High Stakes Burger King Remodel Still a Work in Progress

Burger King (BKC) is releasing earnings on October 29th, and needs some big news to reassure investors as well as ultimately drive sales. On October 17th, it's featuring the $1 double cheeseburgers via national advertising, as Wendy’s (WEN) just began rolling out their new burger, Carl’s and Hardee’s (CKR) new burgers, and of course, McDonald’s (MCD) endless promotion of the Angus Burger. The Burger universe is crowded.

 QSR sales momentum has been slipping from late last year, as I noted on Seeking Alpha on September 11 2009. (seekingalpha.com/article/160498). Even YUM (YUM) reported negative US sales comps, minus 2% Taco Bell, and KFC and minus 13% Pizza Hut.

 Burger King highlighted the so-called 20/20 Design remodel on October 7th. (http://investor.bk.com, news release and photos available). The unit looks great and does give them upside potential to change the brand. But the size of the capital investment—Ad Age reported $300K to $600K investment range, and the quoted sales increase range, 10-15%, will make it difficult to grind out a payback. (Ad Age noted a scrape and rebuild would generate 30%.)

 Restaurants should reimage and refurbish their stores. That, and new menu development, are very critical. But keep in mind in the QSR universe, about 70% of sales come via the drive thru, and customer won’t see the interior, at least on that visit. The 20/20 new drive thru station will be enhanced, however.

 Burger King is 90% franchised, and franchisees don’t have the same access to credit and capital costs that the company has. Even large franchisees have it difficult, see the story of large Burger King franchisee John Gantes, who is in Chapter 11. (www.ocregiswter.com/articles/gantes-restaurants-million-2277643-restaurant-clark).

 The profit math assumes midpoint estimates: a Burger King AUV of $1.2M, 13% sales gain, 50% profit flow through, and resulting pre-debt service variable profit/unit/year of about $78K. But if the franchisees borrow 100% (not likely in this credit environment), debt service would be about $105K year (assumes $450K investment, 10% interest rate and 7 year term). Therefore the variable profit isn’t covering the investment. Said another way, franchisees will have to inject cash and the debt service will be less, but still a long payback.

 Perhaps the press reports aren’t right, or the project is still a work in progress, but it doesn’t seem to “pencil” at this point.    

John A. Gordon
Chain Restaurant Earnings and Economics Experts
www.pacificmanagementconsultinggroup.com