Despite fast food's unhealthy reputation, a fast food stock can certainly be a healthy dose of profit for one's portfolio if you find the right company. With over 300,000 fast food units in the United States alone, the U.S. fast food industry is valued in the billions of dollars, with annual sales grossing over $160 billion. Today, the industry's super-normal growth has encouraged major players to embark on a mission to expand their reach across the globe. Yet despite promising growth, the fast food industry faces challenges in the form of rising food costs, worldwide economic recessions and changing perceptions about health. And in the U.S., market saturation is also a relevant issue, forcing companies to shift their focus to the other parts of the globe, such as Asia, South America, and the Middle East. Yet despite these issues, many companies in the fast food industry remain attractive, largely because of their high growth outlooks and large international expansion efforts.
Let's take a peek at three of the biggest players in the industry:
Burger King (BKW)
Founded in 1954, Burger King is the second-largest hamburger chain in the world, with more than 12,000 locations worldwide, and serving an estimated 11 million customers daily in 83 countries. Domestically, Burger King continues to look for options to differentiate itself and provide an advantage over competitors; the company is currently experimenting with home-delivery service in few select cities and is also working on new technology to keep burgers and fries hot and crispy.
Internationally, Burger King is expanding in a variety of markets, including a planned joint venture with South African gaming and leisure group, Grand Parade Investments (GPI), with hopes of expanding its brand presence in high-growth emerging markets. And earlier this year, the company revealed plans to open 1,000 new restaurants in China over the next five to seven years, providing a big boost in growth and helping it keep up with rivals McDonald's (MCD), which currently has more than 1,400 restaurants in the country, and Yum! Brands (YUM), which opened 168 new restaurants in China in its first quarter; currently Burger King has only 63. However, this previous lack of presence and growth in China is likely due to dedicated expansion efforts elsewhere: in the past year, 80 percent of Burger King's new stores have been in Europe, the Middle East and Africa.
As international growth efforts expand and BKW looks for more advantages domestically, the future is looking brighter for the company overall. Last quarter, profits exceeded expectations, and same-restaurant sales rose. After being taken private two years ago, and only returning to public trading in June, these results are much welcomed, and have come on the heels of major changes, including menu updates, such as adding wraps, smoothies, and other items that appeal to a wider demographic.
An analysis of BKW is not complete without looking at key financial ratios for BKW, which are shown below. Right away, a few things stand out. First of all, BKW has the highest P/E of all three companies discussed here, which at above 20 (for both the prior 12 months and projected for the upcoming 12 months) is a warning sign for many people (especially value investors). Also, with little to no dividend, it trails the other two companies discussed in this article. Another glance over these numbers may seem to show that BKW is overpriced; yet it is very possible that these high values simply show a premium that investors are willing to pay for future growth. The takeaway is that BKW is in a good position for the future, and if anything, slightly overvalued as a result.
The world's largest restaurant chain by sales, McDonald's operates approximately 33,500 restaurants, serving approximately 69 million people in 119 countries each day. Recently, most of the company's growth efforts have been concentrated abroad, and international growth has been booming. In Europe, which accounts for 40% of total sales, income and sales have both been increasing, despite the euro crisis and a troubled economy, highlighting the power of a brand that customizes its offering to local tastes in individual countries.
To this point, the beef-centric fast-food chain plans to open vegetarian-only restaurants in India next year, which will be first of its kind from the Burger giant, signaling a growing effort for expansion in India, which is still a relatively small market for McDonald's (only 270 restaurants). As more proof of its concerted growth efforts, McDonald's plans to invest $2.9 billion on capital expenditures in 2012, half of which will be used to open another 1,300 restaurants (concentrated in smaller and emerging markets).
Much of the company's past success can be attributed to its strong business model, with more than 80% its worldwide locations franchised, helping it to expand more quickly. In these situations, McDonald's owns the land and the franchisee pays the company rent, as well as loyalty charges (usually a percentage of sales).
However, despite this strong business model and past success, MCD has seen a variety of concerns recently. Since January, MCD is down about 15%, with 8% of the loss coming since September (it touched a 52-week low earlier in November). And just a few weeks ago, the company posted its first monthly sales decline in nine years. Many of these problems, including the sales decline, are partially due to the fact that MCD is losing customers to major competitors such as BKW and YUM, as well as smaller and different competitors such as Wendy's (WEN) and Domino's (DPZ), all of which are changing menus, expanding rapidly and marketing widely to a more diverse demographic. As a result of these issues, many investors are now choosing to shy away from MCD, instead preferring competitors with better growth outlooks.
Despite these issues, the financials of MCD do not look quite so grim, but are far from perfect. The big thing that pops out right away is the large dividend MCD pays. For years, MCD has been known as a great dividend stock, and it is currently paying a dividend of about 3.5%. Additionally, with a PE of around 15, it is not as high as BKW, but is still above its peers; pair this with its higher P/B and P/CF values, and you could easily argue that the company is overvalued. Yet once again, similar to BKW, these high ratios can be partially justified because of the ongoing growth and future prospects, as people will be willing to pay more for this future growth. However, overall, it appears that BKW may be better poised for future growth, especially given recent earnings and performance.
Yum! Brands (YUM)
Stepping away from the burger giants, Yum Brands operates Kentucky Fried Chicken, Taco Bell, and Pizza Hut, with over 37,000 restaurants in more than 120 countries. And unlike the other two companies discussed, which are expanding throughout the world, much of Yum's recent focus has been on China, as it has been selling assets in America and purchasing new assets in China. In 2011, the company sold its Long John Silvers and A&W Restaurants to franchisees, while in early 2012, it acquired Little Sheep, a restaurant chain in China, with around 450 locations.
As another sign of positive expectations, the company has spent $1.1 billion on share repurchases in the last few years, perhaps showing that the company believes its shares are undervalued. In addition to this, third-quarter profits soared, boosted by strong sales in China, which contributed more than half of Yum's revenue during the period. Also in its third-quarter earnings, YUM announced an increase in same-store sales, along with the 18% increase in worldwide profit and increased margin. On top of this, in September, the company announced an 18% increase in its dividend, which marked the eighth year in a row with a double-digit percentage increase in the dividend.
Likely due to its recent success and profitability, a variety of important ratios and data in the financial data for YUM all point to the stock being overvalued (such as P/CF, P/Sales, PE). Although this may be attributable to growth prospects like the other two companies, YUM seems be overvalued across the board, and at this point, it may be best to wait for a drop in price. However, on a lighter note, YUM rewards its investors with a 1.7% dividend. Forgetting about the high (perhaps too high) values and ratios for YUM, it appears to be the best of the bunch; however, these numbers are important to consider, and may likely cause people to skip out on a potential investment for the time being.
Although each of these companies is a major player in the industry, and each has major expansion plans internationally, there are a variety of things to look out for, many of which surround economic conditions throughout the world. First and foremost is the uncertain economic situation in the U.S.; with the threat of a fiscal cliff, poor fundamentals, and general uncertainty and volatility, companies may be forced to scale back operations and growth, which could lead to issues both domestically and internationally for these companies. In Europe, the ongoing economic crisis may hamper any growth efforts these companies have. And with slowing economies throughout the rest of the world, many emerging markets may be hit hard as well, and with many of these companies' expansion plans coming in these emerging markets, weak local economies could wreak havoc and force plans to be delayed, slowed, or cancelled.
The Health Concern
It is worth briefly mentioning the health issue, which has caused problems for the fast food industry in the past. As people continue to move toward a healthier lifestyle, fast food companies continue to face a variety of criticism and have been forced to rethink their business models (today, each of these companies has begun offering healthier options). In the future, the companies that can best adapt to the changing world and lifestyles will likely be the ones that are best positioned for long-term growth.
All three companies, with increased focus on emerging markets, have solid future growth prospects. Yum's operating profits in China are growing at such a rate that they are doubling every 4-5 years. And with so much effort in China, there is still ample opportunity to expand into India, Europe, and Africa. However, at current prices, YUM may be overvalued. As for McDonald's, it has managed its European operations well despite all the noise about the financial crisis. With a tried and true business model and a high dividend payout, McDonald's is one of the most respected global brands, even despite its current problems.
Burger King seems to be finally turning the corner, with strong profits and healthy financials. Additionally, its international expansion efforts are not quite as robust as McDonald's and Yum's, but its domestic efforts may give it a boost at home. Overall, each of the three companies has pros and cons. In the end, there are pros and cons to each. MCD may be a good bargain moving forward, and with its worldwide brand recognition and presence, it is bound to be around well into the future; BKW seems to be the best option at the moment given current conditions; and YUM is a strong company with good fundamentals and a great outlook, but at current levels, it is the most overvalued of the three.
Business Relationship Disclaimer: This article was written by an analyst at Catalyst Investments.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.