Is There Any Long Term Value in These 3 Fast Food Giants

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Long-time Fidelity Magellan Fund manager and all around stock guru Peter Lynch has consistently preached the “Buy what you know” mentality to retail investors.

This statement got me thinking: what does a 23 year-old recent college grad know? The first thing that came to mind was fast food. Long nights, whether studying or spending time with friends, typically ended in a Baconator from Wendy’s (NASDAQ: WEN) or a couple of double cheeseburgers from McDonald’s (NYSE: MCD). These fast food places were usually slammed with customers at all hours of the day. They have to be producing some nice profits right?

Let’s evaluate the big three burger chains, McDonald’s, Burger King (NYSE: BKW), and Wendy’s and see if these companies meet the criteria of companies we would like to own.

Serving up value since 1940

It’s no secret that McDonald’s is top dog in this industry. The company owns or franchises 34,000 stores worldwide, making it one of the world’s most valuable and well known brands. In 2012, McDonald’s was able to increase revenue nearly 2%, but free cash flow decreased 11%. The decrease in fee cash flow was due primarily to mix of higher taxes, losses on foreign currency translations, and increased spending on capital expenditures.

At first glance McDonald’s appears to be slightly out of my price range (trading at multiple a little bit too expensive for my tastes). The company trades at 15.77 times 2014 earnings, with a price-to-sales of 3.59 and a price-to-book of 6.51. The price/book and price/sales seem to be inflated, but competitors in this industry sell at similar valuations so it is not necessarily a red flag.

What attracts me most to McDonald's is the dividend. The company has been paying dividends for 36 consecutive years. In the last three years the company has had an average dividend growth rate of 11.9%. McDonald’s current dividend yield is 3.10% with a payout ratio of 55%. McDonalds is clearly dedicated to returning cash to shareholders and will continue to do so for the long term.

The King is fighting back

Burger King has recently completed a re-imaging program, where the company is trying to focus on expanding its premium offerings such as café style coffee drinks and even turkey burgers. This focus on premium menu items did not work well for Burger King as the company saw sales decrease 42% year-over-year for the first quarter of 2013.

However, this significant downturn in sales did not lead to an equivalent reduction in profits. Burger King was actually able to increase net income 150%. The company attributes the increase to its expense-cutting measures and menu diversity. This increase in earnings allowed Burger King to increase its dividend to $0.06 a share. The company also plans to repurchase around $200 million worth of stock.

From a valuation perspective Burger King, similar to McDonalds, seems to be a bit pricey, currently trading at 52.90 times trailing twelve months earnings with a price-to-sales of 4.16 and a price-to-book of 6.01. However, with a Price/Earnings to Growth (PEG) ratio of just 1.53 Burger King appears to be priced just right considering its expected growth rate of 16.85%.

An issue Burger King needs to address in the near future is the company’s mounting debt. Burger King’s debt-to-equity ratio of 2.5 is more than to triple that of McDonald’s (0.8) and Wendy’s (0.7). This amount of debt may prove worrisome as Burger King will need to incur a large amount of capital expenditures to fund international growth. New CEO Daniel Schwartz, who takes over July 1, will have his work cut out for him as he strives to return revenue to previous levels while maintaining Burger King’s aggressive cost-cutting campaign.

Can Wendy’s continue to compete

On paper Wendy’s seems to be the most attractively priced of the three. The company currently trades at 26 time’s forward earnings with a price/book of 1.19 and price/sales 0.93 well below its competitors (See paragraphs above). Wendy’s saw a 1% quarter-over-quarter increase in same-store sales for the first quarter (Q1) 2013, outperforming the same-store sales decrease of roughly 1% by McDonald’s and the same-store sales decrease of 2% by Burger King. Wendy’s also raised its earnings guidance for 2013 from $.20 to $.22 a share.

The new dividend of $0.16 demonstrates that Wendy’s management is dedicated to returning value to shareholders. However, the elevated payout ratio of 72% does not leave much margin of error if earnings are not as expected.

Wendy’s also has a much more limited exposure to international markets than Burger King and McDonald’s. The company has just 374 franchised restaurants in 26 countries and territories outside of North America. Management is dedicated to growing abroad with expansion operations under way in countries like Singapore and Japan. Wendy’s is expecting growth of over 15% annually over the next five years. With a PEG ratio of 1.94 it appears that Wendy’s is valued relatively fairly, to its long term growth rate.

Wrap up

The answer is yes, there is long term value in each of these three fast food companies. Companies in this industry, the three above especially, have shown a fantastic ability to not only present value to their customers, but to continuously tweak their menus to meet an ever-changing consumer appetite.

Burger King and Wendy’s are slightly speculative. The companies are both completing massive brand re-imaging programs and looking to increase their international exposure. These two companies could prove to valuable long term bets if management can remain committed to their new images and can continue to make increasing shareholder value a top priority. 

McDonald’s, on the other hand, is the true leader. The company boasts a global operation coupled with an iconic brand image and a history of stellar business operations. McDonald’s is a safe blue chip with a great yield you can hold for years 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.

Daniel Paterson has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and McDonald's. The Motley Fool owns shares of 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!

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