Seeking Alpha
Profile| Send Message|
( followers)  

Many quick service (AKA fast food) businesses appeared on BrandZ's 2012 Top 100 Global Brand estimates of brand value. These estimates can be used to adjust book values of companies, allowing for a more economically meaningful variation on the price-to-book ratio.

Investors Should Value Brands

Branding allows companies to charge more for what is essentially the same product sold by its generic competitors. Since trademarks and copyrights are government-protected ways for companies to carve out a competitive advantage and differentiate their products. This pricing power alone should be enough to convince you that well-loved brands have value.

Better yet, there is another benefit to brands, which make them particularly interesting assets: they are hard to destroy. It is very hard for outside forces to destroy the value of a brand, both as intellectual property and because it is based on faith, habit and loyalty. In addition to enduring fandom, the legal rights to intellectual property can be extremely long-lived. Trademarks are enforceable forever. Copyrights (initiated since 1978) last up to 95 years after publication or 120 years after creation, whichever is shorter. Though intangible in nature, these assets are less perishable than physical assets. Buildings depreciate and iron rusts, but the psychological impact and legal value of brands endure.

Measuring Intangibles

Millward Brown's 2012 BrandZ Report estimates the value of 100 of the world's top brands. Many quick service brands belong to publicly traded companies including McDonald's (NYSE:MCD), Domino's Pizza (NYSE:DPZ), Starbucks (NASDAQ:SBUX), Tim Hortons (NYSE:THI), Wendy's (NASDAQ:WEN), and Yum! Brands (NYSE:YUM).

Franchise

Brand Value ($M)

Owned By

McDonald's

95,188

MCD

Starbucks

17,072

SBUX

Subway

14,843

Private

KFC

8,852

YUM

Pizza Hut

5,397

YUM

Tim Horton's

3,346

THI

Taco Bell

2,045

YUM

Wendy's

1,722

WEN

Domino's

797

DPZ

Arby's

344

WEN (15%)

These brand asset values can be added to to net assets to calculate an adjusted price-to-book ratio, which can be listed along-side other everyday price multiples:

Company

Market Cap ($M)

P/B

Adj P/B

P/E

P/S

P/FCF

Domino's

1819

N/A

N/A

19.27

1.1

14.99

McDonald's

92824

6.33

0.84

17.07

3.38

53.53

Starbucks

40481

7.88

1.82

30.85

3.21

87.68

Tim Hortons

8302

7.57

1.87

22.28

2.89

45.4

Wendy's

1721

0.86

0.46

55.12

0.7

N/A

Yum! Brands

32460

15.16

1.76

22.37

2.51

N/A

Adding the $797 million in brand value was not enough to turn the negative $1,366 equity value of Domino's Pizza positive, so its P/B ratio remains incalculable, even when adjusted.

Which quick service companies are on sale?

With these revised price multiples in mind, McDonald's and Wendy's are worth further investigation. Are the high P/E multiples of these firms the consequence of temporary setbacks or rich valuations?

McDonald's recent earnings are high on a multi-year basis, and in no way represent a setback. It is clear that the market is pricing in excellent returns for McDonald's into its shares. On the other hand, Wendy's top and bottom line performance have been rockier, though earnings for 2011 were good relative to many terrible losses in recent history. Thus, McDonald's fares better in terms of earnings quality.

McDonald's

Wendy's

Period

Revenue ($M)

Net Income ($M)

Revenue ($M)

Net Income ($M)

2002-12

15,406

894

98

1

2003-12

17,141

1,471

294

-11

2004-12

19,065

2,279

329

14

2005-12

20,460

2,602

727

-56

2006-12

21,586

3,544

1,243

-11

2007-12

22,787

2,395

1,264

16

2008-12

23,522

4,313

1,823

-480

2009-12

22,745

4,551

3,581

5

2010-12

24,075

4,946

3,416

-4

2011-12

27,006

5,503

2,431

10

TTM

27,441

5,561

2,442

24

We can plot return on assets versus adjusted P/B ratios to see which of the best companies from this list are trading at the cheapest valuations. (Return on assets was used instead of return on equity since adding the brand value creates a much larger denominator more akin to asset value than equity value for leveraged firms.)

ROA vs. Adjusted PB Ratio

This plot reveals that McDonald's ROA was well above trend, meaning that investors have received a much higher return on assets than what would normally be expected for a firm trading at its adjusted price-to-book ratio. On the other hand, Wendy's ROA performance has been far below that which is to be expected for a firm trading at its adjusted price-to-book value.

Conclusion

After factoring the value of brands, McDonald's appears cheap relative to other quick service restaurants. However, by most valuation ratios MCD shares are not cheap on an absolute basis. Investors should wait for prices to drop before buying shares of MCD.

Source: Bite Into McDonald'S Brand Value