Weak sales at Burger King coming out of the pandemic, coupled with historically high inflation and rising demand for delivery—which comes with its associated fees—have taken a massive toll on the profit margins for the brand’s franchisees.
That is according to bond rating agencies that have either downgraded the credit ratings for some of the brand’s biggest operators or gave them a negative outlook.
On Tuesday, for instance, Fitch Ratings lowered the bond rating for GPS Hospitality, the 400-unit franchisee that is Burger King’s third-largest operator. Last week, the ratings agency Standard & Poor’s (S&P) gave GPS a negative outlook, though it reaffirmed the company’s rating.
“Burger King’s U.S. systemwide [same-store sales] compared to pre-pandemic have been flat to negative since early in the pandemic as Burger King tried but failed to replicate McDonald’s success with offerings such as the chicken sandwich and celebrity meals and as the company has struggled to transition from paper coupons to digital promotions,” Fitch wrote in its downgrade.
GPS’s EBITDA margins, or earnings before interest, taxes, depreciation and amortization, have declined to 4.5% in the first quarter of this year from 7% in 2020, according to Fitch. GPS’s sales declined 4.2% in the first quarter, according to S&P.
GPS isn’t the only one. Standard & Poor’s downgraded Carrols Restaurant Group, Burger King’s largest franchisee, largely citing the same issues—weak sales coupled with rising costs.
The downgrades highlight the mounting challenges among operators at brands whose sales have been unable to keep pace coming out of the pandemic.
Burger King’s same-store sales have lagged its competitors for years, including the first quarter, when McDonald’s same-store sales rose 3.5% compared with a 0.5% decline for the Miami-based chain. But its struggles since the pandemic have stood out in an era in which consumers gravitated toward drive-thru concepts.
Burger King’s U.S. system sales at the chain have declined 1.7% since 2019. By comparison, rival McDonald’s sales were 14% higher in the U.S. last year than they were in 2019, and numbers were similar or better for other quick-service burger chains. Indeed, the 10 largest fast-food burger chains in that sector have averaged 16% growth since 2019. And only Burger King’s sales were down.
Burger chain system sales 2019-2021
Source: Technomic Top 500 Chain Restaurant Report
The timing for this underperformance has been bad. Companies have had to pay soaring rates for wages and for food, which has hit profitability hard. Carrols’ adjusted EBITDA margin was just 1% in the first quarter and the company reported a net loss of $21.3 million.
“Even if inflation moderates in the back half of this year, we’re likely to feel its impact on our cost structure for some time,” CEO Paolo Pena said last month. The company announced a series of strategies to reduce costs and improve profitability without relying solely on price increases.
Carrols historically has performed better than the Burger King system as a whole. Its financial problems this year have raised questions about the broader system performance. GPS’s sales have lagged for several quarters, according to ratings agencies, which cited labor challenges and weather problems.
Burger King’s broader sales problems have stemmed from a series of failed efforts. It put a lot of money behind its chicken sandwich, which badly underperformed similar sandwiches released by rival McDonald’s and KFC, not to mention its sister chain Popeyes. But the company’s move from paper coupons to digital also caused disruptions and its shift away from its traditional heavy reliance on discounts might have turned away customers.
The company has overhauled management, focusing both on operations improvements as well as marketing. It is also working with franchisees on profit improving initiatives. Yet, Fitch Ratings noted, such efforts could take time.
“Fitch expects it could take at least several more quarters before its franchisees like GPS can deliver meaningful improvement,” it said.
It’s also worth noting that Fitch doesn’t simply place the blame for rising costs on labor and food. It also cites growing demand for delivery, which comes with a hefty fee. “Delivery costs have also weighed on margins given high fees and accelerated consumer demand of the service, prompted by the pandemic,” Fitch said.