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A Deeper Look at Burger King IPO and the Food Services Business

Burger-King-IPO.jpg

Burger King India has filed the draft offer document with SEBI on November 5,2019 and is expected to hit the public markets this year. In this post we look at the IPO and the food services business in India.

The Issue

At the date of filing the DRHP the paid up equity share capital of the company consists of 26.66 Cr shares of 10 each and 1 Cr CCPS (compulsorily convertible preference shares) of face value 100 each. The rate of dividend payable for the CCPS is 8% per annum. The CCPS will be converted at the discretion of QSR Asia at anytime within a period of 20 years from the date of their issuance at the fair market value.

99.39% of the equity shares are held by the promoter and promoter group, QSR Asia is the promoter of the company. 0.61% is held by the public. The average cost of acquisition for the promoters is 19.26/share.

The offer is a fresh issue of 400 Cr and OFS (offer for sale) of 6 Cr shares by the promoters. Proceeds from the issue are to be utilized for rolling out new Burger King restaurants. The company is considering a pre IPO placement amounting to Rs 150 Cr, if the pre allotment process were to be completed the number of shares issued will be reduced from the fresh issue.

Food Services Market

The Indian food services market is classified into two segments – organized and unorganized. Key characteristics of “organized” outlets

  • Accounting transparency
  • Organized operations with quality control and sourcing norms and
  • Outlet penetration

Outlets that do not meet the above criteria fall into the unorganized segment and include dhabas, roadside eateries, hawkers and street stalls.

The organized market can be further classified into

  • Standalone outlets and
  • Chains (domestic or international outlets that have more than 3 branches across the country)

Chains can be divided into six sub segments based on average price per person, service quality and speed and product offering

Food Service Categories

The food services market is estimated to be Rs 4,096 billion in FY19. Chart shows the growth of various categories since FY14

Observations

  • Total market has grown by 9% CAGR. Organized market has grown fastest – organized standalone at 13% and chains at 18%
  • The unorganized market constitutes majority – 62% of the total market. However this is on a declining trend – 69% in FY14 versus 62% in FY19
  • The organized market (Standalone + Chains) stood at Rs 1,446 billion. Both these have gained substantial market share over the 6 year period

Breaking out the Organized Market specifically.

QSR: Quick Service Restaurant

CDR: Casual Dining

FDR: Fine Dining

FD/IC: Frozen Dessert & Ice Cream Outlets

PBCL: Pubs, Bars, Clubs, Lounges

Key takeaways from the above chart

  • Total market has grown by 14% CAGR. The QSR and CDR segment have seen the fastest growth – 18% and 15% respectively
  • Casual dining (CDR) constitutes 56% of the market followed by QSR which is 21%. Together these markets have 77% of the market
  • Fine dining (FDR) has seen the lowest growth 4% in the above period
  • QSR has seen the highest market share gains in this period at 3%

The chain market was Rs 350 billion in FY19, Burger King operates in this market under the QSR category. Trend and breakup of the market by various categories

Observations from the above data

  • Total market has grown by 18% CAGR. All segments except the Cafe segment have seen double digit growth
  • QSR segment has 46% of the total market. QSR and CDR segment together hold 80% of the chain market
  • QSR and CDR have seen highest market share gains in the above period

The top 8 cities constitute 41% of the food services market. Mumbai leads the chart with market size of Rs 438 billion, followed by Delhi NCR with a market of Rs 420 billion. Together these have 51% of the total market.

The IPO Candidate: Burger King

Burger King was founded in 1954 in the United States and is owned by the Burger King Corporation, a subsidiary of restaurant brands international inc. Burger King has a global network of over 18,000 restaurants in more than 100 countries.

Burger King India has a master franchise and development agreement with Burger King Asia Pacific, which is an affiliate of Restaurant Brands International Inc. The master franchise agreement is valid until December 31,2039. The company operates in the QSR segment and was a late entrant in the Indian markets. It opened its first restaurant in November,2014. At the date of filing the DRHP the company had 216 company owned and 8 sub franchised Burger King restaurants spread across 16 states and UTs and 47 cities across India.

The company operates in the QSR segment and break up of the market by food type is shown below

Burgers & Sandwiches account for 31% of the market, followed by Pizza with 28%, however this does not account for Pizza Hut (which is classified as CDR and not QSR). Chicken had a market share of 16% and the others category 25%.

The chain market has shown impressive growth in the last 5 years – 18% CAGR. Some of the reasons for this are

  • Increased eating out and ordering in behaviour – 60% of Indians eating out are millennials (15-34 age group), companies including Burger King target this market segment
  • Increased internet and smartphone penetration
  • Offering exclusively suiting the Indian palate – like the Mumbai Indian masala whopper offered by Burger King, wraps by Domino’s, KFC rice bowl
  • Rise of platforms like Zomato and Swiggy – delivery market has increased from $4.7 billion in FY16 to $8 billion in FY19, projected to reach $18 billion by 2024
  • Increase availability of retail space enabling expansion of food services outlets

Although Burger King has been a late entrant in the Indian market, it has been the fastest-growing international QSR chain in the last 5 years. The below chart captures the growth in the number of outlets of Burger King from FY15. The company is obligated to develop and open at least 700 restaurants by December 31, 2025.

 

Restaurants are spread across India as shown below

Indian Outlets
Source : Burger King DRHP

Restaurants vary across sizes from 400 square feet to 4,000 square feet. Standard restaurant template size ranges from 1,300 – 1,400 square feet.

The USP or the value proposition of Burger King is to provide quality products that suit the Indian palate and are not to heavy on the pocket as well. For instance, the company has a lot of products which are under Rs 100 and runs promotions like 2 crispy veg burgers for Rs 69. The company also has a wide variety of product offerings, it has a range of 22 different vegetarian and non-vegetarian burgers covering both value and premium segment. The incremental pricing between products is also kept low – 10-20 Rs, this enables the customer to upgrade easily.

Some of the suppliers of the company include – Hyfun Foods, Mrs Bectors, OSI Vista, Pepsi Co, Schreiber, Veeba and Venky’s. Supply chain is an essential piece of the business, it is very important for the company to get its supplies on time and in the right condition. The company manages its supply chain through a third-party distributor – ColdEX. The third-party distributor buy supplies from the vendors and Burger King then buys it from ColdEX. This arrangement gives the company access to ColdEX’s warehousing facilities and extensive logistics network across the country. In addition, the company saves on investing in working capital, as the third party distributor keeps all the supplies on its books before the company purchases it.

Supply Chain

Source : Burger King DRHP

Burger King India is required to pay BK AsiaPac a non refundable fee of $15,000 upon opening of each restaurant which will increase to $35,000 from 2018 and will remain so there after. The India unit will also have to pay a renewal fee upon renewal of a restaurant licence.

There is also a monthly royalty fee, which ranges from 2.5-5% of sales that the company has to make to the BK Asia Pacific.

Competition

The organized chain market has more than 100 brands with over 6,500 outlets spread across various cities in India. Competitors of the company are other international QSR chains such as McDonald’s, KFC, Domino’s Pizza, Subway, Pizza Hut and other local restaurants operating in the QSR segment.

 Some of the important metrics with regards to the competition are shown below

Outlets of McDonald’s operated by South and West Franchisee

Observations from the above table

  • Domino’s dominates the market in terms of no of outlets – 1249 across the country
  • The average price per customer is lowest for Subway, 175-200 Rs. Average size of Subway stores are the lowest 750-1000 square feet
  • All companies enjoy high gross margins with Dominos leading the pack with margins of 77-78%
  • Advertisement costs are in the range of 4-7% for all companies. Companies operating in this space have to constantly spend on advertisements
  • All companies do pay royalty to the parent company. Royalties are in the range of 3-8%
  • McDonald’s has the lowest EBIDTA in the range of 13-15%
  • CAPEX ranges from 1.5-5 Cr in setting up new outlets

McDonald’s is the category leader in the Burger & Sandwich segment with 42% market share. In Pizzas, Domino’s has a market share of 80%.

Below are the revenues of key international brands in INR Billion

Domino’s is the leader in terms of revenues, the company posted revenues of Rs 36 billion (3,600 Crores) in FY19. The CAGR for the company was 15%. Westlife Development, which runs McDonald’s outlets in the south and west grew sales by 17%. Burger King registered the highest growth at 64%,this is on the back of its aggressive expansion of outlets.

Below is the trend in number of outlets opened every year since 2015 among the various players in the industry.

Burger King has expanded its outlet base at 99% CAGR in the above period.

Same-store sales growth (SSSG) is an important metric in the food services business. It is growth in sales that the company registers from stores that have been open at least one year. The SSSG for key brands are shown below

The SSSG for Burger King in FY18 and 19 was 12.2% and 29.2%.

Financials

Revenues stood at Rs 632 Cr at the end of FY19, revenues have grown by 65% CAGR in the two year period. Gross profits have grown by 71% CAGR, GPM stood at 64% in FY19, 4% points higher than the margins in FY17. The company has posted operating losses in all of the years, however, the gap has narrowed and the loss was 3.2 Cr in FY19. Fixed costs have also increased as the revenues have increased. Other expenses form a major portion of the expenses and have increased by 46% in FY19. The major components of other expenses are – advertising, power & fuel, commission & delivery expenses, royalty, and rent. Net loss during the year was 38 Cr, however, the losses have narrowed.

On the balance sheet, front majority of the assets are PPE and right to use assets. The financial statements have been reinstated to account for the new accounting standard IND AS 116, which pertains to leases. Under IND AS 116 lessees have to recognize a lease liability reflecting future lease payments and right of use asset for almost all lease contracts. This is different from the earlier standard IND AS 17 where there was distinction between financial lease (on balance sheet) and operating lease (off-balance sheet).

Companies will have to recognize assets and liabilities for all leases with a term of more than 12 months unless the asset is of low value. As a result, depreciation is charged on the right to use assets and interest on the lease liability portion.

On the liability side, the majority is in the form to lease liabilities. The company has taken on borrowings to the tune of Rs 100 Cr this year, the debt to equity ratio stands at 0.4. Due to the losses incurred in all these years, there is a hit on the retained earnings, total equity (Share capital + retained earnings) stood at Rs 249 Cr at the end of FY19 as compared to Rs 368 Cr in FY17. The company has a negative working capital, working capital at the end of FY19 was – 48 Cr, this is because the inventories are in the books of ColdEX as mentioned earlier and there is no credit extended to customers for its products. On the other hand, the company does not pay its suppliers immediately.

The cumulative cash flow from operations (CFO) are positive as compared to the cumulative net profits of -192 Cr. This is primary due to adding back of depreciation and interest costs to arrive at the CFO. On the investment side the company has bought both operating and financial assets. On the financing side the company has issued equity shares worth 270 Cr in FY17 and raised monies through CCPS in FY19 for Rs 100 Cr.

Risks and Challenges

Some of the risks and challenges that the business faces are

  • Food services market is fragmented in India, 62% of the market is with the unorganized players. In this kind of an environment it is a challenge to retain customer loyalty and companies have to constantly spend/carry out initiatives to gain footfalls
  • There is shortage of skilled labour and attrition rates in the industry are 35-40%, the cost of manpower is also high. This can impact the quality of products that the restaurant offers
  • Rentals are the 2nd highest cost component, the average rate is 12-15% of revenues and in some cases can go upto as high as 20%. This is a fixed cost and monthly payments have to be made irrespective of how the restaurant does
  • There are lot of regulations and over licensing to start a food service business. It is estimated that players wanting to enter the food services market require 12-15 licenses from various authorities
  • Awareness among the public for healthy food may hamper businesses of companies operating in this space offering pizza, burgers, sandwiches
  • Cloud kitchens offering the same type of food will be more profitable than walk-in restaurants as there is no major CAPEX in setting this up versus a fully furnished restaurant
  • Delivery aggregators may charge higher commissions to restaurants which will impact the profitability of the players operating in this space

Final Thoughts

We will have to wait and see at what price/valuation will the shares be offered at by the company. There are two other listed players in this space – Jubliant Foodworks (Domino’s) and Westlife Development (McDonald’s).

Below is a table showing important metrics for listed players


 

Drivers like higher incomes, people eating out more frequently and women joining the workforce will drive the demand for the offerings that companies make in this space. The price at which retail investors can participate in this story will be the decider.


NOTE: There is no other relationship between Capitalmind and the above company. Please do not consider this article as a recommendation, It is purely for information purposes only.