Should You Invest in These Fast Food Giants?
Leo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Over the past decade, the fast food industry has rapidly evolved. Fast food companies revamped their domestic menus to cater to a more health-conscious population, while expanding overseas in search of higher growth.
Increased competition from a disruptive group of bistro eateries such as Panera Bread and Chipotle also forced lower-end restaurants to offer higher quality food. Meanwhile, a struggling global economy highlighted the importance of value menus. Unpredictable food cost fluctuations and weather conditions have also made it tough to grow margins and profits. In other words, it’s a tough business to thrive in.
Let’s check in on the three largest hamburger restaurants in America - McDonald’s (NYSE: MCD), Wendy’s (NASDAQ: WEN) and Burger King (NYSE: BKW) - to gauge the health and future of the fast food industry.
Industry leader McDonald’s has been constantly dragged down by Europe, which accounts for roughly 40% of its top line. In April, same-store sales in Europe slumped 2.4% as the ongoing European crisis continued. Meanwhile, same-store sales slid 2.9% in the APMEA (Asia-Pacific, Middle East, Africa) region due to the outbreak of the H7N9 avian flu. In Asia, McDonald’s was able to insulate itself better from the impact of the avian flu better than its rival, KFC parent Yum! Brands, thanks to its more diverse non-chicken menu offerings.
On a bright note, McDonald's reported a 0.7% increase in U.S. same-store sales for April, which came in ahead of analyst estimates. McDonald’s attributed this gain to the release of premium McWraps and strong sales of value menu and breakfast items. However, that anemic gain wasn't enough to offset its disastrous overseas results.
McDonald’s has stated that it intends to roll out more limited-time offers to attract more customers as well as diversify its menu offerings. More importantly, the company has stated that it is willing to sacrifice profitability to gain market share, which was reflected in its first quarter earnings. During the first quarter, consolidated net operating income came in flat on a constant currency basis, diluted earnings per share edged up 2% while revenue rose 1%. Same-store sales fell 1.0% worldwide.
While McDonald’s is stuck in a slow growth cycle with low-single digit top and bottom-line growth, rival Wendy’s is taking some big risks by spending heavily to renovate its restaurants to more closely resemble bistro eateries that have been rising in popularity.
Wendy’s is installing flat screen televisions, fireplaces and higher-quality seating areas to its restaurants. The company intends to remodel half of its company-owned restaurants by the end of fiscal 2015. Wendy’s is working to distance itself from McDonald’s and Burger King, choosing to follow the path of Panera Bread and Chipotle by offering higher-quality food in classier environments. Wendy’s new flatbread grilled chicken sandwich, one of its new higher-quality offerings, sold well in April, according to the company.
Although Panera Bread and Chipotle have grown rapidly, it’s uncertain if Wendy’s can replicate that success. These higher costs are a risk for Wendy’s, which just reported that it only earned a penny per share, or $2.1 million, in the first quarter. Although that profit topped modest expectations, it was an 83% decline from the 3 cents per share, or $12.4 million, it earned in the prior year quarter. However, its year-ago earnings included a benefit of $0.05 per share from the sale of an investment, which means that Wendy’s earnings actually slightly improved from last year.
Wendy’s revenue rose 2% to $603.7 million, but missed the consensus estimate of $615 million. Same-store sales were roughly in line with McDonald’s, rising 1% at company-owned locations and 0.6% at franchised ones.
In addition, Wendy’s is focusing on remodeling stores at a time when its competitors are pinching pennies to squeeze out more value menu offerings at thin margins to gain market share. Wendy’s currently offers a “Right Price, Right Size” value menu of items ranging between $1 to $2, but these initiatives have had a limited impact on revenue growth. The company plans to address this problem with new 99-cent offerings during the current quarter.
Meanwhile, Burger King, the third-largest burger chain in America, has been experiencing lopsided growth, with rising profits on declining sales. During its first quarter, Burger King reported that net income more than doubled to $35.8 million, or $0.10 per share, up from $14.3 million, or $0.04 per share, in the prior year quarter. However, revenue plunged 42% to $327.7 million as global same-store sales slid 1.4%, exacerbated by a disappointing 3% decline in the United States and Canada.
Burger King attributed the sales decline to a poor mix of menu items. Alex Macedo, president of Burger King North America, stated that the company “had strayed from the strategy of having both premium and value messages in the marketing mix.” In other words, it wasn’t offering enough value menu items to drive sales, just as Wendy’s reported last quarter. However, Macedo emphasized that the company would bring back promotions such as the $1.29 Whopper Junior and “2 for $5 special”.
Despite Burger King’s value menu weakness, some unique, limited-time offerings such as the Chipotle Whopper, a turkey burger and Cheesy Tots, were well received and helped offset some of those declines. Burger King also borrowed a play from McDonald’s successful McCafe offerings, recently introducing its new coffee program with Seattle’s Best Coffee to complement its breakfast menu. After the program was implemented, coffee sales rose 20%.
Just like Wendy’s, Burger King is renovating its locations to a more modern look. It renovated 600 locations, or 19% of its system, last year, and intends to renovate 40% of its system by the end of fiscal 2015. These renovations were started when the company was taken private in 2010 by 3G Capital, and have continued since its public return last year.
On a positive note, Burger King, which has nearly half of its locations overseas, soundly beat McDonald’s in Europe and Asia, where it posted respective same-store increases of 0.8% and 2.7%. This suggests that although Burger King is smaller and struggling in the Americas, it could evolve into a major contender in overseas markets.
The Foolish bottom line
Studying these three fast food giants reveals several key factors.
First, properly promoted value menus are essential to boosting top-line growth. Second, the rise of bistros have disrupted the market, forcing fast food companies to offer higher-end products in more modern restaurants. This has caused McDonald’s, Wendy’s and Burger King to engage in a tough juggling act to appeal to both lower and middle income customers. Lastly, global expansion can be a blessing when those markets are soaring, but a curse when they are caught in the grips of a recession.
In closing, let’s compare the fundamentals of these three companies.
Source: Yahoo Finance, 5/9/2013
Although the fast food sector’s growth has slowed significantly over the past year, McDonald’s is still the best all-around choice. McDonald's has the cheapest forward valuation and the highest margins, despite its slow same-store sales growth. Meanwhile, Wendy's and Burger King are more speculative investments, as their remodeling and value menu initiatives are still relatively new and unproven.
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.
Leo Sun 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!