PICK OF THE MONTH

Grand Parade Investments

Will Grand Parade Investments (GPI) lose its flavour in the short term as the costs of rolling out its fledgling Burger King fast food franchise are incurred?

In recent months the share price has drifted down from the 775c high recorded in September last year. That was before CEO Allan Keet admitted at an investor conference in early December last year that the stated target of 100 Burger King outlets by end-June this year would be scaled back to protect operating margins (and presumably moderate the development spend so as not to overburden the balance sheet).

A further complication is that the competition commission has recommended prohibiting a deal in which Tsogo Sun would buy 40% of the GrandWest and Worcester casinos. GPI aided this transaction by selling its significant minority stake in these casinos back to Sun International.

The concerns for investors will revolve mainly around the funding of the Burger King . expansion. At the time of writing GPI had opened 34 Burger King outlets (mainly in Cape Town and Johannesburg with a handful in Durban). This should be considered a fair extension of the brand remembering that when the company reported end-June year-end results in late August there were 18 outlets flipping burgers for long queues of customers. Should this pace continue, GPI would have over 50 Burger King stores opened by the end of this financial year — though management has indicated the minimum number could be closer to 60 outlets.

GPI’s annual report — which was still working on the 100 store plan — noted that the steep roll-out plan for Burger King would incur capital expenditure of around R350m in the financial year ahead.

The question is whether the delay in securing proceeds from the Sun International transaction will hinder the Burger King roll out? Probably not. GPI has already received the proceeds from the sale of its limited payout machine assets to Sun International. These, despite GPI recently declaring a 20c/share dividend, should be sufficient to cover the immediate capital commitments for Burger King.

In a worst case scenario, GPI would retain its stakes in the cash-spinning casinos. Dividend flows are reliable, and GPI could quite easily leverage these holdings to secure longer-term funding for Burger King, which by that time should itself be dishing up solid cash flows.

All things considered the market may be losing its appetite for GPI for all the wrong reasons. The company is one of the few enduring empowerment investment counters on the JSE, and needs to adhere to conservative fiscal management strategies to retain its status (especially among community shareholders) as a reliable dividend payer.

It is highly unlikely directors would agree to gear GPI to the gills and ask shareholders to forego payouts while the Burger King base was built.

With that in mind the decision to rein in the Burger King expansion targets has more to do with protecting the balance sheet, the operating margin and securing future cash flows.

Certainly a key consideration for punters keen to nibble at GPI at current levels is the mature margin that Burger King might attain.

There is unfortunately not much to glean from GPI’s year to end-June results when Burger King generated sales of R127m and an operating loss of R108m.

The annual report noted that food margins were tight, but indicated that by localising the Burger King input, the margins would reset during the 2015 financial year. The bottom line is that Burger king will be in a breakeven position at a store level by the end of 2015.

But more immediate and more importantly will be the margin progress in the upcoming interim results to end-December. Let’s hope GPI will reveal the margins achieved on the handful of older outlets and confirm there’s fat in related central kitchen ventures, giving investors an inkling into whether the company’s stated goal of a 60% margin on Burger King is realistic.

In that regard, Keet’s remarks in December last year are worth noting: “We don’t want to roll out stores while the margin is not right. We are 3% away from the correct margin, and should have the margin right by the end of December. We will get to 56% by the end of December.”

IM is comfortable in recommending GPI as a long-term buy, reassured by the fact that GPI’s recent acquisition of a 10% stake in Spur Corp could pan out into a more compelling partnership.

A key consideration for punters keen to nibble at GPI at current levels is the mature margin that Burger King might attain