Why McDonald's Will Outperform Wendy's, Yum

| About: McDonald's Corporation (MCD)
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When it comes to hedging against a double dip, McDonald's (NYSE:MCD) is one of the safest stocks with 50% less volatility than the broader market, a supportive capital allocation policy, and a top brand. The Street currently rates shares a "buy" versus a "buy" for Yum (NYSE:YUM) and a "hold" for Wendy's (NYSE:WEN). Based on my multiples analysis and DCF model, I find that McDonald's has the greatest upside and is substantially safer.

From a multiples perspective, McDonald's is the cheapest of the three. It trades at a respective 19.4x and 17.2x past and forward earnings while offering a dividend yield of 2.8% - more than 100 bps greater than that of its competitors. Yum! and Wendy's trade at a respective 19.5x and 23.7x forward earnings.

At the fourth-quarter earnings call, McDonald's CEO, Jim Skinner, noted a strong close to the year:

I'm pleased to report a strong fourth quarter and another strong year for McDonald's in 2011. System-wide sales increased 7% in constant currencies, with global comparable sales up 5.6%, marking our eighth consecutive year of positive comp sales growth in every area of the world…

In constant currencies, operating income grew 14% for the quarter and 10% for the year, while EPS increased 15% for the quarter and 11% for the year. Over the past year, we again exceeded our long-term financial targets of 3% to 5% sales growth, 6% to 7% operating income growth and returns on incremental invested capital in the high teens. And while returns are not yet finalized, we will be well above that target.

Fourth-quarter results were topped with stellar performance in December, being the best since January of 2004. Comps for December were 9.8% for the U.S. and 10.7% for Europe - about 300 bps greater than what was expected for both. The core restaurant bottom-line of $856M, however, was roughly in-line with expectations. Overall, high volumes were negatively impacted by greater costs and, going forward, taxes and FX are likely to present stronger headwinds. With a dominant position in all key geographies, however, McDonald's has sustainable free cash flow.

Consensus estimates for McDonald's EPS forecast that it will grow by 8.7% to $5.73 in 2012 and then by 10.5% and 10.4% more in the following two years. Assuming a multiple of 19x and a conservative 2013 EPS of $6.26, the rough intrinsic value of the stock is $118.94, implying 20.5% upside. Even if the multiple were to fall to 17x and 2013 EPS turns out to be a 3.5% miss, the stock would still appreciate.

Turning to Wendy's, we find a company that is focusing more on updating its brand. The launch of Dave's Hot n' Juicy Burger was a total hit and renewed market confidence in the company's brand strategy. With that said, I am reserved about the costs related to an aggressive remodeling plan for stores.

Consensus estimates for Wendy's EPS forecast 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 a conservative 2012 EPS of $0.19, the rough intrinsic value for the stock is $3.80, implying 27.1% upside. Thus, this company is geared more toward investors willing to take on extra risk.

Consensus estimates for Yum's EPS forecast that it will grow by 13% to $2.86 in 2011 and then by 12.9% and 14.2% in the following two years. Modeling a CAGR of 13.4% for EPS over the next three years and then discounting backward by a WACC of 9% yields a fair value figure of $46.79, implying substantial upside. In light of this backdrop, McDonald's is a safe refuge for investors looking for exposure in quick service restaurants.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.