Innovation Sets This Fast Food Giant Apart

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

The idea companies for long-term investments are those that offer not only a constant, growing stream of income, but potential for growth as well. For large, stable corporations, growth usually means that they are good at adapting to changing business environments (new technologies, changing tastes of customers, etc.) If these are the qualifications, it is tough to find a better option than McDonald’s (NYSE: MCD) for your portfolio.

About McDonald’s

McDonald’s is arguably the world’s most recognizable brand name (Coca-Cola is up there too), and for good reason. Currently the company owns or franchises over 33,700 of its restaurants in 119 countries, making it the largest fast-food chain in the world. With $32 billion in U.S. sales out of the $162 billion quick-service industry (or a 20% market share), McDonalds is many times larger than its nearest competitors, such as Wendy’s (NASDAQ: WEN) or Burger King (NYSE: BKW). In other words, 1 in 5 quick-service restaurants in the U.S. are McDonalds!

As mentioned before, the major thing that keeps great companies great is adaptability. McDonald’s has shown time and time again that they have an extraordinary ability to change with the times at keep giving their customers what they want. McDonald’s original menu consisted of burgers, fries, and shakes (maybe sodas too). Their menu has evolved so much over the years that even the McDonald’s menu of 10 years ago would be almost unrecognizable compared to today.

Why McDonalds Will Stay Great

The main difference lately has been the trend toward healthier options. First, McDonald’s got rid of their well-liked “super-size” option. Then, gradually over the past several years, healthier menu options began appearing on the menu. This year, the company has said it plans to focus more energy on its breakfast menu, and just a few days ago announced that it will be introducing an egg white version of its famous Egg McMuffin sandwich, which had been completely unchanged for many years.

The point of all of this is that not only will these changes allow McDonald’s to attract new, more health-conscious customers, while retaining its current customer base. Additionally, healthier options tend to have higher profit margins, as consumers are willing to pay more of a premium for quality.

McDonalds is the most innovative company in its industry, and oftentimes they are a trendsetter, copied by their aforementioned rivals. If you don’t believe me about McDonald’s innovation run a search for a McDonald’s menu from 2000 and compare it with today’s. Do the same for Burger King. Theirs looks almost identical to today’s, save for a few items and the fact that the menu is on LCD screens now.

Valuation

Let’s see how McDonald’s compares to its rivals in terms of valuation. McDonald’s trades for 18.6 times TTM earnings, with a 9% forward growth rate projected (which I feel is a bit conservative, especially if their new breakfast offerings catch on). The company also offers a dividend yield of approximately 3.1%, which has been increased like clockwork every year in recent history (see below).

The Alternatives

Burger King Worldwide seems a bit pricey in comparison, trading for 27.7 times 2012’s earnings. Consensus estimates call for earnings to rise at a 16% rate over the next several years; however I think this is far from certain. Additionally, Burger King is carrying over $3 billion in debt on its balance sheet (almost half of its market cap).

Wendy’s trades for an even pricier 32.6 times earnings, and looks to be by far the most speculative play of the group. The average of the analysts covering the stock calls for about 10% annual growth going forward, but the estimates range from zero growth to over 20% annually. In other words, no one really knows what’s going on with Wendy’s. Wendy’s also has an excessive level of debt, even more that Burger King in relation to their size.

While Burger King and Wendy’s are the closest competitors, product-wise, I’d like to take a quick look at another company with a similar global reach and brand recognition to McDonald’s, YUM Brands! (NYSE: YUM), which is the parent company of KFC, Pizza Hut, and Taco Bell.

With a total of about 39,000 units all over the world, you can see why I think Yum makes a more valid comparison to McDonalds than the two other burger chains. Yum trades for 20.8 times earnings, with 12% annual growth going forward. They also have a very acceptable level of debt, and pay a decent dividend (1.9%).

To Sum It Up…

While Yum looks like a pretty good company (and it is), I still prefer McDonalds. I believe in them as an innovator and trendsetter and I think their growth will exceed all expectations as they transition to accommodate a healthier-eating public. Also, as an income investor, their track record of dividend raises is one of the best in the market. I highly recommend that all investors take a serious look at McDonald’s for their portfolios, as a great play for years to come.


Matthew Frankel 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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