If you try to narrow down one single deciding factor that favors either fast food or restaurant stocks, the metrics are all over the place. If one is going purely by share price change, then Domino’s Pizza, Inc. (NYSE:DPZ) has been the better buy by far the last 5 years. However, any long-term investor knows that past performance isn’t really a good indicator of future performance. If you are going by profit margins, McDonald’s Corporation (NYSE:MCD) turns into the better play, with 5 year profit margin averages near 20%. However, they have the largest market cap (over $120 billion) and one could say most of the easy money has already been made since the Great Recession (over 91%). Instead, we need to dive deeper and find out what the following 5 companies, each of which represents a key sector of the restaurant industry, are doing now and where they may be going.
Darden Restaurants, Inc. (NYSE:DRI) owns this category of the traditional sit-down full-service restaurant. With 2,107 restaurants (up from 1,959 a year ago) in the US and Canada that includes Red Lobster, Olive Garden, LongHorn Steakhouse, The Capital Grille, Seasons 52, Eddie V’s, and the newly acquired 43 Yard House’s, Darden Restaurants, Inc. (NYSE:DRI) is still in growth mode. According to Forbes, Darden Restaurants, Inc. (NYSE:DRI) is now the 417th largest company in the US. They have been able to reach this level by beating their 5 year quarterly net income average of $105 million in 4 of the last 5 quarters. Analysts earlier this year had price targets of $50-$52 per share when the stock was still trading in the $40 per share range. The stock already trades at nearly $53 per share and has increased over 17% this year alone. Arguably the industry leader in the full-service category, and trading at just 13 times earnings, Darden Restaurants, Inc. (NYSE:DRI) has the potential to go even higher–especially if the economy continues to improve.
The Restaurant/Gift Store Hybrid
By definition, hybrid means a product made by combining two different elements. Cracker Barrel Old Country Store, Inc. (NASDAQ:CBRL)’s 621 stores across 42 states fits this definition, since 80% of the company’s revenue comes from the restaurant portion while the rest comes from the gift store located adjacent to each one. The stock has been on a run with over 30% gains this year alone. Profits rose 19% from a year ago based on February earnings. In addition to earnings guidance recently being raised by a dime, the company has made news regarding insiders and big players buying. Director Glenn A. Davenport in October of last year bought 1000 shares of the stock for $67 a share. However, Sardar Biglari and his San Antonio firm is the restaurant’s largest shareholder with a 19.99% stake, but still doesn’t have a board seat since he also owns supposed competitor Steak ‘n Shake.
The Portfolio of Restaurants
When it comes to companies with fast food collections, Yum! Brands, Inc. (NYSE:YUM) is the prototype. The global fast food company has 39,000 units in more than 130 countries and territories–its brands include KFC, Pizza Hut, Taco Bell, and Little Sheep, and each has high expectations to continue to grow. Recently, the growth has halted in China after chicken was found to have too many antibiotics for China’s liking. Operation Thunder, according to Yum! Brands, Inc. (NYSE:YUM), is in full effect to try to fix the PR nightmare and rebuild the brand in China. Earnings were mostly positive despite the recent dilemma since April earnings showed EPS of $0.70, which beat expectations of $0.60 a share. There was a 20% drop in the quarter from China, but since only 5,300 locations of the massive 39,000 in total are in China, Operation Thunder isn’t nearly as extensive as it could be.
The Takeout/Delivery Chain
Domino’s Pizza, Inc. (NYSE:DPZ) has over 10,330 stores (200 more than in 2012) in over 70 international markets and is the epitome of the takeout restaurant category. Seen as the ultimate comeback story (from trading at around $3 per share in 2008 to approaching $60 per share this year), Domino’s Pizza, Inc. (NYSE:DPZ) is using technology and not just pizza to attract customers. In seeking to improve transparency of the food and delivery process, they are going one more step beyond their Online Pizza Tracker program. Recently, they have further distanced and differentiated themselves from the competition by introducing live streaming video of pizza being made called Domino’s Pizza, Inc. (NYSE:DPZ) Live. Now users are able to see their pizza cook in real-time (minus the sound).
The Fast Food King
McDonald’s Corporation (NYSE:MCD) and their 34,565 restaurants across 119 countries earns them the title of king of fast food. Recently, they have had sales weaknesses overseas, with sales drops of 0.6% globally while the US continues to increase at a slow but steady pace of 0.7%. The company is known for changing their menu routinely to meet seasonal needs like fish sandwiches while following dietary trends. McDonald’s Corporation (NYSE:MCD) has also recently added Chicken McWraps and lower calories Egg McMuffins that are made with egg whites. While the menu evolves, and revenue is now up to $6.6 billion (1% increase), same-store sales, measured for stores open longer than a year, dropped 1.2%.
| Profit Margin (5 Yr Average) | EPS (5 Yr Average) | P/E Ratio | Market Cap | 5 Yr Price Change | |
|---|---|---|---|---|---|
| Darden Restaurant | 5.50% | 1.25 | 16.16 | 6.88B | 45.03% |
| Cracker Barrel | 3.53% | 1.47 | 17.81 | 1.99B | 124.46% |
| Yum! Brands | 10.53% | 0.65 | 21.73 | 30.75B | 68.81% |
| Domino’s Pizza | 5.86% | 0.39 | 26.31 | 3.18B | 318.27% |
| McDonald’s | 19.91% | 1.18 | 19.01 | 102.71B | 67.99% |
The Winner Is…
Domino’s Pizza, Inc. (NYSE:DPZ) has clearly been the best the last 5 years in terms of stock appreciation. Going back 2 years further, McDonald’s Corporation (NYSE:MCD) beats the other 4 companies with a 222% share price gains. Neither is my choice for best stock going forward, however–that goes to Yum! Brands, Inc. (NYSE:YUM). First, there are clear advantages that fast food has over full-service restaurant business models. The menu can change much quicker in a fast food model with fewer consequences. If you want to test the market, you can easily invest in a new item while keeping the rest of the menu intact. Higher consumer traffic makes it easier to gauge if the new item is worthy of a permanent spot. In addition, it is easier to expand fast food at a faster rate. Smaller square footage requirements, up-front costs, and less staffing needs (in terms of pay rates and quantity) favor fast food. As a consequence, profit margins suffer in the full service restaurant model.
Industry trends point out that full-service restaurants suffer more during a sluggish economy. However, even if the economy improves, the world is becoming faster and more time-oriented. During the Great Recession, fast food saw visits increase slightly while full-service restaurants saw 2.9% declines and a 3% drop in visits. While the 3%-4% predictions of a rise in food prices for 2013 based on the Department of Agriculture may hurt the margins of a dollar or value menu, Yum! Brands, Inc. (NYSE:YUM) portfolio is diversified enough to succeed in this scenario. Their fried chicken continues to be profitable even when prices rise. Furthermore, if milk and its byproducts hurt the pizza sector, Yum! Brands, Inc. (NYSE:YUM) diversification helps it beat Domino’s Pizza, Inc. (NYSE:DPZ). While Domino’s has clearly been the best investment in recent years, the industry is flooded with pizza take-outs and the barriers to entry are quite low.
Lastly, although China slowly brings down Yum! Brands, Inc. (NYSE:YUM) in the short-term, this is about the long-term investment potential. In time business will eventually return in China, and this makes Yum! an even better buy now that the stock has dropped slightly from its 52-week highs.
The article Which is a Better Long-Term Investment, Fast Food or Restaurants? originally appeared on Fool.com and is written by Michael Carter.
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