Fast Food: One to Own, One to Consider, One to Avoid

Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

This is the first in what will be a series of posts about the restaurant industry. Today we will focus on classic, cheap burger chains: McDonald’s (NYSE: MCD), Wendy’s (NASDAQ: WEN), and Burger King (NYSE: BKW). While all three chains make an argument for future profitability, given the uncertainty of the market I'm inclined to go with the restaurant that has proven its ability to provide value to investors and run a sustainable business model. My conclusion is this: avoid Wendy’s, consider Burger King, and invest in McDonald’s. Let's take a look at the metrics.

Wendy’s

Wendy’s saw a 1% quarter-over-quarter increase in corporate same-store sales for the first quarter of 2013,  which compared favorably to the McDonald’s global same-store sales decrease of roughly 1% and the Burger King corporate same-store sales decrease of 2%.

Management’s first quarter 2013 earnings call raised company adjusted earnings per share (EPS) guidance to $.20 to $.22 for 2013, which would be an increase from the 2012 EPS of $.17 per share. Management’s guidance would indicate a forward price to earnings (P/E) ratio of between 27 and 30, assuming a stock price of around $6. That seems a little pricey for a company that has seen flat-to-declining revenue historically ($3.4 billion in 2010 declined to $2.4 billion in 2011, with a rise to $2.5 billion for the trailing twelve months, according to Morningstar).

The new dividend of $0.04 per share is a good sign that management is serious about returning value to shareholders, but given the high payout ratio -- 72% assuming annual EPS clocks in at $0.22 -- it may not be sustainable. Then again, the dividend may also be a sign that management feels very bullish about the company’s long-term outlook and may have a good reason to think that EPS will steadily increase and reduce the payout ratio.

Personally, I don’t buy it. The stock is too pricey given past performance, and the dividend is suspect. If it grows revenue and the dividend for a couple of years, the stock should be reconsidered, but for a value stock I wouldn't pay 30 times forward earnings.

Burger King

The first thing that leaps out to me about Burger King is its debt to equity ratio, which is 2.5 according to Morningstar. When compared to McDonald’s 0.8 and Wendy’s 0.7, it’s a big red flag. Wendy’s and McDonald’s have an easier ability to expand through additional debt but Burger King is already pretty leveraged. The aforementioned drop in same-store sales is also concerning. On the revenue front, the chain is definitely healthier, with adjusted EPS of $.17 for the first quarter of 2013 ($.10 per share according to EPS calculated according to generally accepted accounting practices, or GAAP). According to NASDAQ, the consensus EPS forecast is $0.81 for 2013, which works out to a forward P/E of approximately 25, assuming a share price of $20.

Management announced a dividend hike to $.06 per share and a $200 million share repurchase program during the first quarter earnings call, which shows optimism regarding the stock. The dividend’s payout ratio is under 50%, so I would not be surprised to see it rise further -- especially given that the dividend is up 50% since the fourth quarter of 2012.

Revenue and same-store sales declines give me pause, as does the heavy debt load, but Burger King seems to be in reasonably good shape. Given the P/E ratio, I think the stock is a bit overpriced, but it is definitely worth a second look.

McDonald’s

No discussion of cheap burger chains is complete without McDonald’s, the 800-pound gorilla and industry leader. NASDAQ reports analyst consensus of an estimated EPS of $5.71 for 2013, which indicates a forward P/E in the high teens assuming a share price of around $100.

To my mind, McDonald’s has it all: a steady, sustainable dividend yielding about 3%, low debt, a reasonable P/E ratio, and revenue growth since 2009. There is still room to expand internationally — although perhaps not in the United States — and McDonald’s is continually refreshing its menu choices with new items. Even if revenue remains flat for the next several years, management can support shareholders with dividend hikes and share repurchases, making this a safe, defensive income stock.

I don’t expect fireworks from McDonald’s; it isn’t a growth stock like 3D Systems. Nonetheless, I view it as a good, safe investment vehicle that will generate a solid return (somewhere on the order of 10-15% annually) over the next several years. The valuation is a big piece of this; despite being in the best financial shape of the three stocks listed above, McDonald’s trades at the lowest forward P/E ratio. When the market pulls back, many investors will be looking for safe, defensive stocks like McDonald’s. Make sure you get in before they do!

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.


Michael Douglass 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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