The Wendy’s Company (WEN), Yum! Brands, Inc. (YUM): Two Tasty Stocks in the Restaurant Business

From my point of view, this considerably moated company stands as a buy, since it trades at 21.6 times its earnings, a 20% discount to the industry mean valuation, while expected to deliver growth rates of about 12% in the years to come.

Tim Hortons: The great player in Canada

Tim Hortons is, by far, Canada’s leading quick-service restaurant (QSR), capturing about 30% of the industry’s total revenue. Its scale provides it with several advantages over its competitors, especially in the advertising and real estate fields, but also in cost control, supplier leverage, and other related areas. The company is also huge in the coffee business, where it controls 77% of the customer traffic of Canada’s brewed coffee in the quick-service category (Morningstar).

Another advantage central to Tim Hortons’ success is its highly franchised business model which provides it with rich and constant cash flows; actually, almost all of its stores are operated through franchise agreements.

However, this business faces several risks that derive from the cyclical nature of the industry in which it competes. Growth opportunities seem limited too, mainly due to fierce competition in the U.S. and an already very high presence in some main Canadian markets. However, international expansion is conceived as one of the main routes for revenue growth. Despite the competition, the U.S. market, especially, still provides plenty of opportunities to expand the firm’s presence.

Valued very similar to Yum! Brands, Tim Hortons trades at 21.2 times its earnings and pretty close to its 10-year high of $58.05 per share. This seems a little expensive to me, considering its below-average income growth over the past few years, combined with declining gross and operating margins. Given this situation, I would recommend holding for now, as other stocks in the industry look more appealing and offer better growth projections at lower stock prices.

Bottom line

Every cyclical industry has its risks. The fast-food segment is not an exception. However, playing big, in this case, could be playing safe. The Wendy’s Company (NASDAQ:WEN) and Yum! Brands are fairly moated companies that offer compelling growth prospects at below-average valuations. I would recommend considering these two stocks for your long-term portfolio as the middle class and disposable income grow around the world.

Damian Illia has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

The article Two Tasty Stocks in the Restaurant Business originally appeared on Fool.com and is written by Damian Illia.

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

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