Burger Makers' Not-So-Meaty Prospects


By Eric Wahlgren Investors looking to beef up their portfolios as the economy recovers will likely see only modest gains from the top three burger makers in 2002. Indeed, this could be a lean year for the troika of hamburger chains that account for 75% of the more than $45 billion Americans spend every year at fast-food burger joints. (The figures are for 2000, the most recent year statistics were available from Technomic, a Chicago-based restaurant-consulting firm.)

Why are these companies in a bit of a pickle? Well, among other challenges, McDonald's (MCD), the hands-down burger leader with a 43.1% market share in the U.S., is facing "mad-cow" concerns in Japan after recovering from the effects of Europe's panic over the brain-wasting disease.

No. 2 Burger King is looking to separate from its parent, London-based conglomerate Diageo (DEO), as it focuses on trying to boost its 18.8% share. (Investors currently can't invest in Burger King directly but may be able to soon enough if the Miami-based chain goes ahead with a previously planned initial public offering.)

CASUAL THREAT. Meanwhile, Wendy's International (WEN), the third-largest burger group, with a 12.7% share of the burger market, lost its chief pitchman when founder Dave Thomas died in January. The Dublin (Ohio) company's performance has shown no signs of suffering from the loss of its avuncular icon. But like its rivals, Wendy's is dealing with a trend that could limit future growth for the quick-service restaurant (QSR), analysts say.

That's the increasing popularity of "fast-casual" dining, or food outlets that offer a gentler ambiance and food that's kinder to the arteries. Fast casual "represents a long-term threat, and the hamburger chains will have to figure out how to respond to it," says Ron Paul, Technomic's president. "The consumer wants to pay for higher-quality, fresher food."

Wendy's, which posted a 6.9% rise in revenues last year to $2.4 billion, is best positioned to respond to the threat, analysts say. It also has the best growth prospects of the three in the near term, with Wall Street predicting earnings per share increases of 12% to 15% annually. The company, which counts more than 6,000 Wendy's restaurants and some 2,100 Tim Hortons coffee-and-donut outlets, has "a heritage that has been based around a higher-quality product than Burger King or McDonald's," says John Ivankoe, equity research analyst at J.P. Morgan in New York.

SALAD SEEKERS. Wendy's spokesman Bob Bertini says products like the company's new "Garden Sensations" salad line, which offers ingredients such as pecans, mandarin oranges, and crispy rice noodles, set the chain apart. "It brings customers into our restaurants who don't normally turn to a QSR for a salad offering," Bertini says.

The chain's menu is part of the reason Ivankoe rates the stock a buy and calls it his top QSR pick. Expectations that Wendy's will increase sales at restaurants open at least one year -- a key measure of sales success -- by a healthy 4.5% in the first quarter of 2002 is another reason for his bullishness. Ivankoe recently upped his fiscal 2002 profit estimates to $1.85 a share. That figure is on the lower end of analyst expectations but would still represent a 12% jump over last year's net income of $1.65 a share. "We expect Wendy's to outperform the major QSR competition over time," Ivankoe said in a recent note to investors.

Despite Wendy's prospects, though, the stock may not have a lot of juice left for this year. Ivankoe has a $35 price target, and the shares closed at $34.66 on Apr. 4. Tony Howard, an analyst with investment firm Hilliard Lyons in Louisville, Ky., thinks the stock has already gotten a little too pricey. Since falling to a post-September 11 closing low of $26.15 on Oct. 30, it has risen more than 32% to current levels.

GLOBAL INDIGESTION. Howard would like to see the stock go back down below the $30 level before slapping a buy rating on it. "We continue to like Wendy's," he says. "We just think the restaurant stocks are getting a little ahead of themselves."

McDonald's stock, which closed at $27.79 on Apr. 4, isn't expected to go far this year either. Part of the problem is the Oak Brook (Ill.) company's exposure to international markets. Mickey D's, which has more than 30,000 restaurants globally, derives more than 40% of its operating income from abroad, according to Ivankoe. In 2001, McDonald's profits excluding special items fell to $1.8 billion, or $1.36 a share, on 5% higher revenue of $14.9 billion, compared with profits of $2 billion, or $1.46 a share in 2000. Weak economies abroad and beef's image problem in Europe as a result of the mad-cow scare were partly to blame.

The good news? Sales in Europe -- ground zero for bovine spongiform ecephalopathy (BSE), or mad-cow disease -- are coming back. They increased 8% (when the negative effects of currency translation are excluded) for the first two months of 2002. But in the same period, sales declined 2% in the McDonald's segment comprising Asia, the Middle East, and Africa. Limp economies are partly to blame. Now, the first case of mad-cow disease in Japan reported in September is also damping demand for burgers. Ironically, McDonald's restaurants in Japan use beef only from Australia and New Zealand, which have not had any cases of BSE.

BELOW TARGET. McDonald's also faces challenges on its home front, which accounts for more than 50% of its operating income. The company posted 3% sales growth in the U.S. in the first two months of the year, which lagged behind its competitors' growth, analysts say. McDonald's is steaming ahead with a quality-and-service improvement plan designed to boost traffic and sales volume. But Mitchell Speiser, a Lehman Brothers analyst, said in a recent research note to investors that the $70 million push, originally expected to have an impact by the second half of the year, "is going to take longer than expected."

Mindful of the challenges, the company on Mar. 22 warned that its 2002 first-quarter and full-year profits would come in below earlier targets. Wall Street's consensus estimate for full-year earnings is now at $1.46 a share, which would represent about a 7% increase over last year's profits. "Street [earnings per share] reductions on tap and global sales/margin pressures [will] limit upside," on the shares, says Speiser. McDonald's did not return calls for comment on this story.

The outlook is more uncertain for Burger King. The chain of more than 11,400 restaurants worldwide posted a 29% decline in operating profit, to $113 million, for the six months ended Dec. 31. Diageo, which wants to shed BK to concentrate on its alcoholic-drinks business that includes brands such as Guinness, Cuervo, and Johnnie Walker, attributed the drop to the costs of preparing the chain for separation.

WHO'S BUYING? It's unclear whether investors will get a piece of the second largest burger chain, if they want one. Ivankoe says BK could be spun off in an IPO or sold to another QSR chain. But he says the word on the street is that BK, which has been through a series of ownership changes after its Miami founders sold the business to Pillsbury in 1967, will probably be sold to a financial buyer. "That's the general assumption," he says.

Burger King spokesman Rob Doughty would confirm only that Diageo's board of directors has hired advisory firm Greenhill & Co. to help it with the process. "The board of directors will make the decision on the timing and the form of the separation," Doughty says.

Meanwhile, the chain is laboring to gain back market share in the U.S that has been lost as a result of management turnover and other troubles. Chairman and Chief Executive John Dasburg in late February told the press he wanted to increase Burger King's share of the U.S. hamburger market 4 percentage points, to 23%, by 2004. The increase would come by pumping up average annual sales per store to $1.25 million from the current $1 million or so, he said.

"ALL-AMERICAN." It's too early for market-share data that would reflect how the effort is progressing, Doughty says. But, he adds: "The initiatives we have in place are going very well." Burger King is aggressively scouting for new restaurant operators -- 92% of its restaurants are owned by franchisees.

And the company launched 14 new products in March alone, Doughty says. Highlights were a new Whopper, BK's signature hamburger, and a flame-broiled veggie burger, which he says will appeal to the fast-casual crowd. "You can now order your Whopper or Chicken Whopper with reduced-fat mayonnaise," he says. "We also know we have a core audience that launched our standard products."

As Technomic's Paul says, "A good burger is still one of the all-American favorites." And that means steady earnings for the chains that fry, grill, or broil them. But investors shouldn't expect major growth from these companies -- at least not in their stock prices -- until they overcome some of their short-term challenges. Wahlgren covers financial markets for BusinessWeek Online in New York


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