How Fast Food Restaurants Are Dealing With the Cost of Beef

 |  Includes: CMG, MCD, PNRA, WEN, YUM
by: Jefferson Starship

The other day I paid $1.70 for a McDouble at McDonald’s (NYSE:MCD). This struck me as odd since the last time I ordered one it was $1.30 and a few years ago when they were introduced they were only $1. (For those who don’t know, a McDouble is basically the same thing as a double cheeseburger but it only has one slice of cheese.) I thought of the possible reasoning for this and, aside from the fact that I was in a train station and that that might have something to do with it, I concluded that it must at least partly be due to the significant increase in the price of ground beef.

In this same time, the Double Cheeseburger has been removed from the dollar menu at Burger King (BKC) and reset in the mid-$2.00s, a Junior Bacon Cheeseburger at Wendy’s (NASDAQ:WEN) is up about 30%, and Taco Bell (NYSE:YUM) has removed the Chicken Burrito from its dollar menu and set the price at $2.70-ish. (If it’s any consolation, a CrunchWrap Supreme is now only 88 cents, but in my honest opinion it’s awful, and doesn't even include real beef.)

Anyway, have a look at this futures chart for live cattle:

[Click to enlarge]
Click to enlarge
Like the rest of the commodities market, it has been stricken by inflation to the tune of 15%. I do not profess to know enough about global economics to predict when this will end, if ever, but I do know that political unrest in Libya should not have a great effect on American fast food companies. However, I did see Sen. Robert Menendez (D-N.J.) giving Ben Bernanke a really hard time yesterday regarding rising prices of basically everything in the state. This certainly is an issue.

In order to fight this, McDonald’s will be raising prices on select menu items. But if the price of a McDouble or a SnackWrap were to go up 3%, would people even notice? A raise of this nature should go unnoticed by most. Furthermore, people have begun trading down from restaurants to fast foods according to this study. This is another great thing for the industry: More customers are paying slightly more to cover increased input costs.

With this in mind, here are some stocks that may be affected and my general assessment on them.

McDonald’s – This is the largest name in the industry, in terms of market cap, by leaps and bounds. All of this basically goes without saying, but it has strong margins, global dominance, amazing brand recognition, and has been branching out with smoothies and McCafe, as well as (more recently) oatmeal. At $5 off a recent top, it may be a strong pickup, if for nothing else but its dividend growth abilities. Its dividend has been increasing for 33 years and the yield is very tempting here at 3.3%. Its P/E is modest, given it's a Dow stock, and its earnings are expected to keep rising. Some of its recent prosperity may be tied to the purchase of Burger King by 3G Capital.

Wendy’s – I’ve written about Wendy’s in the past; the basic conclusion is that it won’t be able to succeed as a stock until it dumps Arby’s. The company has been losing money on this deal since it was struck, and it’s normally rumors of a sale that move WEN up a little. It does pay a dividend; nothing to write home about at 1.6%. The stock got smacked yesterday (but what didn’t?) and there’s a good chance we’ll see some resistance at $4.50.

Yum Brands – YUM is going to be sponsoring the Kentucky Derby again, so be prepared to see its logo all over the place two months from now. I wrote an article on this last year calling it a buy at $39, and I would argue that it still has room to grow. Taco Bell has been increasing its global presence and has dealt with the beef lawsuit admirably (a full-page ad in the Journal and a new commercial I saw for the first time yesterday). It has a 2% yield and a P/E of 20, which is fine, though I’d prefer to see a higher P/E, meaning the investors have faith in quicker earnings growth. What concerns me with YUM is the threat from Domino’s (NYSE:DPZ) on Pizza Hut, and if any of Cramer’s nonsensical promoting is going to have an effect.

Chipotle Mexican Grill (NYSE:CMG) – This is easily my favorite on the list. Its food is delicious, albeit slightly over-priced, but that's because it is fresh and much healthier than most fast food restaurants. I wrote an article regarding the opening of its 1,000th location. According to Yahoo, it was up to 1,084 as of the end of 2010. What’s interesting about Chipotle is that it owns all of its stores rather than franchising, and this seems to work very well. At first glance, its stock would appear to be overbought, but given its growth prospects (opening new sites) the earnings potential is certainly there. McDonald’s definitely missed the boat when it sold this company a while back.

Panera Bread Company (NASDAQ:PNRA) – This company is similar to Chipotle in its business model of not really being fast food but not really being a traditional restaurant. It took a recent leap in price up to the $120 area but has the earnings to back it up. I just hope it has a way to deal with the cost of wheat and flour. I would also think that as some more re-upping of buy ratings come in from the analysts, the stock will continue to rise.

These five companies should be able to deal with rising commodities costs fairly well, and will hopefully weather the storm of volatility we’ve been driving through this past week or so. If you liked any of this you may find this article from last summer interesting; it covers the entire restaurant industry.

Disclosure: I am long MCD, WEN.