Are Quick Service Restaurants Still Tasty for Investors?

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

Historically, McDonald’s (NYSE: MCD) has proven to be a great long-term stock, as it rose steadily in the past 10 years. Including dividends, McDonald’s has returned more than 717% over the last decade. But is McDonald’s a buy after its first-quarter earnings results? 

Recently, McDonald’s announced not-so-impressive first-quarter 2013 earnings results. The global restaurant chain missed Wall Street earnings estimates. In addition, the company also expects a decline in its global comparable-store sales in this month due to a soft global consumer spending trend. Let's examine the stock

A quarter earnings that missed Wall Street estimates

McDonald’s is a global operator and franchiser of its namesake restaurants in more than 119 countries around the world. In 2012, McDonald’s had 34,480 restaurants worldwide, including 27,882 franchised restaurants and 6,598 company-operated restaurants. More than 67% of its total revenue, or $18.6 billion, was from company-operated restaurants while the franchised restaurants generated nearly $9 billion in 2012 sales.

In the first-quarter 2013, McDonald’s produced more than $6.6 billion in total revenue, including $4.4 billion in company-operated restaurant sales and about $2.2 billion in franchised-restaurant sales. Revenue just inched higher by nearly 1% compared to the sales in the first quarter 2012.

Net income came in at about $1.3 billion, about the same as the first quarter of last year. Its EPS experienced year-over-year growth of 2% to $1.26 due to lower total outstanding shares. However, EPS fell short of Wall Street expectations of $1.27 per share.

What makes investors more worried is the 1% drop in global comparable sales, indicating the McDonald’s declining operating performance on a global basis. McDonald’s could be considered the cannibal of itself. In the first quarter, the company reported that it has returned $1.1 billion to its shareholders through dividends and share repurchases. In the past five quarters, the company has spent a total amount of $3.4 billion to buyback its shares.

A shift to Dollar Menu

McDonald’s has shifted its focus back to its dollar menu in an attempt to gain market share in the long run. Peter Bensen, the CFO, commented that the shift in focus was quite important to the company’s long-term success. He said in a recent conference call:

In this environment where you continue to have the cost pressures, so commodities will be up, labor rates are going up et cetera, and yet you have soft economics declining to flat eating-out markets, that battle for market share becomes so critical to the long-term health of the business that we’re willing to sacrifice a little bit of margin to maintain that traffic and grow the market share.”

The highest margin, highest yield with a reasonable valuation

At around $100 per share, McDonald’s is worth $100.2 billion in market capitalization. The market values McDonald’s at only 11.5 times EV/EBITDA.

Compared to much-smaller companies in the quick service restaurant industry, including Burger King Worldwide (NYSE: BKW) and Yum! Brands (NYSE: YUM), McDonald’s is not relatively cheap at its current price.

Burger King Worldwide is a hamburger fast-food restaurant under the Burger King brand, operating nearly 13,000 restaurants in 86 countries around the world. Burger King is one of the favorite investments of famous activist investor Bill Ackman. He currently holds more than 38.3 million shares in Burger King, accounting for 6.9% of his total portfolio.

Recently, the company announced the sale of 94 restaurants of its Canadian subsidiary to Redberry Investments. In the agreement, Redberry will have a new restaurant-opening program and a strategy of remodeling the locations. Burger King is the smallest company among the three, with only $6.4 billion in total market cap. At $18 per share, Burger King is the most expensively valued at 13.8 times EV/EBITDA.

Yum! Brands is another giant quick-service restaurant chain with the majority of operations in China. It has around 39,000 restaurants in more than 125 countries under three main brands: KFC, Pizza Hut and Taco Bell. China is the biggest revenue contributor, with $6.9 billion, or 50.7% of the total revenue in 2012.

In its recent first quarter, Yum!'s operating performance got hit pretty hard, especially in China. Revenue dropped by 10% to nearly $2.1 billion. EPS came in at only $0.72, which is 24% lower than last year's 1Q EPS of $0.96.

In China, its operating profit experienced a significant year-over-year decline of 40% to only $154 million while the comparable-store sales decreased by as much as 20%.

Indeed, Yum's Chinese operation has been hit hard by the food scare over contaminated kitchen. Consequently, Yum! has decided to tighten food safety to gain back Chinese consumer confidence by cutting ties with more than 1,000 slaughterhouses in China. The share price was recently hovering at around $65, with a total market cap of $29.3 billion. The company is valued the cheapest at around 11.2 times EV/EBITDA.

What makes me interested in McDonald’s is its high profitability with the highest operating margin at 30.3%. While Burger King generates around 26.7% in operating margin, YUM!’s operating margin is the lowest at 16.3%. Another positive point about McDonald’s is its conservative capital structure. Its debt/equity ratio stays low at only 0.9 while the debt level of YUM! and Burger King are much higher, with debt/equity ratios of 1.4 and 2.5, respectively.

Income investors should really consider McDonald’s with its decent dividend yield at 3% while YUM pays investors dividends with a yield of 2%. Burger King offers lowest dividend yield at only 1.3%.

My Foolish take

I personally think that with a strong global footprint, McDonald’s is still the long-term stock for investors. In addition, it generates the highest operating margin, offers highest dividend yield and has a reasonable valuation. A focus on the dollar menu would let McDonald’s gain more global market share, which would certainly benefit this restaurant chain in a long run. 

Anh HOANG 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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