McDonald's To Stay Above $100; Wendy's And Yum! Are Riskier

| About: McDonald's Corporation (MCD)

From strong emerging market exposure to a leading brand among quick-service restaurants, McDonald's (NYSE:MCD) has unsurprisingly outperformed the market. Since I first wrote my bullish case on the company here, the stock has appreciated by 15.8%, meaningfully beating the S&P 500 by around 560 basis points. Going forward, I expect more upside - albeit, limited - as macro trends improve. In my view and that of the Street generally, Wendy's (NYSE:WEN) and Yum! Brands (NYSE:YUM) are exposed to greater risk.

From a multiples perspective, McDonald's is the cheapest of the three. It trades at a respective 19.6x and 17.4x past and forward earnings. Wendy's and Yum! trade at a respective 18.6x and 24.6x forward earnings while offering meaningfully lower dividend yields than their largest competitor. With a dividend yield of 2.8% and a low beta of 0.46, McDonald's not only has the strongest upside amongst the three, it also has the smallest downside.

In light of the growing competition, McDonald's has an almost seductive the-winner-takes-all story going for it. Major footholds in key locations, coupled with loyal demand, drive sustainable free cash flow. At the third quarter earnings call, Wendy's CEO, Emil Brolick, noted the increasingly challenging industry.

"Those obvious change to all of us is the evolution that we've seen in the competitive and consumer environment. Quick-serve restaurants, I call them the new QSRs, have surged to success in the past 10 years. Why? I believe that they have demonstrated to consumers that they offer a superior overall experience to that of many old-line traditional QSRs. Specifically, they offer high-quality food, as well as food transparency or food with integrity, as some would call it. They offer a better restaurant environment and they have restaurant teams that represent the brands extremely well.

The bottom line is that they offer a better total experience and many would say, a better overall value. The success of the new QSRs is unmistakable as they have accounted for 80% of QSR growth since 2005 and 100% of growth if you eliminate breakfast. So, yes, the competitive set has changed significantly. We understand this, and we are confident that we can successfully build our brand, build sales and build profits in this new environment".

Buoyed up by "Dave's Hot n' Juicy" burger, October sales for the fourth quarter were quite strong. Even still, as advertising has declined, same-store sales have slowed. Franchisees are also noting margin erosion from higher food prices, particularly in ground beef. While the choice for the CEO was well done, I am skeptical about the store remodeling in 2012. It is crucial that the company differentiate itself as a premium competitor to McDonald's, but consumer preferences are unpredictable. If the success of previous launches are any indication, however, investors should be optimistic about the focus on product creation.

Consensus estimates for Wendy's EPS are that it will grow by 7.1% to $0.15 in 2011 and then by 46.7% and 27.3% in the following two years. Assuming a multiple of 20x and 2012 EPS that is 9.1% below consensus, the stock would fall by 22.2%. Note that analysts are historically around 11% overly bullish with estimates. With this in mind, I solidly recommend holding out.

A much more attractive pick exists in McDonald's. In almost every key company, the restaurant chain has a leading market share. And with Yum having more units globally, the potential for growth is significant. In Japan, McDonald's had same-store sales of 5% - far above expectations. Over the last five years, management has expanded operating margins by more than 1,000 basis points and thus has a track record that instills investors with confidence that it can get through a double dip and soar in a recovery.

Consensus estimates for McDonald's EPS are that it will grow by 13.4% to $5.23 in 2011 and then by 9.6% and 9.9% in the following two years. Assuming a multiple of 19x and a conservative 2012 EPS of $5.65, the rough intrinsic value of the stock is $107.35, implying 7.7% upside. This may not be the greatest reward, but it comes with limited downside and a near "strong buy" rating on the Street.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in MCD over the next 72 hours.