Burger King India (NS:BURG) is one of the largest IPOs of the year and since listing, has soared over 125% over its list price. The pandemic hit Burger King’s earnings hard, with revenues declining 68% in the first half of the year, but the lifting of restrictions should see its earnings for the second half of the year improve. It is not likely that the recovery will lead to pre-Covid-19 levels of growth and profitability given that Burger King’s clients also have to recover economically.
It seems to me that driving the price upward are the near-term macroeconomic outlooks more than what is going on within the company. With monetary and fiscal stimuli bolstering markets, there is a belief that the recovery will be sharper than expected and lockdown restrictions will remain eased for some time. Furthermore, foreign investors in search of high yield opportunities, coupled with the news of a Covid-19 vaccine, have led to investor enthusiasm for the prospects of the company.
Revenue growth from 2018 to 2020 is at 50% CAGR, something which only 2.5% of companies achieve over similar periods. Burger King is a growth company that has set very high standards for growth, and in that time, they have not been able to earn profits. A history of after-tax losses is marginally ameliorated by a rise in gross margins of 64% this year.
Burger King has negative working capital and this has driven operating cash flows over the last three years.
Burger King India is competing in a very competitive market, which is likely one of the reasons for its failure to achieve profitability. On the surface, Burger King is in the ideal place, operating in a fast-growing economy with a huge addressable market and it already operates 261 outlets there. In comparison, Domino’s Pizza Inc (NYSE:DPZ) has 1354 outlets; Subway has 541, McDonald’s (NYSE:MCD), 481; KFC, 454; and Wow! Momo (NASDAQ:MOMO), 17.
Overall, Burger King makes up only 4% of its market, by outlet count, and 5% by revenues. On the other hand, competition has the effect of forcing companies to spend heavily to win market share, and removes pricing power from the hands of the companies. Given the growth story in India, it is not a surprise that so many franchises have cropped up in India. The economic profits on offer are very attractive. Burger King has dug deep and borrowed to grow this fast. Indeed, its motivation for listing is partly to pay back debt and partly to fund further growth. The company plans to have 700 outlets by the end of 2026. The economics of opening a franchise in India are such that we should expect to see an increase, rather than a decrease in competition.
Competition has been steadily increasing since the 1980s, as Indian consumer consumption patterns have changed and people have embraced eating in fast food outlets. Eating out had not previously been a feature of Indian lifestyle. Added to that, the explosion in the wealth of India has made India an attractive investment destination, inviting business from established international brands like Domino’s Pizza, McDonald’s, and Pizza Hut, followed by KFC, Subway, KFC, Haldiram’s, Taco Bell, Moti Mahal and of course, Burger King, among others. This will not end anytime soon. Competition is fantastic for consumers for obvious reasons but is not a friend of capital.
The success of Burger King or any of its competitors will attract competitors to the market. With no real barriers to entry, at least with respect to franchises from the United States, there is little preventing more entrants from entering the market and forcing a price war or capital expenditure to defend market share. The $36,4 billion in plant, property equipment is an indicator that as large as the franchise may be, the sums needed to compete with it are well within reach of many fast-food franchises. Analysts seem to be fixated on the notion that Burger King is growing, but growth does not imply the creation of shareholder value. The present fixation of analysts on Burger King’s growth is an indication of the demand for Indian growth stories and the present mania for growth at any price, even if that price is profit. Consequently, it is likely that Burger King’s share price will continue to appreciate sharply in the near-term.
Nevertheless, the effect of this profitless growth is that it is and will continue to destroy economic value. This is not the kind of investment you could peacefully leave in a special investment trust and never have to worry. The future does not bode well for profits.
Investing in Burger King carries certain risks. Firstly, there is no guarantee that lockdown restrictions will not resume, and that the vaccination program being planned for India will go ahead without hiccups. In the event of renewed lockdowns or further outbreaks of Covid-19, Burger King would not be able to keep all its outlets open and even if they could, the health risks involved would likely limit profitability.