina-style barbecue Whopper. Same old stuff.
Yum! Brands and Chipotle Mexican Grill may be better alternatives
Yum! Brands, which has exhibited similar stock performance to McDonald's over the past 5 years, owns KFC, Taco Bell and Pizza Hut. Also, the company has increased its assets to liabilities ratio from 0.98 to 1.31 in the past 5 years, while Burger King's debt to equity ratio is close to 2.47, due to a $3 billion long-term debt.
Chipotle Mexican Grill, which is calling for opening 165-180 locations this fiscal year, also has an excellent balance sheet and, what is more important, has more potential for future growth in revenue, because it offers a middle point between fast food chains and restaurants, which is quite appealing to the average consumer. Also notice that Chipotle is using organic procedure, raised proteins and dairy products in its menu, which are more expensive but at the same time, more attractive to an increasingly diet concerned customer.
The bottom line
Burger King needs more differentiation in its products and a stronger business model if it wants to stop losing market share against competitors with more resources. Also, considering that the current PE is probably the highest in the industry, the current price is too elevated to consider opening a long position. The company also has a "substantial level of indebtedness" that could make it difficult for the firm to pursue an aggressive expansion in the next years, due to significant operating and financial restrictions. Taking all these factors under consideration, I believe the current price is too high and expect an inevitable correction.
Instead of speculating on Burger King's future, why not invest in a rising star. in fact, Chipotle's stock has been on an absolute tear since the company went public in 2006. Unfortunately, 2012 hasn’t been kind to Chipotle’s stock, as investors question whether its growth has come to an end. Fool analyst Jason Moser’s premium research report analyzes the burrito maker’s situation and answers the question investors are asking: Can Chipotle still grow? If you own or are considering owning shares in Chipotle, you’ll want to click here now and get started!
Adrian Campos has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide, Chipotle Mexican Grill, and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. 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!