- Drive-thru restaurants have thrived in the U.S. since first coming to fruition over 60 years ago.
- Income investors should look at drive-thru restaurant chains for long-term dividend growth options.
- When investing in industries that you support financially, it often pays to invest in companies you find best-of-class as voted by your personal pocketbook, however, not always.
- As a consumer, I can relate to 14 drive-thru options, of which half are public companies.
- The best-of-breed drive-thru that I want to own is Starbucks Corporation, however, the valuation is a bit pricey today for income investors.
The exact date of the first drive-thru restaurant occurred in the U.S. just after WWII. Two initial chains that used the concept in California, In-n-Out (privately-owned) and Jack in the Box (NASDAQ:JACK), claim to have first implemented the concept successfully in 1948 and 1951, respectively.
While both of these chains have no doubt mastered the experience with ~75 years of experience each, what most people don't realize is that the first McDonald's (NYSE:MCD) drive-thru wasn't established until 1975 in Arizona.
In terms of company growth, however, MCD wins hands-down versus In-n-Out and JACK, as the company is a ~$95 billion Dow Jones Industrial Composite blue-chip that holds over 35k global locations, while JACK is valued at ~$2.6 billion, with less than 3k total restaurant locations.
MCD is also an income investor favorite. As a dividend growth stock, the company has consistently raised the dividend for 38 consecutive years, has a 5-year dividend compound annual growth rate of 10.13% and currently yields 3.35% on a $96.60 share price.
So the question remains, is the quick-serve restaurant "drive-thru" window an income investment opportunity? Is there dividend growth available here as the concept has matured?
Is The Drive-Thru Window Your Ticket To Income Growth?
Income investors are well-diversified into several asset categories to reduce risk while maintaining both income and growth prospects. For the stocks portion of the portfolio, income-oriented investors like dividend growth stocks, as they raise payouts over time, thus helping the portfolio target distributions increase beyond the rate of inflation.
With MCD, a solid blue-chip with respectable earnings and continual growth, many income investors choose the stock wisely. Other investors may take a more biased approach, considering stocks in this category that they enjoy supporting as much as they enjoy owning.
When looking into a category that individual names may be wonderful to own, for dividend growth reasons of course, picking favorites can be one of the keys to success. After all, if you enjoy spending money there, so do others. Not only that, it feels good to support companies you own, just ask any utility investor that owns stock in his/her utility company.
Investors must be careful, however, as valuations, dividend growth history and company outlook must be taken into consideration. Let's take Target Corp. (NYSE:TGT) and Wal-Mart Stores, Inc. (NYSE:WMT) as a personal example.
Where I live in San Diego, there are two Target stores within a three-mile radius. Both are convenient, have items I like and work out to be a very enjoyable experience.
Wal-Mart, on the other hand, is a 20-minute drive and is not located near any other businesses I frequent. In other words, Wal-Mart is a "mission," while Target is an "errand" that just fits into the day by location.
On top of location, Target wins me over on quality on several fronts. Although I always love the Wal-Mart greeter, as well as the large sports and auto departments, Target wins me over on quality on several fronts.
The quality of goods sold, quality of shoppers, quality of store (floors, lighting, stocking, cleanliness, overall ambience) and quality of the grocery department (TGT house brands are awesome, WMT's look cheaper like from a food-drive) are hands-down better at Target.
Clearly, I love Target over Wal-Mart for personal reasons, however, for investment reasons, I have favored Wal-Mart heavily. Both appear to be great stocks, however, TGT is losing big on the international front versus WMT, and from what I've seen in other states, the WMT store I've been to in San Diego, CA, where I live, is an anomaly for its below-standard quality.
In Kauai, HI, for example, WMT is a staple that has excellent standards for quality and is an absolute zoo in terms of popularity. Also, Kauai has no alternative option for many goods sold at WMT, which gives them a location monopoly that I'm sure they observe elsewhere as well.
While Target has been a better dividend growth investment over the last 10 years,
Wal-Mart outperformed TGT in terms of share price performance last year. TGT declined on weak international growth, while WMT promoted their international leader, Doug McMillon, as the new CEO in February 2014.
Also to note, TGT fell heavily last summer, results are intensified using the past 1-year return.
Let's Meat The Drive-Thru Contenders (pun intended)
While the drive-thru restaurant concept did start with a meat-driven convenience, evolution has brought on new contenders to the drive-thru arena, such as coffee with Starbucks Corporation (NASDAQ:SBUX) and donuts with Krispy Kreme Doughnuts Inc. (NYSE:KKD).
From my experience living in San Diego, Oregon and Georgia, as well as travels to Hawaii, Palm Springs, Los Angeles/Orange County and Key West, here are the 14 drive-thru restaurants I've been to and have something to say about.
To make the list, the companies must have multiple locations. One of the coolest drive-thrus I've been to is The Varsity in Atlanta, GA, however, they are not a large chain. Also, I've never been to Sonic (NASDAQ:SONC), so they've been left out as well. Currently, SONC only has 1 location in San Diego, which is about a 30-minute drive inland from the beach community I reside in.
The rankings are a proprietary ranking system for my personal taste. In this investment philosophy, I start with companies I personally support in the genre as the top priority, such that companies I don't have a taste for don't qualify for additional investment research.
Using the A-F grading system, where 90 = A, 80 = B, etc..., Starbucks clearly comes out on top with an A++ score of 133. Bringing up the rear is Arby's, which has a location within five miles of where I've lived for 30 years. Arby's scored a zero, as I've only been there about twice in my life and haven't had any interest in returning.
1. Starbucks Corporation
In my opinion, Starbucks has become the greatest drive-thru corporation in America today. I first tried the frappuccino in high school during the mid-1990s. A friend of a friend worked there, and we went once to hang out and get hooked up for free.
I never thought of the company as an investment back then, however, I got hooked on the caramel frappuccino in 2002 while in college and working for the now-defunct retailer Circuit City. The drinks were about three bucks and a great way to start my sales day. Not to mention the whipped cream and caramel on top of the caramel frappuccino was like Christmas in a cup - a Christmas I could afford on a daily basis.
As Starbucks grew, they became aware of the importance of food sales, which has helped increase sales and win over more customer dollars from consumers such as myself.
Today, Starbucks has an assortment of health-conscious food to-go, along with their indulgent line of pastries. Healthy items such as an egg-spinach-feta wrap for breakfast and egg salad sandwich on whole wheat do the trick for me.
As the dominant domestic provider of coffee-related products to caffeine-addicted customers and a respected provider in the food category, the Starbucks drive-thru experience now fulfills two major categories of desire: the pick-me-up caffeine rush and the need for food.
As Starbucks evolves, they are also aware of the heath-conscious consumers. The skinny latte, for example, is a twist on the popular steamed-milk and espresso drink that comes with an optional flavor such as vanilla.
As opposed to the normal latte, the skinny latte uses non-fat milk, and if the customer asks for a flavor, they get sugar-free flavors. In other words, reduced sugar and fat content is a normal, advertised option. Instead of ordering a "non-fat, sugar-free tall vanilla latte," customers can now order a "tall skinny vanilla latte." With in-store advertising and menu inclusion, other health-conscious consumers that didn't know "skinny" was an option also are now aware and as such, SBUX gains customer loyalty for their excellent menu evolution.
While staying true to the health movement, Starbucks also is on top of their indulgence category, which of course, is a natural fit for a coffee shop menu.
For example, when cake-pops became popular, which are like lollipops but with cake and a hardened frosting coating, the company issued a few flavors and encouraged customers to try them. They became a hit, and instead of becoming big grocery store hits, they became a Starbucks hit. The local Starbucks locations in San Diego and Palm Springs all carry cake pops to this day, however, the local grocery store bakeries rarely sell them, and when they do, customers usually don't have the option of buying just one.
Starbucks Cake Pop Ad
Currently, I go to Starbucks just about every other day, their customer service is top-class and the quality of every item I buy there could not be better.
2. Taco Bell - YUM! Brands, Inc. (NYSE:YUM)
Although I only frequent Taco Bell about one time per month, I do enjoy the food. The reason I don't go there often is because there are real Mexican food options in San Diego, such as taco shops that make locally-in-demand options, such as large burritos, fish tacos, rolled tacos with guacamole, enchiladas and, of course, plates that come with beans and Spanish rice.
When I leave San Diego, there are generally fewer Mexican food options the further I travel. In Oregon, for example, finding good Mexican food is nearly impossible and there is no such thing as a "taco shop." With this truism spread across America and the world, I can imagine how important Taco Bell is to satisfy that particular food craving.
The quality of Taco Bell food, for what it is (very small items, no fish tacos, etc..), strikes me as high-quality. The menu evolution is excellent, as well. I still remember the new double-decker taco when it came out, as the commercial with Shaquille O'Neil made it look very tasty. Of course, it's been a menu staple ever since.
Another great stroke of genius in company history was the recent replacement of the small hot sauce packets with larger packets. Rather than open a new packet with every bite of a menu item, now one packet seems to be fit for an entire taco or burrito.
To top the great menu off, Taco Bell serves Mountain Dew. I rarely drink Mountain Dew, however, the mix of that soda and Taco Bell food just happens to be simply amazing.
Also, I like to go to Taco Bell because I can count on their A+ service The workers are very fast and are known to get the order correct. As many know, when a drive-thru order is incorrect, it's usually tough luck, as nobody wants to drive back, let alone go inside to rectify a mistake.
For thirsty folks, Taco Bell drive-thru employees are a dream come true. Rather than make you wait for your drink, their standard policy is to hand you your drink when you give them your payment. Before you get change or a credit card receipt, boom -- you have a drink in your hand. Now that's customer service.
Taco Bell scores a 10 on both food quality and customer service, however, since I only go there about once a month, the total score, using my proprietary grading system, is a 71, or C-. If I lived outside of the Mexican-food zone, where no taco shops or good Mexican restaurants were available, I'm sure I would eat there much more often.
3. Carl's Jr., Privately-Owned
I'm a fan of the Carl's Jr. commercials, and the burgers are pretty good as well. My top choice there is the Santa Fe chicken sandwich, however, which is probably the best fast food option-in-a-bun I've ever tasted.
The service is good, as well, however, they are a little slow. It seems that the drive-thru usually takes too long, and when I go inside, it seems that the employees aren't too quick to get the line moving.
4.-14. The Other 11 Options
The bottom 11 drive-thrus all scored below 50 points and are not suitable, for me personally, as investment options. Not only do I want a great financial investment, I want to know that they are good enough that I value them highly as a customer.
Wendy's (NASDAQ:WEN) comes in at number 4, as they score high on quality and fair on service. I do like the burgers, however, there are just better options out there for my taste buds. I do like that they serve Coca-Cola however, as when a restaurant serves Pepsi with their burgers I'm always disappointed.
In-N-Out comes in at number 5, however, they are privately-owned.
San Diego-based Jack in the Box Inc. comes in 6th place, with high marks on service, but infrequent visits and just "okay" food quality.
I have to hand it to JACK for the excellent advertising they do, which is both catchy and fun. The problem is that they do not evolve their menu appropriately, as new options all seem to be aimed at people who are not concerned with high-cholesterol and/or concerned with the risk of a stroke.
As you can see from the new "Bacon Insider" burger, JACK seems to be serving up heart attacks on a plate. Note the nutritional values as well, with nearly 400 fat calories and 1,400 mgs. of sodium (2,300 U.S. FDA recommended max. daily intake, 1,500 for those 40+, African American or those with hypertension).
Also, I don't like the burgers, except for their Jumbo Jack, as it seems there is something off with their seasoning. On the bright side, I love JACKs curly fries. For this reason I do frequent JACK more often than Carl's Jr., even though Carl's Jr. wins hands-down on the burger/sandwich front. JACK also serves Coke, which in combination with their curly fries is quite the treat.
Bringing up the rear and scoring 35 or less points are Rubio's (private), KFC, Del Taco (private), KKD, Chick-Fil-A (private), MCD, Burger King (NYSE:BKW) and Arby's (private/WEN).
One note here is a particularly disturbing low score from McDonald's, the leading fast food concept in the world. I feel MCD may be a great investment for many people, however, I just don't go there. I don't like the food, I am afraid to try their SBUX-style coffee drinks and only go there once a year when I go to a Wal-Mart store and feel like a $1 chicken sandwich they serve in the store MCD kiosk.
Furthermore, I do not agree with the leadership at MCD. Just last year, in response to a 9-year old girl questioning the company's marketing practices to children, CEO Don Thompson stated "First off, we don't sell junk food, Hanna."
For me, if the MCD CEO (who has a $12 MM+ pay package) does not understand the fact that burgers, fries and soda are categorized as "junk food" and that "junk food" is MCD's leading platform, how can I trust his judgment as a leader? Simply stated, I cannot.
In conclusion, I do remember that I prefer WMT to TGT as an investor, however, as a San Diego consumer, I vote my dollar to TGT. In respect to MCD, however, the lack of confidence in the CEO and poor menu evolution that I just can't follow just makes it an unwise "personal" investment decision.
For me to invest in MCD, I'd need a new CEO and some long-term menu items that I could really enjoy. For other income investors, however, MCD may be a great investment.
For those considering MCD as an investment, please read "A No-Brainer Dividend Growth Investment," published January 21, 2014 by Larry Smith.
Rating The Leaders: Starbucks vs. YUM! Brands
As Starbucks rates an A+ and YUM's Taco Bell rates a C-, they are the only drive-thru contenders I could personally invest in.
As an investor, it is important to believe in what you own, as long as the fundamentals make sense (of course, keeping in mind the TGT versus WMT example).
If you love Nordstrom (NYSE:JWN) and never shop at J.C. Penny (NYSE:JCP) or Sears (NASDAQ:SHLD), for example, then there is a likelihood that many others feel the same way and as such, JCP and SHLD could be poor investment decisions before fundamentals are even considered.
Investors must keep in mind that this theory does not always prove correct however, as great companies could always have fundamental problems that translate into poor share price performance.
For those who are on the same page as I am, SBUX is really the only contender, as a YUM C- does not really make my heart sing, especially when I love and support SBUX so heavily.
The Benefits Of Owning Starbucks
While it is always painful to buy a stock that is up 500%+ over the past 5-year period, investors must remember that there is a chance the stock is up higher than the market average for a reason.
Starbucks is evolving as a company should, with excellent management, that translates into an example of capitalism at its finest.
In terms of valuation, SBUX is rated 4/5 stars (BUY rating) from S&P Capital IQ, with a 1-year price target of $91 (18.2% upside to current pricing). The stock is valued at $76.96, which is 27.19x S&P's 2014 EPS estimate of $2.83/share. S&P's 3-year EPS growth rate estimate for SBUX is 15%, with a 2015 EPS estimate of $3.11 per share (9.9% YOY growth).
The company also gives out $1.04/share in dividends per year, which equates to a 36.7% 2014 payout ratio and 1.4% yield.
While SBUX has upside potential, as noted from S&P Capital IQ, the shares are just seem too expensive to be an astute income investment. I look at safe, stable dividend growth stocks with a margin of safety for income investments.
While the SBUX 4-year dividend compound annual growth rate is 30%, which is very impressive, and the dividend appears very safe with a low payout ratio (36.7%), the shares don't seem to offer any margin of safety.
With a P/E of 27.19, the earnings yield is 3.68%, which is a 90-basis point premium to the 10-year treasury bond - very small considering the equity risk involved. For example, WMT's EY is 7.12% and MCD's EY is 6.1%, which translates into 434 and 332-basis point risk premiums, respectively (albeit at a slower EPS growth rate).
In looking at the PEG ratio, SBUX is overvalued with a PEG of 1.81 (although much lower than MCD's at 2.34). In looking at the SBUX EYG root, the stock is valued at 7.42, which suggests a fair valuation (i.e. no margin of safety).
Conclusion & SBUX Price Target
While the drive-thru concept is nearly 70 years old and working well in America, there is only one great company to my personal taste, which is Starbucks Corporation. As the shares are valued with a 2014 earnings yield of 3.68%, the price just seems expensive for a company with a 3-year growth rate of 15%.
As such, I'd wait for better valuation prospects in looking at SBUX as a safe, stable dividend growth stock. Other companies such as McDonald's may be suitable for income investors, however investors are advised to first look to places they already support financially and on a regular basis.
For SBUX, with a 15% short-term growth rate and a 2014 EPS estimate of $2.83/share, I'd suggest a price target with an earnings yield of 5% (20x 2014 EPS), which equates to an EYG root of 8.7 and a market price of $56.60/share (-26.5% from current pricing). At $56.60, the shares would yield 1.83%, which isn't bad considering the company's 30% historical dividend compound annual growth rate.
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