As the holiday season ramps up to full speed, Americans are opening up their wallets. Malls are full, restaurant parking lots are full and just yesterday we got the latest batch of good economic news. One sector we think warrants attention in 2012 is the restaurant sector which ebbs and flows with the economy.
McDonald's (MCD) is a company everyone has heard of, and many own or have exposure to due to their inclusion in the Dow Jones Industrial Average. The company’s value menu, along with their laser focus on clean, modern stores paired with above average customer service have combined to turned this once lost company around. The company has been on a tear the past few years, and should be positioned to benefit from an economy turning around. Investors should not view a strong economy as an impediment to continued success at McDonald's, but rather the company’s chance to increase revenues due to an expanding overall food services “pie” due to their selection on the menu. We previously highlighted the company in an article here on Seeking Alpha when the shares were trading at $87.20, and even after having risen to a close Tuesday at $98.82 we see further upside potential. The company consistently raises its dividend, something which has not changed, to maintain a respectable yield and reward long-term shareholders and income investors.
For 2011 there is not much to say about Darden Restaurants (DRI), the year was a real disappointment. Food inflation, uncertain economic times and an inability to execute have most investors more than willing to forget about 2011 and move onto 2012. It is our belief that the US economy will crank up in 2012, and with better economic times, US restaurant goers will increase their frequency of visits to restaurants and move up the food chain so-to-speak (from Captain D’s to Red Lobster, and Fazoli’s to Olive Garden to give a few quick examples). Darden, the world’s largest full-service restaurant chain and owner of brands such as Red Lobster, Olive Garden and Longhorn Steakhouse, is a great way to play a pick-up in dining out more, due to the portfolio of restaurants they hold. The company continues to build new units and replace aging ones, which leads to increased business at these stores. Darden trades at a lower P/E multiple than many of its peers, which leaves room for an increase in share price should the story around the company change in the quarters ahead. Until then, the company pays a respectable 3.9% yield, only a 41% payout ratio currently indicating that the payout is safe while management manufactures the turnaround we expect in 2012.
Yum! Brands (YUM) should be on every income investor’s radar. The company has been a poster child for how to return cash to shareholders. Since Q3 of 2004, when the company initiated a $0.05/share dividend, Yum! has raised the dividend rate 7x – each time by 10% or more and once they actually doubled the dividend. The dividend currently yields 2% with the current rate of $1.14/share. Over about the same time span, the company has bought back roughly $6.75 billion in shares at an average price of $30/share. Of importance for investors is the fact that due to these buybacks Yum! has taken the average diluted shares from 611 million outstanding to 481 million. The business itself is performing well, having grown at a double digit clip over the past decade, and plans to continue to increase their brands’ international presence. We like the company’s strategy of shedding company owned stores in markets which are suitable for franchising and Yum! itself owning stores mostly in international markets; taking control of their own destiny, especially considering the company is located in over 115 countries. Yum! is more a play on world growth than US, however still a great way to play restaurants over the next year, as the company opens more stores in China to further penetrate that large market.
DineEquity (DIN) is another intriguing play. The company is freeing up capital by selling company owned restaurant units to franchisees. This is mostly taking place on the Applebee’s side of the business as IHOP is already 99% franchisee operated. The company has been undergoing serious changes, including changing the look of the Applebee’s chain, the aforementioned refranchising of company owned units and an added emphasis on higher margins at company owned Applebee’s restaurants. Both brands are #1 in their respective categories, and the Applebee’s brand-wide same restaurant sales growth appears to have reversed from its recent troubles. DineEquity is a play on a rebound in the US economy as well as a deleveraging story. As the company sheds its company owned Applebee’s restaurants and uses that capital along with its free cash-flow to retire debt, investors should see payouts in the form of dividends in the future.
Pizza Inn (PZZI) is a small cap play, but one of those investments which we really love. Being in early to a potential new concept is always rewarding to the investor’s mindset and the wallet, and Pizza Inn delivers this opportunity. We are mainly interested in the company’s Pie Five Pizza Co. which, according to last quarter’s numbers would indicate that the first prototype restaurant generated 10% of the company’s operating income (before taxes), or $50,000 on sales of $230,000. The company is going to start rolling out new locations, in fact they are up to four locations now, and if these new restaurants are as successful as the first location the company may have found a new platform to drive growth. It is still early in the game on the concept, however the stock has risen sharply from around $2/share to yesterday’s close of $5.36/share. At the rate the company is adding restaurants to this new category, we are betting that 2012 will show that Pizza Inn is on to a good idea.
Although common thought these days in regard to restaurants is that they are lagging the S&P and that they are indicating future troubles for the economy, we disagree. It is our belief that the economy is indeed turning around, and that the restaurant chains will be beneficiaries of this with increased revenues and hopefully profits.