Despite a rollercoaster ride in the stock market and uncertainty in the overall strength of the global economic recovery, some fast food stocks and exchange traded funds that hold them remain attractive.
First off, as long as the unemployment rate remains north of 9% and employers remain cautious about hiring, consumers will continue to seek discount alternatives, and when it comes to eating, fast food joints will likely be the benefactors of this trend.
One such fast food chain positioned to reap the benefits of consumer’s penny pinching is McDonald's (NYSE:MCD). The Oak Brook, Illinois-based fast food giant’s emphasis on value contributed to the burger chain reporting double-digit percentage growth in first-quarter revenue and earnings [see call transcript], highlighted by robust sales returning to the U.S. In the U.S., earnings rose 11% and revenue increased 10%. Similar trends were seen internationally, as McDonald’s global same-store sales rose 4.2%, with the Asia/Pacific, Middle East and Africa segment gaining 5.7% and Europe increasing by 5.2%.
To further highlight McDonald’s attractiveness, a benign commodity environment will help keep costs low and mitigate any need for near term future price hikes of goods offered. Additionally, McDonald’s utilizes various purchasing mechanisms to keep costs down and predictable, giving them a competitive advantage over competitors. Last, from a technical standpoint, McDonald's has outperformed the S&P 500 by nearly 10% and is trading well above its 200 day moving average. As for the future, the company will likely continue to outperform as it continues to focus on its dollar menu items and plans to expand its higher end price items by adding frappes and smoothies to its already successful Angus burgers and premium chicken sandwiches.
Another notable mention is the world’s largest fast food operator, Yum! Brands (NYSE:YUM), which owns and operates Taco Bell, Pizza Hut, KFC, A&W Root Beer and Long John Silver’s seafood. Overall, Yum boasts more than 37,000 outlets and operates in nearly 110 different countries. In the first quarter of 2010, Yum witnessed an 11% increase in revenues and strong growth internationally. In China, the company grew by 23% and continued expanding its presence in the fastest-growing consumer market around the globe. From a technical perspective, Yum is relatively cheap trading around 14.7 times earnings and is well above its 200 day moving average, both enhancing its attractiveness.
The last worthy mention in the sector is coffee giant Starbucks (NASDAQ:SBUX). Most recently the company reported profits of $151.5 million on cost cutting measures. The Seattle, Washington-based company exited nearly $60 million worth of corporate leases which were highly unproductive and focused on finding in-store efficiencies like new ways to steam milk that reduce the amount that’s thrown away, and better ways to load pastry cases so that less labor is required. From a technical perspective, Starbucks is above its 200 day moving average and is trading at about 12.5 times positive cash flow. What further makes Starbucks attractive is that there's plenty of market share available to gobble up. Despite having a presence in over 50 countries, the coffee house only constitutes about 1% of all coffee consumption outside of North America and less than 10% in North America. For Starbucks, its cost cutting moves will likely to continue to enhance its bottom line, but could potentially face headwinds when it comes to revenue growth due to instable consumer discretionary spending.
Four ways to gain one-stop exposure to all three of these companies include the following:
- PowerShares Dynamic Food & Beverage (NYSEARCA:PBJ), which allocates 16% of its assets to McDonald's, Starbucks and Yum, collectively. PBJ closed at $15.73 on Friday.
- PowerShares Dynamic Leisure & Entertainment (NYSEARCA:PEJ), which allocates 5.56% of its assets to Yum, 5.18% to Starbucks and 4.8% to McDonald's. PEJ closed at $14.78 on Friday.
- Vanguard Consumer Discretionary ETF (NYSEARCA:VCR), which allocates McDonald's as its top holding, in addition to holding Yum and Starbucks. VCR closed at $49.20 on Friday.
- Consumer Discret Select Sector SPDR (NYSEARCA:XLY), which boasts McDonald’s as its top holding and allocates a small percentage of its assets to Yum and Starbucks. XLY closed at $30.81 on Friday.
At the end of the day, the overall outlook for the consumer is starting to look a little better, but spending levels will not return to pre-recession levels until the unemployment rate continuously improves, paving the road to prosperity for the aforementioned.
When investing in these equities it is equally important to consider the inherent risks involved. To help mitigate these risks and preserve returns, the use of an exit strategy which identifies specific price points at which an upward trend could come to an end is important.
According to the latest data, these price points are as follows: PBJ at $15.03; PEJ at $14.07; VCR at $48.36; XLY at $30.35.
Disclosure: Long PBJ