This past week I have sifted through charts looking for short ideas to offset some of my long exposure in the volatile markets. I came across some names that I took initial short positions in based on the trading patterns with the intention of reviewing the company’s later for a better fundamental understanding of what drives the stock price. Burger King (BKC) was one of those names.

This weekend I took a closer look at the details and was actually impressed by what I saw. The company is actually a turnaround story after faltering in the early part of this decade. The company makes most of its profit on royalties it receives from franchisees. Back in 2002 and 2003, one of its largest franchisees who ran over 300 stores declared bankruptcy. In February, the company started the Franchisee Financial Restructuring Program (FFRP) and within 6 months it had 2,540 restaurants in the program. BKC has had to write off $106m in uncollectible receivables but now appears to have the company in a much better financial place.

The company is on a fiscal year schedule that ends June 31. The annual earnings release and conference call is scheduled for 8/24. Looking back at their 2006 annual report, there were 11,100 restaurants operating. According to the latest quarterly numbers, the company opened more than 300 stores and expected to add 170 to 190 in Q4. This fits well with the 2007 goal of opening more than 400 stores, but the statistic is somewhat tainted by the fact that many more stores were closed than originally anticipated. As of Q3, management was only guiding for 200-220 net new stores which means over 250 were closed. While closing stores definitely doesn’t sound like a positive movement, it goes along with the company’s goal of increasing average sales per store to $1.3m annually by picking off non-performing stores. This has been a big part of the turnaround story and margin improvement.

Debt was a significant issue for the company when they began as a publicly traded company. Disciplined management of cash-flow, however, has allowed the company to pay down debt to a reasonable level, and the effective rate on remaining debt is 6.7% which is very attractive. This past quarter they announced a $0.0625 quarterly dividend which is a great start, and also mentioned that they may use cash to purchase franchises from franchisees who are unhappy and would like to exit the business. BKC could subsequently sell these franchises to motivated new partners hopefully at a premium, and should recognize better revenues from more involved local management.

One overhanging issue is the fact that 59% of the stock is held by private investors that the company refers to as “Sponsors” At the beginning of the year the sponsors owned 75.9% but they priced a secondary offering of shares in February that reduced their holdings and increased the float in BKC’s shares. It would be normal to expect the investors to periodically offer more stock in secondary offerings until they substantially reduce their position.

So now I have a short position that I wish to get rid of. I’ll probably end up making a small profit and I’m not ready to buy the stock yet as the overall market environment and the stock chart aren’t opportunistic, but BKC will be on my radar list and I anticipate taking a long position at some point this year.

BKC notes

FD: Author has short position in BKC

Additional Reading:

Going Private is concerned the debt load will continue to be a problem

Investopedia compares BKC, WEN, and SONC