Updated: Dec 1, 2020
Burger King, as most of you know, is a fast food chain of restaurants that operates in what we popularly call the "QSR or Quick Service Restaurants" industry in the food services market.
Before we delve into the company itself, it may help to learn a little about the broader food services market structure in India.
MARKET STRUCTURE -- FOOD SERVICES
The food services market is broadly divided into two segments: (1) organised and (2) unorganised.
The unorganised segment consists of dhabas, roadside small eateries, hawkers, and street stalls.
The organised segment, on the other hand, consists of (1) chains, (2) standalone outlets, and (3) restaurants in hotels.
Within chains, we also have 6 sub-segments. These are primarily (1) fine dining restaurants or FDR, (2) casual dining restaurants or CDR, (3) pub, bar, club, and lounge or PBCL, (4) quick service restaurants or QSR, (5) cafes, (6) frozen desserts and ice cream brands.
Since the subject of our analysis is the QSR industry within which Burger King operates, we will focus on that. The size of India's food services market was Rs 4.2 lakh crores in 2020. Of this, only 4 per cent or Rs 16,950 crores was contributed by the QSR segment.
The biggest segment of the food services market was the unorganised sector, which accounted for more than half of the market.
THE SHIFT FROM UNORGANISED TO ORGANISED
As you can notice in the table above, the unorganised market made up of dhabas and road side eateries comprised as much as 68% of the food services industry in 2015.
Owing to a host of both microeconomic and macroeconomic reasons such as higher disposable incomes, shifting tastes and preferences, preference for better hygiene standards, and government policies such as demonetisation and GST, the share of unorganised sector has since reduced to 59.5% in 2020 while that of organised standalone and chain segment has increased. The trend is further expected to continue in the post-pandemic economic order.
Notice another piece of data: While the unorganised food sector has grown at a CAGR of only 5% over the past 5 years, the organised segment has growth much faster. For instance, the standalone outlets have grown at 13% every year and chain restaurants have grown at a staggering 18% every year.
Will the organised food services sector continue to maintain this growth over the next 5 years?
Given the reasons discussed above, I reckon yes. The post-pandemic economic order is only going to accelerate the shift of economic pie from unorganised to organised sector, not just in the food services market but others such as real estate, banking, paints, autos, or chemicals too.
THE ACCELERATED GROWTH OF THE QSR SEGMENT
Within the organised food services sector -- which has been growing at 18% in the past 5 years -- the QSR segment has been growing the fastest at 17% every year.
From a market share of 19% in 2015, its share has increased to 22% in 2020 and is expected to reach 25% by 2025. Though casual dining or CDR accounts for 57% this year, its market share is expected to remain stable over next five years.
Within the "chain" (not standalone) QSR segment, Domino's Pizza has the highest market share at 19% (by number of outlets), followed by Subway, McDonald's, KFC, and Burger King. Domino's also has the higher market share by revenues (at 21% of total chain QSR industry revenues), followed by McDonalds, KFC, Subway, and then Burger King. See below.
As you may notice, Burger King is a relatively newer entrant in the market. But going by its revenue growth and outlet expansion (as discussed in the financials section), it seems to be catching up with others at a quicker pace.
Even though Domino's largely dominates the QSR industry, it may help to note that going by food category, burgers and sandwiches comprise as much as 31% of the total Indian chain QSR subsegment, followed by pizzas and chicken.
McDonald's is the category leader in burgers and sandwiches with close to 42% market share. In the pizza segment, Domino's commands 80% market share. This, by the way, partly explains the exponential rise in share price of Jubilant Foods (which owns Domino's).
And finally, take a look at the number and growth of outlets of key players in the industry:
Though Burger King has about 261 outlets across India, the lowest among its competitors, it has been expanding reach at an average rate of 85 per cent every year over last 5 years.
Globally, Burger King is the second largest fast food burger brand -- after McDonald's -- with 18675 outlets in more than 100 countries. Burger King India is an exclusive national master franchisee of America's Burger King Corporation (which owns the Burger King brand), which in turn is a subsidiary owned by parent Restaurant Brands International Inc. Some other brands owned by Restaurant Brands International are Tim Hortons and Popeyes.
As part of the franchise agreement, Burger King India would be paying royalty to the parent company, which is capped at 5% of revenues every year.
What could make the Burger King brand a promising contender to McDonald's?
One, it rivals McDonald's on the value front by pricing its burgers at competitive rates -- below Rs 100. Its combos, for instance, "two good menu with variety" and "2 for" promotions such as 2 Crispy Veg burgers or 2 Crispy Chicken burgers, are priced at anywhere from Rs 69 to Rs 89. They also have 3 for Rs 99 and 3 for Rs 129 with varied option promotions. A majority of their burgers are priced at increments of Rs 5 to Rs 20.
Two, their national master franchisee model allows them to source raw materials from a single third party distributor -- who facilitates logistics and warehousing services. This national distributor in turn sources raw materials from a list of company-approved suppliers. Having a third party distributor helps the company maintain control on distribution costs and also reduce working capital requirements.
The flexibility of having national master franchisee also helps the company "negotiate and actively manage suppliers". The company also uses long-term contracts with select suppliers where the price of certain raw materials are set in advance through negotiation -- and then don't change throughout the contract period. This helps counter inflationary impacts on input pricing.
Three, the company differentiates its burgers from McDonald's through its distinct "flame grilling" expertise. They serve flame grilled patties to customers besides offering made-to-order burgers tailored to customers' taste preferences.
Let's look at Burger King's financials.
FINANCIAL ANALYSIS OF BURGER KING
Burger King has been a loss-making company, though it has been able to increase its sales at an average rate of 55% in past 3 years.
Take a look at the income statement metrics below:
Sales have been growing rapidly, along with operating profit (EBITDA) as well as operating margins. Operating margin expansion has been aided by lower cost of raw materials as well as employee expenses. This suggests the company seems to be managing its input costs well. As discussed above, this could probably be a result of relatively weaker supplier power. The national master franchisee helps Burger King India negotiate better with suppliers while a single third party distributor helps reduce the logistics and distribution costs. The company also has long term contracts for certain ingredients, thus shielding their prices from inflationary impacts.
The increase in sales is partly a result of outlet expansion. The company has grown its outlets at an average rate of 85% annually -- from 12 in 2015 to 261 as of Sept 2020. Of course, the product and value proposition the company offers could also be playing a pivotal role. The company has 18 veg and non-veg burgers in its menu (a large number of them below Rs 100), catering to ethnic palates and regional tastes, and distinguishes itself on its flame grilling expertise.
The company has positive cash flow from operations or CFO, which have been rising from Rs 30 crores in 2017 to Rs 113 crores in 2020 (right to left below)
The company, as you may notice above, is loss making. The loss is primarily on account of high depreciation expense and interest costs. Remember the company is capital intensive. This explains why the company had to take on debt of Rs 178.7 crore last year and an IPO of Rs 810 crore (Rs 450 crore of fresh issue) this year. The high interest expenses on debt have been eating off its operating profits.
What's more, the company's reserves (retained earnings) are negative owing to these losses. When the company is making losses, the return on capital employed (ROCE) ratio is rendered useless. Ideally, my investment policy requires that (1) a company must have positive and improving ROCE and (2) the company has low to negligible debt. Burger King therefore does not make the cut despite positive and improving CFO.
Untested management quality and corporate governance: The company's CFO and compliance officer had resigned in the past one year or so. To be sure, this may not necessarily be a red flag provided we know the reason for the resignation. Or at least an assurance that there was no material reason for resigning.
One more thing I'd have preferred is for there to be at least 50% independent directors on the board. As of Sept 2020, there were less than 50% (or only 3 out of 8 directors) independent. Also, as a matter of good governance, the nomination and remuneration committee should be fully comprised of independent directors so as to avoid any conflict of interest in deciding the management remuneration. However, Burger King's nomination committee has only 2 out of 3 independent directors.
That said, the company's IPO valuation offers some comfort. Since the company is loss-making, we cannot use traditional metrics such as price to earnings (as the denominator would be negative) to determine comparative value. But we can use price to sales or P/S.
Jubilant Foodworks (which owns Domino's) has a P/S of 10.4x
Westlife Development (which owns McDonald's) has a P/S of 6.32x
Burger King's IPO has an implied market capitalisation of approximately Rs 2290 crore. Therefore, it would have a P/S of ~ 2.72x (this is Rs 2290 divided by FY20 sales of Rs 841 crore = 2.72)
At 2.72x sales, this is not bad.
But remember, valuation is only one piece of the puzzle. Since a newly listed company is untested on corporate governance and management quality, and given the fact that it's tough to gauge these qualitative metrics merely through an IPO prospectus, one must be extra cautious in taking investment decisions.
That said, the grey market has been pricing the IPO at around 56% premium, two days ahead of the IPO date. This suggests there could be high demand for the IPO.
NOTE: This article is only information/educational and not intended to be a financial advice or stock recommendation. Please consult a registered SEBI advisor before taking any investment action.