Everyone Has to Eat Part 2: The Restaurant Oligarchy

By William Bias - June 19, 2012 | Tickers: DRI, MCD, WEN, YUM | 0 Comments

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Everyone has to eat and drink to survive. As an investor one has to ask, ”Can great investment gains be made from investing in the companies that make the items that nourish our body?” In this four part series I examine the investment viability of these companies.

I like to travel. As I travel around I eat in restaurants. In my travels I seem to notice that there are always a certain group of fast-food restaurants that are available at a nearby location for your convenience. Every exit on the interstate on my travels in the north eastern United States seems to have the golden arches of McDonald’s (NYSE: MCD), Wendy’s (NASDAQ: WEN) and at least one Yum! Brands (NYSE: YUM) variety restaurant such as KFC, Taco Bell, or Pizza Hut. If you drive by a shopping mall you are also likely to see a Darden’s (NYSE: DRI) Red Lobster, LongHorn Steakhouse, or Olive Garden. I call these companies the “Restaurant Oligarchy.” A look at two of the biggest companies’ – McDonald’s and Yum! Brands – free cash flow suggests sustained growth and success over the last three years:

I have 5 theories as to what contributes to this success.

1. Convenience- The sheer number of restaurants, especially McDonald’s, allows convenient access. Of the 33,510 McDonald’s restaurants worldwide there were 14,098 restaurants in the United States alone as of the end of 2011. There are also about 16,000 Yum! Brands stores in the United States, so a good KFC meal or a taco from Taco Bell is always just around the corner.
2. The restaurants provide a happy experience while eating- In addition to the pleasure of eating and hanging out with friends and family at a restaurant, some McDonald’s and Yum! Brands stores provide promotional toys for happy meals and kids meals. Darden’s dine-in style at Red Lobster, Olive Garden and LongHorn also provides an excellent setting for a family meal.
3. Product Value- The chains, especially McDonald’s and Yum! Brands provide good value for the product. You can buy McDonald’s hamburgers off the dollar menu and tacos from a Yum! Brands’ Taco Bell for small change.
4. Product Innovation- Restaurants, especially the fast food chains, continually update their products to hold consumers’ interest. McDonald’s food quality seems to get better while prices tend to stay low. Yum! Brands introduces new chicken recipes into their KFC chains. You also see new items on Darden menus from time to time.
5. Foreign Expansion- With restaurants as far as the eye can see one has to wonder where the growth is going to come from. It looks like Yum! and McDonald’s are looking outside the United States for expansion. It is rather obvious from Yum’s 2011 annual report that the CEO of Yum! Brands, David Novak sees a bright future in China and emerging economies. He throws out facts such as the increase in the consuming class in China over the next 10 years, “the consuming class is expected to double over the next 10 years, going from 300 million to at least 600 million people, as significant urbanization continues.” The shareholder letter also talks about how there are “58 restaurants per 1 million people in the United States” and “there are 2 restaurants per 1 million people in emerging markets.” The economic importance of emerging markets is highlighted in the charts below.

McDonald’s largest segment in terms of percentages of revenue comes from Europe which is 40% of total revenue. The largest percentage in growth comes from the Asian continent which is 19%. Wendy’s revenue has minimal foreign exposure at 11%.

An investor should take a hard look and do further research on McDonald’s and Yum! Brands because of their push into foreign markets; in this country they are everywhere and already rule.

Next: Everyone Has to Eat Part 3: Groceries and the Emerging Markets Frontier

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