Burger King India IPO – Should you subscribe?

Burger King, ‘Home of the Whopper’, needs little introduction. , Burger King India holds the exclusive pan-India right to open and operate outlets under the global Burger King brand. The company is part of the growing quick service restaurant (QSR) industry in India. And despite being a relatively new entrant to this space – the first Burger King outlet opened only in November 2014 – the company has quickly ramped up outlet count to 261 today. The Burger King IPO is open from December 2-4, priced at a band of Rs 59-60.

On offer are 13.6 crore shares, of which 6 crore shares are an offer for sale by one of Burger King India’s promoters, QSR Asia Pte. The remaining is a fresh issue. Of this amount raised, Rs 450 crore of which will be used to fund expansion with the rest going towards general corporate purposes.

At the upper end of the price band, the company’s market cap is likely to be around Rs 2,300 crore, placing it in the small-cap category. This is below Jubilant FoodWorks’ (Dominos Pizza and Dunkin’ Donuts) Rs 33,000 crore, as well as Westlife Development’s (McDonald’s) Rs 6,780 crore.

Burger King IPO – the good and the bad

The positives of the Burger King IPO are as follows:

• The QSR space in India is a growing one, projected to expand at a 19% CAGR over the next 5 years, according to the offer document. After casual dining restaurants, QSR holds the biggest market share at 22% of the food chain services market currently. The QSR space is also under-penetrated, leaving enough scope for growth.
• In the listed space, options to play the QSR potential is limited to Jubilant FoodWorks and Westlife Development. Specialty Restaurants is another option, but it operates in the fine-dining space.
• The Burger King brand is a strong, visible one. It has control over its menu and can modify it based on local tastes, which has led it to have a wide range of offerings across price points and food styles.
• Burger King India has managed quick expansion, following a cluster-based outlet opening strategy for better control over costs and logistics. It opts for high-traffic locations, as well as aiming to capture transit customers such as airports and metro stations. It receives support from promoter BK AsiaPac on quality standards, supplier approvals, cooking methods and ideas, and marketing.
• The issue is priced based on where the company stands vis-à-vis peers. Burger King India is loss-making. A valuation metric that can be used, therefore, is marketcap to sales. Jubilant FoodWorks trades at 8.4 times FY-20 marketcap to sales, while it is 4.4 times for Westlife Development. At the upper end of the price band, Burger King India would be around 2.7 times FY 20 sales. Another metric is EV/EBITDA, where Burger King India would be about 21 times FY-20 EBIDTA while Jubilant FoodWorks is more than double that.

However, we still recommend avoiding the Burger King IPO. The key detracting factors are a lack of profitability and no near-term improvement in the same, uncertain post-Covid recovery, and lack of control over deciding expansion that can make it harder to adapt to different market conditions.

Difficulties in profitability

Burger King India is a loss-making entity, and has been so from FY-18 (latest data available from the offer document). Now, revenue growth has been strong – it grew 32.9% in FY-20 and 67.3% the year before. Of the expenses, input costs form a chunk. As a proportion of sales, raw materials consumed account for about 36% of sales though it has been coming down. Other big-ticket expenses go on staff costs and rent, both of which have risen as a proportion to sales. Another rising expense has been commission and delivery expenses. With rapid outlet expansion, EBITDA margins have been uneven, even ignoring the six months to September 2020 as the lockdown bit.

But while the company manages on the operating profit front, it doesn’t do so at the net level. Net losses went from Rs 82 crore in FY-18, to Rs 38 crore in FY-19 and back to Rs 76.6 crore in FY-20. The company therefore posts no ROE or ROCE numbers.

One key factor pushing the company into losses is depreciation. With depreciation costs accounting for a whopping 13% of sales, it pulls the company into losses at the net level. Leasehold assets and others like furniture have high depreciation rates. Therefore, while the company is positive on EBITDA and operating cash flows, net profits are nowhere on the horizon.

Burger King has to significantly ramp up profitability at the EBITDA level in order to turn profitable at the net level and maintain such profitability. Jubilant FoodWorks, in contrast, has both lower depreciation levels as well as better EBITDA margins at about 24-25%. For Burger King India, there are a few challenges that can keep profitability suppressed.

One, depreciation costs are likely to remain high. The company aims to primarily use own outlets in its expansion. Two, costs such as rentals, adspends, and delivery charges are unlikely to dip – the company needs to be present in high-traffic areas such as high streets and malls where rentals are expensive, it needs to push its products and offers in the face of increasing competition and the delivery model is fast catching on.

Three, the company may need to tap other funding sources if issue proceeds and internal accruals fall short. Rs 164 crore of the issue proceeds will go towards repayment of debt, which is at Rs 175 crore (long-term debt) currently and boost margins in the coming quarters. As per the RHP, the cost of an average-sized company-owned Burger King outlet is about Rs 2.7 crore and the company needs to open about 70 outlets a year over the next 4 years. As of the latest balance sheet, it has limited reserves to draw on. If the company turns back to debt to fund expansion, interest outgo can again dent margins.

Mandated expansion

On the expansion front, Burger King India needs to have 700 outlets in place by the end of December 2026 as per its master franchise agreement (of this, at least 60% need to be company owned and not franchises). Not just that, it additionally has an annual outlet opening target, of which at least 70% needs to be met and the remaining within 6 months of the following year.

More, the agreement also requires a franchisee fee of USD 25,000 (later increasing to $35,000 from calendar year 2023) to be paid for every outlet opened, in addition to normal royalty of up to 5% of sales. Burger King India has 261 outlets today. The company has steadily stepped up the number of outlets it opens each year, as shown in the table below. The company plans to maintain this pace, opening about 70-80 outlets each year over the next 4 years.

Burger King India therefore has little wiggle room to alter its outlet network or targets based on changes in market conditions, consumer behaviour, or the company’s own position on funding expansion. For instance, should the company wish to focus more on ensuring better performance of its existing network, or slow down expansion because of unfavourable conditions, or alter targets, it will find it hard to do so.

This in turn demands a level of capital commitment and expansion costs that the company will have to incur. The company is also committed by agreement to spend at least 5% of own-store revenues towards advertising. Though Burger King India’s adspends do hold slightly above this, it is yet another factor where the company has lower control.

Uncertain future

It is also not clear how well outlets once opened manage to keep up revenues and profitability. Given that the company is relatively new and that outlet count has been smaller in earlier years, same-store sales growth (SSSG) is inconclusive. Same-store sales measures sustainability of an outlet, and is an indicator of how dependent the company is on expansion to drive revenues.

As per the RHP, SSSG clocked in at 12% for FY-18, rose to 29% for FY-19 before crashing to -0.3% in FY-20. Even ignoring the March 2020 quarter, SSSG was lower at 6.1% for the nine months ended December 2019. Peers such as Jubilant FoodWorks also saw SSSG dip in FY-20, on the back of a strong FY-19.

How dining recovers in a post-Covid world also remains to be seen. With customers staying away from dine-ins, delivery sales have grown. On this count, Jubilant FoodWorks was an early entrant; as a result, it commands better pricing from delivery platforms, has a sizeable contribution from its own delivery network, and keeps store costs down by focusing on delivery.

Other QSR players, including Burger King India, have a good way to go yet. Aggregator platforms are also more likely to push customers into looking for options that offer better discounts – this both reduces brand loyalty while also increasing costs for the company. For Burger King India, delivery costs have risen from 2.5% of sales in FY-18 to 5.5% in FY-20 and stood at 14.7% for the six months ended September 2020.

The bottomline in this Burger King IPO is whether you would want to buy into a company that’s been steadily incurring losses, based on the strength of the market potential and topline, when there are other ways to play the Indian consumer space. We think not. Note that we are not considering listing gains in this recommendation, and we are solely basing it on a fundamental, long-term perspective.

Burger King India’s IPO is open from December 2 to 4. Each lot size is 250 shares.