It's a dog-eat-dog world in the fast food industry.
On the one hand, negative economic factors such as high unemployment, stagnant wage growth, and higher food and fuel costs limit the discretionary income consumers have to spend on an $8-$10 meal of a chicken sandwich, french fries and large soda.
On the other hand, those who still have a little money to spend are opting for the value that fast-food giants like McDonald's (NYSE:MCD), YUM! Brands (NYSE:YUM) and Burger King (BKW) can offer. And having the economies of scale that come with their large sizes and expanded presence, they can offer less expensive meals without hurting their bottom lines too much. So while the industry as a whole may be in decline, its largest players are doing just fine.
The PR Battle
Fast food companies seem to always be plagued by negative public relations headlines. A decade ago, mad cow disease threatened McDonald's business. Most recently, a scandal over antibiotics in chicken in China has adversely affected Yum Brands business there, while reports of horsemeat in the beef supply in the United Kingdom have put Yum and McDonald's in a negative light.
Then there is the ongoing debate about how much responsibility fast food companies bear for the obesity epidemic. But attempts to make their menus healthier largely strike out with chains, but its core customers still want the Big Mac and french fries, fat grams and calories be damned.
The trend toward healthier eating may be partly responsible for a slight decline in fast food consumption. According to a recent Bloomberg report, the Centers for Disease Control found that U.S. adults consumed an average of 11.3% of their calories from fast food between 2007 and 2010, down from 12.8% in the 2003 to 2006 period.
But the trend, which also took place during the heart of the 2008-09 financial crisis, hasn't adversely impacted the value of fast food purveyors. Shares of McDonald's nearly doubled from the beginning of 2007 through 2010, and a total of 158% since January 2007.
Since Burger King went public in June of 2012, its stock has climbed 17 percent.
Yum Brands, which owns Pizza Hut along with other chains such as KFC and Taco Bell, saw an 81 percent increase from 2007 through 2010. Since 2010, the firm's stock has climbed 150 percent.
A key measure used in chain restaurants and retail is growth in same-store sales. This measures how much sales increased or decreased in stores that were operating in the previous measuring period until now. Anemic growth or decline is a signal that demand is slowing, or that the chain in question has overextended itself and is essentially cannibalizing its own business.
This is an area where McDonald's has shown weak results lately. Global same-store sales grew only 0.1% in the fourth quarter, with a 0.3% increase in the U.S., a 1.7% decline in Asia and a 0.3% drop in Europe. The trend looks to continue for McDonald's. January same store sales fell 1.9% globally, and the company warned that February's numbers would drop about 3% compared with last year.
During the same period, rival Burger King grew its global sale-store sales 2.7%, with 3.7% growth in the U.S.
Yum Brands' 2012 same-store sales for the full year grew 4% in China, 3% for its Yum Restaurants International and 5% in the U.S.
Wendy's (NASDAQ:WEN) North American restaurants had same-store sales decrease 0.2% for the fourth quarter and increase 1.6% for the full year. It anticipates average same-store sales growth of 2% to 3% in 2013.
The fast food market continues to become more fragmented. The traditional hamburger establishments are being slowly overtaken by healthier options like Subway and fast casual restaurants like Chipotle (NYSE:CMG), Cosi (NASDAQ:COSI), and Panera (NASDAQ:PNRA), which combine the convenience of fast food restaurants with the quality of casual dining.
But positive signs also abound. In January, the National Restaurant Association reported that its Performance Index rose to its highest level in five months, driven by a more optimistic outlook among restaurant operators. The RPI -- a monthly composite index that tracks the health of and outlook for the U.S. restaurant industry -- stood at 100.6 in January, up 1.0 percent from December and its highest level since August 2012. In addition, January represented the first time in four months that the RPI rose above 100, which signifies expansion in the index of key industry indicators.
To gain exposure to this industry without having to pick winners, some investors opt for exchange traded funds (ETFs). Some that invest in the fast food industry include:
PowerShares Dynamic Leisure & Entertainment (NYSEARCA:PEJ). This ETF currently trades around $25 a share. It has a year-to-date return of 7.64%, a one-year return of 26.76%, a three-year return of 24.04% and a five-year return of 11.09%.
This ETF focuses on firms in the broad leisure and entertainment space, zeroing in on media, restaurants, and hotels, among others. Among its current top 10 holdings are fast food companies Yum Brands and Krispy Kreme.
PEJ holds 30 stocks, but no one company accounts for more than 6% of its total assets.
Consumer Discretionary Select Sector SPDR (NYSEARCA:XLY). This fund trades just under $51 a share. It has a year-to-date return of 5.67%, a one-year return of 23.34%, a three-year return of 22.02% and a five-year return of 12.17%. McDonald's is the fund's fourth-largest holding, accounting for 6.24% of its assets.
Vanguard Consumer Discretionary ETF (NYSEARCA:VCR). This ETF currently trades at $81 a share, with a price-to-earnings ratio of 15. It has a year-to-date return of 6.05%, a one-year return of 24.11%, a three-year return of 22.41% and a five-year return of 12.03%. McDonald's is the fund's third-largest holding, accounting for 4.58% of its assets.
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Business relationship disclosure: This article was written by an analyst at Catalyst Investments.