Old-School Fast Food Stocks Could Be Bad For Your Financial Health. Spice it Up a Little.

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I have been thinking a lot about fast food recently. Of course, that could be due to the fact that I have been on a diet, but it is also to do with a continuing shift in focus by the major companies and the increasing popularity of upstart competitors.

In days gone by, McDonalds (MCD), Wendy’s (WEN) and Burger King (BKW) seemed to fundamentally compete on who made the best burger or the best fries. There were differences for sure, MCD was the standard, WEN had more interesting menu options (chili and baked potatoes for example) and BKW dressed up their “chargrilled” burgers with bacon and mushrooms.

These differences have become blurred as burger chains have all copied one another, however. Their marketing efforts now seem to be focused on one of two things; trying to catch, or maybe create, a trend with new menu items (pretzel bun, anybody?) or attempting to portray themselves as healthy (egg white breakfast sandwich or “satisfries”).

Outside of burgers, Yum! Brands (YUM) has embraced both trends. KFC offers grilled chicken while Taco Bell doesn’t even pretend to be healthy but has had great success by making taco shells out of Doritos. This is all well and good, but the fact that over half of all revenues for YUM come from China has made the stock more a play on the health of the Chinese economy and real estate market than anything.

Despite all of this reinvention, the big four fast food firms seem to be stuck in a rut. While they are busy competing with each other, new competitors are grabbing attention and customers and the big four as a whole seem to have stalled. Combined Q1 and Q2 revenue for MCD increased by 1.68% from 2012 to 2013. Wendy’s managed 1.22% growth in that time, while YUM posted a reduction in revenue of 7.98%. Similar numbers are not available for BKW, which was taken public by private equity firm 3G fairly recently, so no numbers are available before Q3 2012. BKW has, however, seen revenue decline in every quarter since going public. It would seem, then, that the global appetite for traditional fast food is slowing. These companies all make decent profits, but their best days of growth would seem to be behind them.

Real growth is happening among many competitors here in the US. Using the same metric of revenue change from the first half of 2012 to the first half of 2013, Buffalo Wild Wings (BWLD) has grown by 24.4% and Chipotle Mexican Grill (CMG) by 15.9%. It is obviously easier to grow quickly in percentage terms from a smaller base and it should be said that MCD, WEN, BKW and YUM all have a global presence and still dominate the market, but investors are better off looking at BWLD, CMG or a recent IPO such as Noodles and Company (NDLS) if they want capital appreciation.

When I started researching this article, I expected to find that valuation would be a problem for all three of the above emerging companies. The struggles of the traditional powers are well documented and BWLD and CMG have had phenomenal years as you can see.

 

 

In fact, on a forward EPS basis, both BWLD and CMG look reasonably priced as long term investments; by coincidence, both are trading at a 33.02 multiple. Of course, you must bear in mind that forward EPS incorporates some assumptions about profit growth, but compared to many trendy companies, EPS of 32 is very reasonable.

NDLS is a different story. The company only went public a few months ago, so a lot more guesswork is involved in revenue and profit projections and many analysts have yet to initiate coverage, and investing there requires much more of a leap of faith. Predicting the future is more intuitive and reliant on anecdotal evidence than on data analysis, and on that level a company like NDLS which focuses on fresh, relatively healthy ingredients may be where the future is. My kids and their friends, at least, talk more about the latest horror stories of what’s really in a chicken nugget than the latest product lines.

NDLS and CMG have “fresh” and “Healthy” in their image, while BWLD is more about traditional food in a sports setting, but they all rely on bold flavors and spice to sell themselves. Asian noodles, Mexican food and hot wings seem to capture the demand for interesting flavors and innovation better than putting a burger in a different color bun or reducing the fat content of your fries. Assuming that demand for the new continues, I think that BWLD and CMG will continue to outperform the more traditional names in the sector and it is only a matter of time before NDLS joins them.

I know that the death of the fast food industry has been frequently predicted yet always avoided, and I am not predicting that now. It is just that recent disappointments would indicate that the incredible growth of the past is, almost inevitably, coming to an end. If you own stock in any traditional fast food provider and same store sales releases regularly give you indigestion, you may want, oddly enough, to spice it up a little.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Business , Stocks

Referenced Stocks: BKW , BWLD , CMG , MCD , YUM

Martin Tillier


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