Restaurants Stocks to Consider Buying

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

Two of the top restaurant chains in the market have a lot to prove going forward for shareholders. Despite its scale, McDonald's (NYSE: MCD) has still plenty of room to penetrate abroad and Wendy's (NASDAQ: WEN) is undergoing a turnaround. Below, I present my take on both firms.

McDonald’s

McDonald’s is the world’s largest restaurant chain company with around 3,400 restaurants. It has a huge global presence serving at least 100 countries and a market cap of $100 billion.

The company is, however, facing increased competition from other restaurant chains, such as Wendy’s, that have become increasingly popular. And for the first time in nearly a decade, McDonalds witnessed a 1.8% decline in sales in October 2012. Sales have since recovered. The company also returned cash to shareholders through share repurchases and dividends amounting to $5.5 billion.

Going forward, McDonald's main strategy for growth is to increase its global presence. It plans to spend $3.2 billion building 1,500 restaurants and upgrading 1,600 others globally. The company is also financially stable enough to support this plan, considering that it has bought Treasury shares worth $60 billion and continues to invest $3 billion each year.

In 2013, the company hopes to achieve EPS growth of 8% while dividends are expected to grow to $3.20. The entire restaurant industry has been facing headwinds due to declining numbers of customers. This has put McDonald’s management on its toes, and it is already working out ways to improve the company’s performance in the long run. Less than 3% of the company's profit comes from China right now, so it has a huge opportunity expanding into that region.

Wendy’s

Wendy’s is the third largest restaurant chain for hamburgers. It has more than 6,500 restaurants and a presence in around 26 countries outside the world. It finished 2012 strong with consolidated revenue amounting to $2.5 billion in 4Q, a 3% increase compared to 2011. Company-operated same store sales in North America rose by 1.6% for the whole year. Franchise restaurants in North America also registered similar same store increases. Margins for the company-operated restaurants remained the same in 2012 as they were in 2011 at 14%. 

Guidance for 2013 for adjusted EPS had an increased range of between 13% and 25%, which represents a range of $0.18 to $0.20. The company’s ability to register increasing same-store-sales is a major indicator of its stability during challenging times. Hitting the expected 25% EPS increase in 2013 will also place Wendy’s as a preferred stock compared to others in the restaurant industry.

At around 1.2 times book value, Wendy's is a cheap but highly uncertain stock. The industry average price-to-book multiple stands at 7.1. Wendy's is forecasted for double-digit EPS growth over the next five years. Gross margins of 19%, however, are substantially below the 44.2% industry average.

I encourage hedging with a momentum stock, like Dunkin' Brands (NASDAQ: DNKN). This stock may be expensive at around 47 times past earnings, but it has been on a relentless rise -- gaining 62% up to its 52-week high. Analysts are still bullish on the company, which has plenty of upside if it can continue with its international expansion strategy.

Conclusion

Restaurant stocks are fairly expensive right now. However, there is plenty of turnaround and growth potential. I recommend broadly investing across the industry but keeping overall exposure to restaurants limited. With a strong bull market, it is time to position your portfolio more towards undervalued investments.

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David Gould 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. Think you can do better? Join us and write your own!

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