3 Fast Food Choices to Satisfy All Tastes
Damian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When friends tell me to visit McDonald's (NYSE: MCD) for lunch, my face turns Grinch-like. If chicken wings are mentioned, a timid smile recalls Buffalo Wild Wings (NASDAQ: BWLD). But, when Domino’s Pizza (NYSE: DPZ) is mentioned, my mouth starts to drool. There are no doubts that hamburgers, wings, and pizza are three North American staple foods that have crossed the Rio Grande, the Atlantic Ocean, and more recently, the Pacific Ocean. As satisfying as any of the three may be for investor’s appetite, revenues and dividends have a different story that will be unraveled below.
All that I want for you my son, is to be satisfied
Reporting positive same-store sales is the challenge faced by companies expanding into new markets. Domino’s has been able to do so during the last 77 quarters, making a strong statement for investors to flock to the company. The firm has been showing remarkable success at crossing frontiers, while maintaining a sound financial structure through its franchise strategy; evidence of this fact is the company’s presence in most international airports.
This success overseas stems, in part, from its strong brand recognition and franchise strategy. The company has exploited its brand recognition, and even though it has just recently developed a strategy to expand in the East (Japan), prospects are good, mainly because it has demonstrated, over the years, that crossing frontiers would not hurt profits.
However, expansion alone cannot be responsible for Domino’s acceptance in foreign markets. Innovation joined in to give customers a reason to return. Unlike Wild Wings and McDonald’s, Domino’s has lesser room to refresh its menu. For the same reason, order placement was the focus of improvement. The company has made online ordering one of its mainstays, reducing ordering time and increasing order volumes by 5%. The only new introduction to Domino’s menu has been pan pizza, as a way to stand toe-to-toe with competitors.
Leaving aside macroeconomics, Domino’s is risking its financial health by letting debt accumulate; and, although its operating margin remains good when compared to past records and current industry levels, accumulating debt while expanding in new markets is a combination that spells disaster. The situation is only under control thanks to an ever-increasing cash flow. However, debt is leaving its mark by curtailing revenue and EPS growth. Lastly, Domino’s will face a higher operating cost as non-cash compensation increases.
In all, Domino’s stands strong. Nevertheless, the train has passed and expected upside is not as good as it used to be. And this is not because the company has made bad investments, but because it has already made its bet and is currently collecting the winnings. Notwithstanding, investors looking for long-term returns are recommended to buy this stock, given its strong market position, its expected annual EPS growth rate of 14%-15%, and its relatively cheap valuation at 28.2 times its earnings, compared to the 29.2x industry average.
Troubles will come and they will pass
Buffalo Wild Wings has a lot to learn still; the company is young and has a great deal of room for expansion, which has limited itself to North America until now. Offering a great menu and continuous in-store innovations, it is no accident that these restaurants has been able to mix sports-fans and families in the same environment.
Buffalo Wild Wings has achieved a strong brand recognition that has, however, not crossed many international frontiers; the company remains concentrated on doing well and expanding within known ground. Remarkably, expansion has not been limited by macroeconomic contraction. Hence, the company has set several objectives for 2013, including that of reaching 1,000 stores. The franchise strategy has been widely put to use in order to reduce financial exposure with great results, although frontiers were never crossed.
The biggest challenge for Buffalo Wild Wings will be increasing operational costs. Rising chicken prices and wages will put a strain on the company’s revenue. Management has already proved to have the knowledge to confront bad weather by expanding operations successfully against economic uncertainty. So, the remaining challenge is to replicate past experiences: maintaining low debt levels without hurting cash inflow.
Cash inflow has, however, been on the decline. During 2013’s first quarter, Buffalo Wild Wings performed below conservative estimates. However, I should highlight the fact that earnings remained positive. The evidence points to the the firm having reached its roof; at least, for the time being. Although a forward P/E of 26x is considerably lower that trailing P/E of 32x, it's still high.
So, the stock is relatively expensive and return on investment is not at its highest. Buffalo Wild Wings is not a bad investment, but investors are recommended to hold until the next train arrives.
Don't forget son, there is someone up above
Few brands and tastes are so widely recognized as McDonald´s. Expansion and innovation are two characteristics shared with the other two companies. Same can be said about McDonald’s franchise strategy and menu improvements, which helped maintain strong financials over the years. So, what differentiates it from the bunch? Its size.
During the last economic crisis, much was said about too-big-to-fail banking institutions. McDonald´s is sewed from the same thread, in a different cloth. But, the company has not been greedy, avoiding risky investments and paying investors steady dividends. Also, debt is controlled by continuous share repurchase, leaving evidence of steady cash inflow.
Another size related advantage is its leading market penetration. While Domino´s is attempting to enter the Japanese market, Ronald has already landed in China. Although the balance sheet in the country is not as favorable as, let’s say Germany -- one of the most successful abroad ventures -- having entered is already a very important achievement.
Also, market penetration has an entrance cost and that explains McDonald´s sluggish growth in China. Government regulation, personnel training, and logistics are just some of the obstacles it will have to wrestle with in order to establish itself in China, and balance its finances.
So, besides its size and dominant market position, McDonald´s does not have much to say. Dividends will surely be paid in the long-term, but in the short-term, prospects are not that good. In line with most analysts, it is recommended to hold until the company proves to have learned from managerial mistakes committed during 2012, and new products pass customers’ taste test.
Investors have to look after one’s own gold, and where it is deposited. Macroeconomic pressures are not ignored, but rather set aside of my analysis, since they pose the same threat to all three companies. The importance of macroeconomic performance here relates to how much pressure is put onto the economic system as a whole. An important question is whether the pressure will break a country’s back, or if that pressure will significantly reduce disposable income.
If the country’s back is broken, meaning the pressure reached its maximum, no one will visit a restaurant. So far, the world has survived without Buffalo Wild Wings, while McDonald’s has yet reached the lower classes outside the developed world. Meanwhile, Domino´s is the most recommendable stock to buy because it possesses the widest customer base and a fair valuation, and returns on geographical expansion are soon to come.
McDonald’s turned in a dismal year in 2012, underperforming the broader market by 25%. Looking ahead, can the Golden Arches reclaim its throne atop the restaurant industry, or will this unsettling trend continue? Our top analyst weighs in on McDonald's future in a recent premium report on the company. Click here now to find out whether a buying opportunity has emerged for this global juggernaut.
Damian Illia has no position in any stocks mentioned. The Motley Fool recommends Buffalo Wild Wings and McDonald's. The Motley Fool owns shares of Buffalo Wild Wings and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!