Love it or hate it, it seems that everywhere you turn nowadays, there's a fast food restaurant nearby. At the same time, it's hard to blame fast food companies for expanding so aggressively. Though their meals are inexpensive, the best quick-service restaurants can be extraordinarily lucrative for patient investors.
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But not all fast food chains are created equal. And some serve as much more effective gauges for understanding the health and changing nature of the fast food industry as a whole. In my opinion, then, these three stocks offer the most valuable insight for investors looking to put money to work in fast food:
1. McDonald's Corporation
First, with more than 36,000 locations in over 100 countries, you can't ignore the global fast food juggernaut that is McDonald's.
Photo: The Motley Fool
But despite its enormous size, McDonald's isn't impervious to weakness. Only a few weeks ago, McDonald's announced that global comparable store sales fell 0.6% year over year in April, including a 2.3% decline in the U.S., a 1% gain in Europe, and a 3.8% drop in its Asia/Pacific, Middle East, and Africa segment.
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This wasn't an isolated month of weakness; April marked McDonald's 11th straight month of declining global comps.For that, investors can thank a variety of challenges, from increasing labor and food costs to consumers' waning preference for McDonald's food compared to higher-quality -- and slightly higher-priced -- wares from competitors in the fast-casual space.
McDonald's also stated it will stop providing monthly reports on same-store sales going forward -- something the company has done consistently since 2003 -- and instead will report the metric on a quarterly basis.
To be fair, that's consistent with the reporting habits of nearly every other publicly traded restaurant chain. McDonald's CEO Steve Easterbrook also insisted that the move is being made "to focus our activities and conversations around the strategic, longer-term actions we are taking." Only a few days earlier, McDonald's had unveiled the initial steps in a long-term turnaround plan with three main priorities: "Driving operational growth, returning excitement to our brand, and unlocking financial value."
As a result, McDonald's is restructuring its business to better capitalize on key market segments, Easterbrook explained, using "streamlined teams with fewer layers and less bureaucracy." McDonald's also intends to refranchise 3,500 restaurants by the end of 2018. This accelerates its previous pace -- which called for refranchising 1,500 locations by 2016 -- and will increase the global percentage of franchised restaurants from around 81% to 90%.
Finally, McDonald's is aiming to use its new structure and refranchising strategy to reduce general and administrative expenses by $300 million annually over the next two years. Thanks to its strong balance sheet and cash generation, McDonald's will also return $8 billion to $9 billion to shareholders in 2015, and set a goal of reaching the top end of its $18 billion to $20 billion three-year target for cash returned to shareholders by the end of next year.
2. Yum! Brands
Another fast food giant to watch is Yum! Brands, best known as the owner of Taco Bell, Kentucky Fried Chicken, and Pizza Hut. Between these three chains, Yum! Brands boasts an incredible restaurant base of over 41,000 locations in more than 125 countries and territories.
KFC is showing improvement in China, Photo: Yum! Brands,
But like McDonald's, Yum! Brands has suffered from weaker-than-expected results amid increased competition and -- arguably even more significant -- sluggish sales from KFC in China. For the latter, Yum! can thank widely reported meat handling issues with one of its now-former Chinese suppliers last September.
To be fair, Yum! Brands SVP Jonathan Blum told me at the time that the company immediately severed ties with the supplier, and that the supplier only provided two breakfast items to KFC in the region. Even so, the incident predictably hurt KFC's rapport with consumers, and the chain only recently began to show moderate signs of improvement there.
In addition, Yum! Brands is working hard to bolster performance at Pizza Hut in the U.S. Despite an ambitious brand and menu revamp launched last November, Pizza Hut lagged behind other concepts last quarter with a modest 2% increase in sales, driven entirely by new locations.
According to Blum, U.S. consumers seem to be enjoying the new Pizza Hut, with as many as 90% of diners who try the new menu items intending to buy them again. But for now, the trick is convincing consumers to actually try those items in the first place. As Blum statedin April, Pizza Hut's "competition is doing a better job defining differentiation."
That said, Taco Bell is firing on all cylinders, with revenue climbing 9% year over year last quarter on 3% unit growth and a 6% increase in comparable store sales.
It should come as no surprise, then, that Yum! Brands is implementing initiatives to not only expand Taco Bell internationally in markets like India, but also tonearly double revenue from U.S. Taco Bell locations to $14 billion by 2021. To achieve the majority of that growth, Yum! is taking advantage of its new breakfast day part as well as building thousands of new locations in small towns and traditional suburban markets.
3. Popeyes Louisiana Kitchen
Finally, I think investors should consider watching a smaller player in the fast food space: Popeyes Louisiana Kitchen. After all, Popeyes has shown an enviable track record of turning in solid results quarter after quarter.
Just last week, Popeyes reported a 13.4% increase in quarterly revenue to $79.5 million, and a 22.5% increase in net income to $13.6 million, or $0.58 per share. That's small beans compared to Mickey D's and Yum! Brands, for sure, but the latter figure handily outpaced analysts expectations for earnings of $0.54 per share.
Credit: Popeyes Louisiana Kitchen
Popeyes credits its strong results to what CEO Cheryl Bachelder calls its "five pillar strategic road map," comprised of admirable goals including "build a distinctive brand," "create memorable experiences," "grow restaurant profits," "accelerate 'quality' restaurant openings," and "develop servant leaders."
As a result, Popeyes' U.S. same-store sales have outperformed the chicken-QSR segment for an incredible 28 consecutive quarters, and beat the overall QSR segment for the 14th straight time. And much to Yum! Brands' chagrin, Popeyes' share of the chicken-QSR market rose to 24.6% by the end of last quarter, up from 22.3% in the year-ago period.
Popeyes is also expanding quickly overseas, with 85 to 95 new franchised locations expected to open internationally this year. For perspective, the midpoint of that range represents around two-thirds of Popeyes' total anticipated restaurant development this year, which (in total) will increase its restaurant base by around 5% to 6%.
Combine that with an expected 4.5% increase in same-store sales, and it's no wonder the stock trades at a relative premium of 32 times trailing 12-month earnings, and 25 times next year's estimates as of this writing. In the end, if Popeyes can continue its healthy growth while taking market share from larger competitors, I won't be the least bit surprised if it, too, keeps rewarding patient investors from here.
The article 3 Stocks to Watch in Fast Food originally appeared on Fool.com.
Steve Symington has no position in any stocks mentioned. The Motley Fool recommends Popeyes Louisiana Kitchen. 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.
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