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3 fast-food IPOs that may sizzle
Lots of fast-food restaurant companies are going public, but investors must choose carefully. Here are three IPOs worth a sniff.
By Michael Brush
Given Americans' obsession with counting calories, youd think the last initial public offerings to catch fire would be those of fast-food chains.
Not so. Investors are gobbling them up.
When McDonald's (MCD, news, msgs) spun off part of its popular Chipotle Mexican Grill (CMG, news, msgs) at an IPO price of $22 a share Jan. 26, the stock immediately jumped to $40. It settled in recently at $46.50. That adds up to a tasty 111% gain for anyone who got in on the deal.
Domino's Pizza (DPZ, news, msgs) began trading as a public company at about $13 in the summer of 2004. It recently changed hands for $25.50, nearly a 100% gain.
In the next two months, two more fast-food initial public offerings are about to come off the grill. They are Burger King and Tim Hortons, a popular Canadian coffee, pastry and lunch joint.
Given the way investors are drooling over shares of fast-food chains, youd be smart to get in on these deals during the IPO if you can.
That's the catch: If you can. IPOs are one of the least democratic corners of the investment world. You have to have an account at a brokerage that is helping the company go public. And you need to be a customer who makes a lot of commission-generating trades.
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And if you arent one of the chosen few? Is it worth buying shares of these fast-food chains after they start trading -- and after their share prices jump? Yes, but you have to choose carefully from the menu.
Its all about timing
First, to address one obvious question: Why are so many fast-food chains coming public right now?
Its because of a dirty little secret: As much as we say we want to lose weight, we are hitting the fast-food chains more than ever.
Burger joints from McDonalds to Carl's Jr., a part of CKE Restaurants (CKR, news, msgs), and the drive-through chain Sonic (SONC, news, msgs) have had great success launching new menu items and opening new stores. Investors have noticed, and their stocks are in style.
The group now trades for an average of 19 to 20 times earnings expected over the coming 12 months. The three-year average is about 15, says Solaris Asset Management consumer stock analyst Rob Morton. Companies see those valuations, and obviously they want to come public at those levels, says Morton.
Indeed the popularity -- and rich valuations -- turn the stomachs of value investors. For me as value-oriented buyer, I just wont stretch to these numbers, says David Nierenberg, of Camas, Wash.-based Nierenberg Investment Management.
But that doesnt mean you cant make money in fast-food IPOs as a growth investor. Heres a look at how to play the current crop of fast-food IPOs.
Tim Hortons
Founded in 1964 by National Hockey League star Tim Horton, this fast-food chain is now the biggest in Canada. Though it is scarcely known in the U.S., Tim Hortons is a big deal in Canada.
The chain serves a mix of premium coffee, bagels and pastries. On the lunch menu, it offers home-style soups and fresh sandwiches.
Since 1995, Tim Hortons sales have increased 18.5% a year on average through new store openings and continued growth at existing stores. Tim Hortons still has room to expand in Western provinces of Canada. But the big prize is the U.S. market.
It will be a question of getting people to understand Tim Hortons as a brand, says Dennis Lombardi, who consults on restaurant development at WD Partners in Columbus, Ohio.
Theres good evidence Tim Hortons can pull it off. Over the past 10 years, sales at existing stores have grown 10% a year in the U.S., compared to 7% in Canada. The company has more than 2,500 restaurants in Canada, but just 270 or so in the U.S., located in the Northeast and Midwest. So there is plenty of room to grow.
I think it will be Chipotle Grill-type success, predicts Scott Rothbort, who invests in quick-serve restaurant chains as president of LakeView Asset Management. This is a fresh new brand, a new name that with some capital and independent management can really grow here.
Wendys has owned Hortons since 1995. But now it is spinning the chain out. After the IPO -- which Wendys says will happen before the end of March -- the parent company will still own about 85% of the stock.
Chipotle Mexican Grill
Named after a smoked jalapeno chili pepper, Chipotle (pronounced chi-POAT-lay) serves Mexican food in a format that Mellon Financial analyst David Tuzzolino calls conveyer belt casual.
You watch your meal being made in front of you as it moves down the assembly line, says Tuzzolino, who follows consumer stocks for Mellons Private Wealth Management group.
One attraction is that you can customize your meal along the way -- skip the sour cream, add the olives, etc. Chipotle also has a reputation for quality. It is a notch above average fast food, says Tuzzolino.
These factors help explain why Chipotles growth has been hotter than its tomatillo-red chili salsa. Since 2002 sales are up 44% a year, on average. But there is plenty of room left to grow. With only about 490 restaurants, Chipotle has just 6% of the Mexican fast-food market.
The chains food is such a hit, Prudential Equity Group analyst Larry Miller believes it could have 2,300 stores in nine or 10 years. He says that will support 20% to 25% annual earnings growth over the next five years, if not longer. Despite the promise, Miller has a hold rating on the stock. At $46, it trades at 64 times his 2006 earnings per share estimate of 71 cents.
So if you buy shares now to get a piece of this growth story, plan to hold for the long term. You may have to ride out some near-term downdrafts. At some point, McDonalds will distribute its 69% of Chipotle to McDonalds shareholders. He believes some institutional shareholders who get those shares may be forced to sell because their mandates don't allow them to hold companies as small as Chipotle.
Cutting ties with McDonalds will bring some risks, too. Right now, the bargaining clout of the golden arches helps Chipotle get better deals from suppliers. When it becomes a completely separate entity, those costs go up, says Tuzzolino.
Burger King
While Hortons and Chipotle are exciting growth stories, Burger King is an established company in a space crowded with names like McDonalds, Wendys and Jack in the Box (JBX, news, msgs). Burger King is a great brand with a tremendous signature product in the Whopper, says Lombardi. But it is a mature brand in a mature segment.Burger King IPO
| 1954: First restaurant opened in Miami.
Now: More than 11,220 restaurants.
Operates in 61 countries.
A registration statement with the S.E.C. for an initial public offering is expected in late February or early March. |
So Burger King probably won't explode on its IPO like Chipotle. But it could still generate some nice gains. Here are two of the big issues:
- Connecting with the franchises.
Bought by private-equity firms Texas Pacific Group, Bain Capital and Goldman Sachs Capital Partners in 2002, Burger King is in turnaround mode. The company has cycled through 10 CEOs in the past 15 years, leaving the King on shaky footing.
"That makes franchisees wonder: 'Who is going to be in charge next month, and what are they going to want us to do that is different from what the last person wanted us to do?'" says Lombardi. So beware if current CEO Greg Brenneman leaves shortly after the IPO.
- Who gets the money?
The private-equity firms that have been fixing Burger King want an IPO so they can realize profits for their work. This is natural. But in IPO filings due out soon, look for signs that Burger King is getting enough of the IPO funding to allow it to help franchisees and -- more importantly -- develop the brand. Its going to come down to how they differentiate themselves in the marketplace, says Louis Neeb, who was chairman of the board of Burger King from 1980 to 1982 and now serves as chairman at Mexican Restaurants (CASA, news, msgs). The name of the game in restaurants is getting the customer to drive by somebody else to come to you.
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