When Will Franchisors Release Same Store Profits instead of Same Store Sales?

Last July 2014, Bloomberg Businessweek had a detailed cover story about Burger King's (NYSE:BKW) leadership.

It's not much of a useful analytical piece. The piece did not move the market, the Bloomberg editorial standard. Deep analytics must not sell anymore in our time-starved span of attention. The piece is Wall Street personality and issue focused.

Franchised Restaurant companies require a lot more investor due diligence, on both the equity and bond investor side, and on the franchisee side. And I want to talk about that.

First, franchisors don't release their franchisee financials results other than same store sales. 100% franchisors like DineEquity (NYSE:DIN), Burger King and Tim Hortons (NYSE:THI) don't release a single franchise operations number.

Popeyes (NASDAQ:PLKI) alone of the publicly traded group releases franchisee EBITDAR - EBITDA less rent.

Some limited clues may be possible from the 10Q/10K statements and the franchisors' Franchise Disclosure Document that details unit opens/closes.

The 10Qs/10Ks don't detail why units open or close, but the FDD broadly classifies closings into categories.

The same store sales metric is more visible.

But to focus in isolation as Businessweek tried (Burger King's same store sales exceeded McDonald's) is flawed: a .5% same store sales gain on a $2.7 million sales base yields a much more healthy picture than 2.0% on $1.0M store AUV base.

Actually, both comps and unit opens/closings need to be examined together, it's very possible to open a lot of stores but realize negative same store sales trends (Five Guys, Smashburger are best recent examples, experiencing both conditions).

Positive same store sales are nice, but are they profitable sales (might not be if discounting is involved) and are they high enough (restaurants need about 2% growth per year typically to cover inflation).

Bad debt expense, the value of franchise royalties not paid to the franchisor and eventually aged and reported, is also a poor, lagging metric. Once bad debt expense is posted, it's really late in the business cycle, the franchise model problem is very intense, the horse is out of the barn.

Franchisees don't talk much - they are afraid to and told not to, and are constrained from communicating via franchise agreements. More research and due diligence is needed. Consider the 3G Capital and Fortress experience, their astoundingly bad 2012 Quiznos investment ($350 million investor group loss and counting).

Getting franchisee EBITDA is great (it is possible, but you have to dig and hire the right people) but it's only half of the story. Restaurants are capital expenditure (CAPEX) intense and some measure of after tax, after debt service, after loan amortization economic gain or loss number is needed.

As usual, business analysis is not what you read on the cuff - it's not what you expect, it's what you inspect.

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