Three Fast Food Giants That Will Rule the Planet

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

Editor's Note: The original article referenced McDonald's store plans in China. According to a company spokesperson, McDonald's has not given a store guidance number for China. This version has been corrected.

It's a simple fact of modern life: people will always need quickly prepared food. In an ideal world, that food would be healthy, full of nutrients and vitamins, and not cause morbid obesity and diabetes. Yet despite knowing this, people still love their extra large fries, buckets of fried chicken and venti caramel macchiatos. In my opinion, this is unlikely to change over the course of the next century, despite health concerns.

Over the past decade, a trend has emerged of large American fast food companies moving into countries and dominating their local fast food brands. The local competitors try to fight back, but they usually find it impossible to keep up with the low prices and product volume of these big multinational companies.

Food Inflation Will Help, Not Hamper, Fast Food Growth

Many investors avoid fast food companies due to fears that the rise of commodity prices - starting from oil and spreading to food and raw materials - will hurt the profitability of food suppliers and restaurants.  

While food inflation is inevitable, many investors miss the bigger picture - that the largest fast food companies are able to buy raw materials at a lower price than restaurant chains, smaller supermarkets or the local food truck. They are also able to sell their products much faster, making up for lower margins with higher sales volumes.

In other words, even though fast food restaurants may need to periodically raise prices to keep up with food inflation, eating out at fast food chains will always be significantly cheaper than cooking at home. Fast food stocks are also considered recession-proof, often benefiting from an economic pullback due to lower commodity prices.

Since this fact is a worldwide constant, three major fast food companies will take advantage of this and dominate the planet in the next few decades: Yum! Brands (NYSE: YUM), McDonald’s (NYSE: MCD) and Starbucks (NASDAQ: SBUX). Let’s take a closer look at these three stocks and acknowledge their strengths and weaknesses.

Yum! Brands: Chinese Domination

Over the past five years, Yum Brands, the parent company of KFC, Pizza Hut and Taco Bell, has evolved into an Asian superpower, generating over half of its revenue from China.

In China, Yum has a store count of 4,500, a far larger footprint than McDonald’s 1,600. In addition to its flagship KFC and Pizza Hut brands, Yum also owns local brands East Dawning, a Chinese fast food chain, and Little Sheep, a Mongolian hot pot restaurant. It is the undisputed Western leader in China, where Yum’s flagship brands have become synonymous with “fast food.”

However, Yum expects some tough headwinds in China, warning that same-store sales would drop 6% in the fourth quarter of 2012, a shocking drop from the 21% gain it posted in the prior year quarter.

This was revised from its prior forecast for a 4% decline. An ongoing probe into KFC’s Chinese suppliers, which the government claims are injecting antiviral drugs and growth hormones into their chickens, is expected to dent both Yum’s top and bottom lines. Full-year 2012 earnings were also revised downwards to $3.24, two cents below analyst estimates.

This probe has prompted a social media backlash on Chinese social media site Weibo, where netizens have called for a boycott of all KFC restaurants. The PR blow comes at a time when analysts are increasingly concerned regarding intensifying competition from Taiwanese fried chicken chain Dico and other smaller competitors.

McDonald’s: European Stagnation

McDonald’s staged an incredible comeback between 2009 and 2011, nearly doubling its stock price by the beginning of 2012. A revamped menu promoting healthier items, an expansion of its McCafe coffee and beverages, and strong growth in Europe contributed to McDonald’s rapid growth under the guidance of former CEO Jim Skinner.

Unfortunately, that success came to a grinding halt after the European sovereign debt crisis unfolded. McDonald’s generates approximately 40% of its revenue from Europe. At first, McDonald’s sidestepped the damage, but as the crisis spread to economic leaders France and Germany, where a bulk of its stores lie, the company started to report weak monthly same-store sales.

Back at home, McDonald’s fired its U.S. president, Jan Fields, after the company posted its first monthly sales decline in a decade in October. McDonald’s shares also deflated, dropping more than 10% over the past twelve months, a humbling blow after being crowned “Best Performing Dow Component” in 2011.

Despite this series of setbacks throughout 2012, McDonald’s appears to be gaining strength again, after November same-store sales came in higher than expected.

Starbucks: Asian Ambition

Just like McDonald’s, Starbucks pulled off an epic turnaround between 2008 and 2012, with its stock surging over 400% after the return of founder Howard Schultz. Schultz returned as CEO in 2008 after a disastrous streak of consecutive losses under CEO Jim Donald.

In the fourth quarter of 2012, Starbucks posted a whopping 10% gain in same-store sales in the Asia-Pacific region, including China, easily topping both Yum! and McDonald’s.

Starbucks is now focused on expanding into China, which Schultz considers its most important market. Starbucks plans to reach 1,500 stores in China, more than double its current 700, by the end of fiscal 2013. It expects China to become its second largest market as early as 2014.

Starbucks is also expanding into India and Vietnam, and testing its tea offerings - buffed up by its $620 million acquisition of Teavana - in an attempt to capture non-coffee drinking markets.

Back at home, Starbucks intends to add another 1,500 stores in the United States by the end of fiscal 2015, bringing its total store count to 12,500. Its stated goal is to add 3,000 new stores in the Americas by the end of 2017. In its fourth quarter earnings, North America was Starbucks’ second strongest market, posting 7% same-store sales growth.

Starbucks also has an ace up its sleeve - the Verismo single-serve coffee pod brewer that is designed to compete with Nestle’s Nespresso machines and Green Mountain Coffee Brewer’s (NASDAQ: GMCR) Keurig machines. If Starbucks’ previous success with its Via instant coffee is any indication of its clout in the instant coffee market, then the company is about to create a whole new revenue stream with this disruptive product.

Conclusion

Let’s compare the fundamentals of these three companies, and see which one has the highest growth potential.

<table> <tbody> <tr> <td><strong>Company</strong><br /><strong>(1/7/2012)</strong></td> <td><strong>Trailing P/E</strong></td> <td><strong>Forward P/E</strong></td> <td><strong>5-year PEG Ratio</strong></td> <td><strong>Return on Equity</strong></td> <td><strong>Dividend</strong></td> <td><strong>Beta</strong></td> </tr> <tr> <td><strong>Yum! Brands</strong></td> <td>20.09</td> <td>18.51</td> <td>1.47</td> <td>77.61</td> <td>1.96%</td> <td>0.68</td> </tr> <tr> <td><strong>McDonald’s</strong></td> <td>16.92</td> <td>15.54</td> <td>1.97</td> <td>37.92</td> <td>3.43%</td> <td>0.31</td> </tr> <tr> <td><strong>Starbucks</strong></td> <td>31.11</td> <td>21.26</td> <td>1.40</td> <td>29.15</td> <td>1.51%</td> <td>0.82</td> </tr> </tbody> </table>


From this chart, we can conclude that McDonald’s is the safest choice for conservative investors, with its low beta, high dividend yield and low P/E ratios. However, based on its 5-year PEG ratio (which can be distorted due to unforeseen macro events), it has the lowest growth potential.

We can also gather that Starbucks has plenty of momentum behind it, due to its higher P/E ratios and lower PEG ratio. Starbucks is also heavily traded by short term traders, so its beta is much higher than its peers, and ideal for more risk-tolerant investors.

Yum is the comfortable, middle of the road choice. It trades at healthy P/E levels, its dividend yield is decent, and it has a flexibility to shift between its brands and regions that its competitors lack. However, recent macro and micro concerns in China point to a lower price down the road, so it definitely isn’t a stock to buy right away.

These three choices are all solid picks for your portfolio, but remember to consider the fundamentals as well as the company’s key growth regions. Yum and Starbucks are focused on China and Asia, while McDonald’s is heavily exposed to Europe. Macro concerns, along with currency impacts, could heavily impact shares both positively and negatively. In closing, let’s take a look at how these three stocks have fared over the past twelve months.

<img src="http://media.ycharts.com/charts/532972d15df236af0c23e1134d281b2a.png" />

YUM data by YCharts

Next time you travel abroad, notice how widespread these three companies are, and how popular they are with locals. Then you’ll understand that soon we’ll be dealing with a “Fast Food Planet,” rather than a “Fast Food Nation.”


Leo Sun owns shares of Starbucks. The Motley Fool recommends McDonald's Corp and Starbucks. The Motley Fool owns shares of McDonald's Corp and Starbucks. 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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