Restaurant Stocks: Gross & Operating Margins

When analyzing gross & operating margins among restaurant chain stocks, it becomes apparent how their different business models affect their margins. As the following chart shows, with the exception of Tim Horton (THI), the rank ordering of operating margins bears little relation to the rank ordering of gross margins:

Data in table version:

		Quarter	Gross	SG&A	Operating
Ticker	Company	Ending	Margin%	Margin%	Margin%

(MCD)McDonald's06/30/0631.9%10.7%20.8%
(PNRA)Panera Bread06/27/0635.8%8.3%10.9%
(RI)Ruby Tuesday06/06/0626.2%7.0%13.0%
(SBUX)Starbucks07/02/0624.0%5.9%10.9%
(THI)Tim Hortons07/02/0639.5%6.8%24.2%
(WEN)Wendy's International07/02/0624.9%7.9%4.5%
(YUM)Yum! Brands06/17/0626.2%12.5%14.2%

If we look at Tim Horton and Starbucks (SBUX), which have the highest and lowest gross margins respectively, we realize that we need to dig a little deeper to see how each company is run.

Almost 97% of Tim Horton restaurants are franchised. This affects the way the company calculates expenses towards gross margins, since store occupancy costs are not included. For the last three fiscal years, THI has had revenues increase 39.9% and operating income increase 47.1%.

Tim Horton (THI) - 12 Months Ending:

($000,000)	12/29/02	12/28/03	01/02/05	01/01/06
Revenue	$1,059.57	$1,171.78	$1,338.27	$1,482.03
Revenue Growth (YOY)		10.6%	14.2%	10.7%
Gross Profit	$484.23	$535.47	$597.07	$578.65
Gross Margin	45.7%	45.7%	44.6%	39.0%
SG&A ($)	$71.85	$80.39	$85.74	$108.96
SG&A (%)	6.8%	6.9%	6.4%	7.4%
Operating Income	$233.31	$278.90	$319.31	$343.15
Operating Inc. Growth (YOY)		19.5%	14.5%	7.5%
Operating Margin	22.0%	23.8%	23.9%	23.2%

Since Starbucks restaurants are primarily company owned, their cost of sales includes (store) occupancy costs (see 10-q). For Starbucks’ last three fiscal years, revenues have increased 93.7% and operating income has increased 148.4%.

Starbucks (SBUX) - 12 Months Ending:

($000,000)	09/29/02	09/28/03	10/03/04	10/02/05
Revenue	$3,288.91	$4,075.52	$5,294.25	$6,369.30
Revenue Growth (YOY)		23.9%	29.9%	20.3%
Gross Profit	$832.15	$1,014.51	$1,312.64	$1,598.18
Gross Margin	25.3%	24.9%	24.8%	25.1%
SG&A ($)	$234.58	$244.55	$304.29	$357.11
SG&A (%)	7.1%	6.0%	5.7%	5.6%
Operating Income	$314.23	$420.85	$606.59	$780.62
Operating Inc. Growth (YOY)		33.9%	44.1%	28.7%
Operating Margin	9.6%	10.3%	11.5%	12.3%

Starbuck’s stock has performed impressively over the last 36 months, driven by its revenue and earnings growth. Tim Horton is being spun off by Wendy’s (WEN) this year (the remaining portion at the end of this month). It will be interesting to watch how these stocks perform going forward, given their different strengths (margins vs. growth).

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