Americans love their fast food, and are very good at running fast food business. Looking around, from McDonald's to KFC, from Wendy's to Sonic, we have full spectrum of fast food restaurants that share many similar food offerings. In this article, I'm going to examine 6 fast food restaurant chains: AFC Enterprises, Inc. (AFCE), Jack in the Box, Inc. (JACK), Sonic Corp. (SONC), The Wendy's Company (WEN), McDonald's Corp. (MCD), and Yum Brands Inc. (YUM).
In a nutshell, I found these companies not as similar as one might imagine in terms of valuation and prospects. Overall, the two bigger ones, McDonald's and Yum, are different species compared to the other four smaller ones. I'll break the article down into 2 parts. In part 1, I focus on the 4 smaller chains.
AFC Enterprises, Inc. is a very franchise-focused company. Out of its 2,035 restaurants, only 40 are company operated -- one can imagine these are perhaps more like "model homes" for new franchisees to learn the A-to-Z's of operating a Popeyes restaurant.
Headquartered in Atlanta, Georgia, Popeyes food leans towards Southern taste buds. It offers predominantly fried chicken-based tenders, sandwiches, and wraps. In today's world, such a menu goes against a healthy eating trend (be it a fad or not). As trend setting people are generally the more affluent and less price sensitive, it also means Popeyes chain has little pricing power over competitors.
Because of AFC's heavy leaning on franchising, its revenue number is low at $154 million in 2011 for its total number of restaurants, but its operating margin is fairly high at 26.5%. It is not growing fast (6.1% from 2010 to 2011). It has no dividend.
The investment prospect? Not much, as the company has no yield, little growth, and is not very undervalued at an EV/EBITDA of 9.7. If the company starts to convert some franchised restaurants into company owned without running into debt trouble, its stock price could see a sizable increase -- that's a big "if," though.
Jack In the Box
Jack in the Box, the company running odd advertising with a bobblehead dad sometimes with his somewhat cute bobblehead son, has two restaurant chains: Jack in the Box (2,200 restaurants) and Qdoba (600 restaurants). About half of the restaurants are company owned the other half franchised.
Jack in the Box has been shrinking in revenue for a few years now. It seems to have finally stabilized. Partly because of its heavily company owned structure, its operating margin is fairly low at 6.5%. Its revenue per company-owned restaurant is $1.58 million, the highest among the four small chains (see the table at the end of the article). From operations point of view, part of Jack in the Box restaurants' operations issue lies in its complicated menu. Based on my own experience, Jack in the Box takes perhaps the longest time to serve each customer. That to a fast food restaurant is almost a fatal flaw.
Qdoba restaurants don't seem to have been as heavily promoted by Jack in the Box. Given the success of Chipotle Mexican Grill (CMG), I wonder if Qdoba can be repositioned to become a competitor in the similar arena. Qdoba represents Jack in the Box's potential for growth. It should, based on Chipotle's current restaurant count, have at least 50% growth potential, which gives Jack in the Box 20% upside in restaurant count.
The investment prospect? With better growth potential, Jack in the Box is slightly undervalued compared to Wendy's. But the Jack in the Box has to first make sure its revenue growth picks up, even at a slow pace such as 5%. Under that scenario, Jack in the Box should see better stock price increase. At this point, it is not a worthwhile stock to own.
Sonic differs from other restaurants in the way that it offers a park-and-order service, but doesn't provide dining space. It is sort of a "drive through only" restaurant. It has little growth and no edge in its menu. It also requires a lot of space in its standard restaurant setting (Sonic does have a number of non-drive-throughs), limiting where it can open restaurants.
It also means Sonic cannot afford to open restaurants in places with high population density, where land is expensive. Given its debt burden, it is very unlike to start paying dividend in the foreseeable future. This is a forgettable stock, in my opinion, the least worthy of investment among the four small chains.
Wendy's is the biggest among the four, also the one with a menu most similar to that of McDonald's. Even in terms of franchised restaurant percentage it is similar to McDonald's (79% vs. 81% company owned). But its restaurants, on average, sell about half of that of McDonald's, and its operating margin of 5.6% is less than one fifth of that of McDonald's.
Wendy's problem is less in its menu, more in its governance. In 2008, Wendy's was acquired by Triarc, the holding company of Arby's (when was the last time you visited an Arby's?). Anyways, the marriage didn't work out. In June 2011, Wendy's and Arby's split. What a mess.
Wendy's future rides on a turnaround story. If Wendy's can improve its operating margin to double digits -- it should be able to given its peers' numbers -- the stock will hit double digits with the operating margin. However, I'm on the pessimistic side of its prospect given the company's patchy history of maintaining a decent operating margin -- this was even true when Wendy's was expanding quickly and founder Dave Thomas was a figure in Wendy's advertising. Wendy's hasn't had a double digit operating margin over the past ten years.
With a menu similar to that of McDonald's, it doesn't have much pricing power either. Based on Wendy's per company owned restaurant sales ($1.5 million), Wendy's should be able to raise its franchise fee. It appears the company might have given up a lot of money for quick expansion by adding franchisees at too low a fee. Or, it might have run too many promotions to draw traffic, while killing its profit margin the process. Either way, Wendy's has to change that.
The investment prospect? It is important to watch what changes Wendy's can bring to its business. It is slowly buying back shares, a slow but nevertheless positive move for shareholders. If it starts to earn more from its franchisees, Wendy's stock price can double.
To summarize, I believe the investment prospect goes in the order of Wendy's, Jack in the Box, AFC, and Sonic. The latter two should, perhaps, be avoided.
Finally, I put these four restaurants in a table for a side-by-side comparison. This gives a better overview of their similarities and differences.
Click to enlarge.
Stay tuned for a comparison between McDonald's and Yum in part 2.