I happen to like fast food. You may not and it really doesn’t matter; whether you like fast food or not, don’t miss the opportunity to grab a serving of profits from the businesses that provide it. The fast food industry does well in bad economic times as it provides food that large numbers of people like at prices they can afford. It does even better in good economic times when people can afford more of what they like.
However, just because a business has food that customers enjoy does not necessarily mean it presents a good opportunity for profits. Management must be able to operate the business in an efficient and profitable manner as well as providing a product the public wants to consume. In reviewing three of the major fast food names, Burger King Worldwide Inc (NYSE:BKW), McDonald’s Corporation (NYSE:MCD) and Yum! Brands, Inc. (NYSE:YUM), we can find clear examples of the difference.
My favorite fast food but a distasteful investment
When I want a fast-food burger, I love to have a Whopper with cheese. When I was a child, there was a Burger King within four blocks of my house, and I could walk there once in a while and buy a Whopper with cheese for about $0.45 as a special treat. The current business side of Burger King is not quite as appealing as those childhood memories.
In 2002 Burger King Worldwide Inc (NYSE:BKW) was purchased by a private equity alliance of Texas Pacific Group, Bain Capital Partners and Goldman Sachs Group, Inc. (NYSE:GS). In 2006, the business was sold in a public offering and remained publicly traded until 2010 when it was purchased by 3G Capital Partners and taken private again. In June of 2012, Burger King was once again sold to the public in a stock offering.
After all of this turmoil, the company now has a current P/E multiple of 58.94, a forward P/E of 21.85 and a debt to equity ratio of 2.6. The business only generates enough income to cover the interest payments on its debt 1.7 times, and it produced a net margin of a meager 5.99% last year. While I like the food, I like my capital too much to risk it here.
You can’t argue with success
One of the most successful businesses of my lifetime has been McDonald’s Corporation (NYSE:MCD). No matter which restaurant you enter, the food is consistent, the service is fast and the prices are reasonable for the products provided. You can go anywhere in the world and the golden arches are known and recognized by virtually everyone. The management of McDonald’s has done a masterful job of building a powerful global brand.
While the stock might seem to be just a bit expensive with a forward P/E of 15.54 and a 5-year projected earnings growth of only 9.2%, you can’t expect to buy one of the most recognized brands in the world cheaply. However, considering the 3.13% dividend yield and the 5-year average returns on equity, assets and capital of 34.5%, 15.9% and 17.7% respectively, it is virtually impossible to argue that the stock is overpriced. Once the annual dividend increase of 13.86% for the last five years is included, it is clear that this business is attractively priced. The management here obviously knows how to reward the owners. McDonald’s Corporation (NYSE:MCD) might not serve up my favorite burger but I can take the profits from the investment and go eat anywhere I choose.
Multiple categories equal less risk
We all know diversification helps to spread risk, and that holds true in the fast food business as well. Yum! Brands, Inc. (NYSE:YUM) has done an excellent job of developing a diverse set of offerings through three distinct brands. The brands are KFC, Pizza Hut and Taco Bell, and all three serve very popular food types. Also, as with McDonald’s, they have done an exceptional job of maintaining consistency of product and service across a multi-national business. In China, Yum has done a very good job of building their brand in the fastest growing consumer market in the world. They are also developing new concepts targeted particularly at the Chinese consumers that will aid in future growth.
Yum treats its owners very well. Over the last five years, the dividend has increased at an annualized rate of 22.47%, and the current yield of 1.88% requires a payout rate of only 36%, allowing room for further increases. In addition, the 5-year averages for return on assets and capital are an impressive 15.9% and 21.9%. Considering the global economic conditions during that time makes the results even more impressive.
With a market capitalization approximately 1/3 the size of McDonald’s Corporation (NYSE:MCD) and a successful track record of international expansion, the growth prospects for Yum! Brands, Inc. (NYSE:YUM) are probably superior to those of McDonald’s, making it a compelling opportunity.
The end result
While Burger King Worldwide Inc (NYSE:BKW) has a choppy history and a weak financial foundation, McDonald’s and Yum Brands seem to be poised to continue providing investors with safe, steady returns for many years to come. With projected earnings growth rates around 10% and dividends between 2% and 3%, these two businesses look well positioned to satisfy investors’ appetites for profits, regardless of what you think of the food.
The article Try Fast Food to Satisfy Your Appetite for Profits originally appeared on Fool.com and is written by Ken McGaha.
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