A Tasty Burger Bite for Investors

A Tasty Burger Bite for Investors

I am always fascinated by franchise restaurant chains, which normally deliver significant growth and generate good free cash flow. Burger King Worldwide is one great example of franchise-operated business model. Currently, out of its total 13,259 restaurants, there are only 74 company-owned locations, while the franchise restaurants account for nearly 99.5% of its total restaurant count.

However, the business seems to be a bit expensively valued, at around 22.3 times the forward P/E. Is Burger King Worldwide a good buy at its current price? Let's take a look.

Re-franchising is a good strategic initiative
In its recent third-quarter earnings, the company provided mixed results between its top line and bottom line. While revenue experienced a nearly 40% drop to $275.1 million, net income surged by more than 933%, from $6.6 million last year to $68.2 million this year. The significant drop in year-over-year revenue was due to the decrease in the company-owned restaurant revenue, by $217.6 million, while the franchise and property revenue was higher than last year by $37 million.

Personally, I am not worried about the revenue drop because it was caused by the impact of the global re-franchising initiatives of its 519 company-owned restaurants in the past 12 months. Actually if the re-franchising impact was excluded, the company would have recognized an 8% rise in sales.

The re-franchising strategy is to sell the company-owned restaurants to franchisees, lowering the capital investment and overhead costs. By moving its business model to only franchising, Burger King Worldwide will experience significant growth and generate a better amount of free cash flow in the future.

Wendy's and DineEquity made similar moves
Wendy's , another smaller hamburger/sandwich restaurant chain, has been focusing on re-franchising to optimize capital and improve profitability. The company plans to sell 425 restaurants in its total 6,500 stores system wide, lowering its system ownership from 22% to only 15%. With that move, Wendy's estimated that it could improve the restaurant margin by at least 50 basis points. This process should be completed by the end of the second quarter in 2014.

has also been moving in the same direction, selling company-operated restaurants to franchisees. In the third quarter, its net income dropped by 69% to $18.73 million, or $0.97 per share, from the same period a year ago. The significant drop in net income was because last year's third-quarter period included the gain on restaurant sales of more than $73.6 million. DineEquity has completed the re-franchising program for the Applebee's chain, improving the chain's margin and boosting its profitability. As a result, its third-quarter general and administrative expenses declined by 11% due to its recent re-franchising initiatives and lower personnel costs.

Lowest leverage with decent valuation
What might make investors scared is Burger King Worldwide's huge debt. As of September, the company booked $1.4 billion in equity but as much as $2.1 billion in net debt. With the trailing-12 month EBITDA (earnings before interest, taxes, depreciation and amortization) of $561 million, the net debt/EBITDA stays at 3.8.

Interestingly, Burger King Worldwide enjoys the lowest financial leverage ratio among the three. While Wendy's leverage ratio is 3.9 times net debt/EBITDA, DineEquity is the most leveraged with nearly 4.4 times net debt/EBITDA.

In terms of valuation, DineEquity has the lowest valuation at around 18 times its forward earnings. Burger King Worldwide ranks second with 22.3 times its forward P/E while Wendy's is the most expensive, valued at 31.2 times its forward earnings.

Thus, although in absolute basis Burger King Worldwide seems to be quite expensive, when investors compare BKW to its peers and factor in its potential growth, Burger King Worldwide does not trade for an outlandish valuation.

Foolish Takeaway
With the ongoing re-franchising, Burger King Worldwide will deliver a higher return on capital, more growth, and a greater amount of free cash flow in the future. As it is the lowest-leveraged business among its peers, not so crazy valuation, Burger King Worldwide could be a good stock for investors to hold in the long run. As always, Foolish investors should do their own research before making any investment decisions.

Other 6 great picks for portfolio growth
Tired of watching your stocks creep up year after year at a glacial pace? Motley Fool co-founder David Gardner, founder of the No. 1 growth stock newsletter in the world, has developed a unique strategy for uncovering truly wealth-changing stock picks. And he wants to share it, along with a few of his favorite growth stock superstars, WITH YOU! It's a special 100% FREE report called "6 Picks for Ultimate Growth." So stop settling for index-hugging gains... and click HERE for instant access to a whole new game plan of stock picks to help power your portfolio.

The article A Tasty Burger Bite for Investors originally appeared on Fool.com.

Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide. 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.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Originally published