Grabbing a Bite in Burger Chain Stocks?

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

In 2013, all restaurants in the food industry expect rising input pressure. This has been driven largely by an increase in the price of corn, a major food ingredient. With that said, the economy is generally improving despite signs of unrest in Europe. How will the large burger chains perform in this environment? Below, I review two key stocks to speculate on.

McDonald's (NYSE: MCD)

Earlier this year, McDonald's guided for a global drop in restaurant sales for the month of January 2013. This forecast was a a result of reduced consumer spending related to macro uncertainty. The forecast ultimately proved accurate in defiance to broader stock market trends. As the global leader in the burger chain industry, McDonald's is seen as a macro bellwether.

In regard to external expectations, Wall Street has forecasted the company experiencing difficulties in early 2013 because of input pressure, rising competition, and increased frugality. Same restaurant sales remained flat globally throughout December, and this was attributed to the small 0.9% increase in same restaurant sales in the U.S. The increase in domestic sales is thought to have resulted not from strong fundamentals but rather from the warm weather that prevailed in December. 

The firm has been facing stiff competition from other fast food restaurants, such as Burger King. To add insult to injury, regressive payroll tax hikes have decreased the spending ability of McDonald's target market. With that said, the firm has been successful in executing. In the recent fourth quarter, the company produced EPS that was $0.05 above the average forecast. Analysts are saying that in spite of the challenges that McDonald's is facing, it is successfully leveraging its enormous size to stabilize business.

Wendy's (NASDAQ: WEN)

While dwarfed by McDonald's, Wendy’s is a leading fast food restaurant chain. The company reported that their business strategy continues to be focused on driving same store growth. Wendy’s has also reported that they are committed to improving shareholder value by targeting growth in operating income and consolidated revenue. In particular, the strategy will be to make strategic acquisitions in the restaurant industry to drive growth (memo to Wendy's management: This is inorganic growth; not same store sales growth). 

In regard to the outlook, it is important to note that the Midwest part of the US is coming out of a drought, and this will lead to a reduced quantity of corn and a subsequent increase in prices. Analysts think that big restaurant chains like McDonald's are better placed to withstand the effect of high prices compared to those like Wendy’s. But although Wendy's has been facing some financial challenges before May 2012, it is now picking up the broken pieces and reported positive third quarter earnings in 2012. It reported revenue growth of 4.1% in the third quarter while same store sales grew by 2.7%. And market research through several independent surveys still ranks Wendy’s as a “top overall mega chain” and ranked Wendy’s at the top of the hamburger category. It is this kind of value that Wendy's is trying to communicate through its aggressive marketing strategy.

Conclusion

While McDonald's is a safe stock, it also trades at a premium 17.8x multiple because of that. Wendy's, which is moving into profitable territory, remains highly uncertain with a consensus rating of 2.9 out of 5 where "5" is a "sell." I encourage considering Yum Brands, which is the leading American fast food chain in China, for higher growth prospects. The stock trades at a respective 19.2x and 17.3x past and forward earnings. It is forecasted for 12.1% annual EPS growth over the next five years, which is around 300 bps below what was achieved in the past five years. And it's not nearly as risky as some will make out--the stock's volatility is 17% below that of the market.


TakeoverAnalyst has no position in any stocks mentioned. The Motley Fool recommends 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. This article was written by the staff of TakeoverAnalyst, which does not intend on opening a position in the next 48 hours.

blog comments powered by Disqus