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4 tasty fast-food stocks to feast on now
Fast-food restaurants may be making us all heavier or, worse, obese, but theyre still making money for investors. Heres a look at the group -- and the three stocks that look the tastiest just now.
By Robert Walberg
In his documentary film Super Size Me, Morgan Spurlock showed us just how fat were likely to get by eating nothing but McDonalds (MCD, news, msgs) all day long.
Now, it should come as no surprise to any of us that a strict diet of fast-food is an unhealthy way to live. But it might surprise many of you that, by indulging in fast-food stocks over the past year, you could have fattened up your portfolio rather nicely.
Based on a basket of 13 stocks, the average gain over the past 52 weeks is a healthy 54%. Admittedly, the percentage is skewed by Cosi Inc.s (COSI, news, msgs) gain of 420%. But even if we remove that number from the equation, the average gain of 23% is still rather appetizing.
The groups gains have come in a year when the industry is being scrutinized for contributing to the countrys obesity crisis. Its also surprising that sales are rising even though many Americans are obsessed with low-carbohydrate diets. The fast-food chains may have moved quickly to add low-carb alternatives to their menus, but no serious dieter should be making regular stops at Wendys (WEN, news, msgs) or Taco Bell, a division of Yum! Brands (YUM, news, msgs).
No time to sit down to dinner
So why the big gains in sales?
Basically, the industry continues to benefit from two well-established trends: dining out and dining quickly. With both parents working and the kids enrolled in soccer, baseball, martial arts, music or dance, quite often theres just no time for a family to have a nice sit-down meal. Were a country on the go that wants its food to go, which explains why the majority of fast-food revenues come from the drive-through windows. Even doughnut shops have discovered the beauty of the drive-through, as evidenced by Krispy Kreme Doughnuts (KKD, news, msgs) enormous success with the concept.
There is an opposing trend at work as well: Trying to eat healthier at quick service restaurants. This trend explains the explosion in growth of the Panera Bread (PNRA, news, msgs) chain. If there were any business that should have been crushed by the low-carb craze, one with bread in the title would have been a good candidate. However, Paneras appeal comes from its quick, friendly service, pleasant surroundings and relatively healthy offerings of soups, salads and sandwiches. Portions are relatively modest and prices relatively high -- a good mix for the bottom line. And Paneras bottom-line growth is the envy of the industry, with earnings expected to jump 25% this year and another 28% in fiscal year 2005.
Whether its tacos, pizza or burgers served hot and fast or soup and sandwiches served with a smile, theres no denying that Americans have a love affair with fast food. No movie, no matter how revolting, will change that simple fact. We might think twice before super-sizing our fries, but we wont hesitate one minute before grabbing that glazed doughnut, vanilla latte, enchilada or Whopper with cheese. That might just explain why virtually every strip mall in America has a burger joint, pizza place or Subway. Heck, if it werent for fast-food chains and hair/nail salons, the commercial real estate market might well be dead.
But I digress. Lets get back to discussion of how we can fatten up our portfolios by riding the favorable fast-food trends.
The big three subgroups
The industry can be broken down into three subgroups.
- The burger/hotdog chains. These include McDonalds, Wendys, Steak n Shake (SNS, news, msgs), Checkers Drive-In Restaurants (CHKR, news, msgs), Sonic (SONC, news, msgs), Nathans Famous (NATH, news, msgs) and Jack in the Box (JBX, news, msgs).
- Alternative fast-food places. Such as Papa Johns International (PZZA, news, msgs), Arbys, a division of Triarc Companies (TRY, news, msgs), and Taco Bell, KFC, Pizza Hut, A&W All-American Food and Long John Silvers -- all divisions of Yum! Brands.
- Specialty quick-service chains. Here we include Panera, Starbucks (SBUX, news, msgs), Krispy Kreme, Cosi and others.
Growth rates are generally the highest in the last group; the average annual earnings gain over the next five years is projected at anywhere from 20% at Starbucks to 35% for Cosi.
In most cases, however, along with these high growth rates come lofty valuations. The poster child for this is Starbucks. Honestly, this is one of those companies I judged wrong from the start. When the business started years ago, I never thought people would pay $3 for coffee. While Ive been convinced otherwise, theres no way you can convince me the stock is a good buy now when its trading at 3.7 times trailing sales and nearly 48 times this years estimated earnings. Growth has been phenomenal, but its about to slow to under 20%. As it does, the price almost certainly will be compressed.
Panera is another stock thats overpriced at 2.9 times trailing 12-month sales and 29 times fiscal 2004 projected earnings. Its a good company with a good concept, but, at current prices, I wouldnt even nibble at the stock. Meanwhile, Cosis is still searching for profitability, and, with the stock up more than 400% over the past year, I dont think its the wisest of investments just now.
What does look like a decent intermediate- to long-term investment from this group is Krispy Kreme. The stock is down more than 45% over the past year, despite modest earnings growth. One reason for the decline is that the company experienced its first earnings disappointment of note -- citing the low-carb craze for surprisingly sluggish sales. But with fewer than 400 stores worldwide, Krispy Kreme has plenty of room left for growth. In fact, with long-term growth projected at 21% and price to earnings multiples for this year and next of 20.7 and 17.2, the stock is a relative bargain today. And, with the stock hovering just above its 52-week low, theres no need to rush in to buy the shares.
| Dining on Wall Street with Walberg | | Market capitalization | June 22 price | Fwd P/E ratio | Return on equity | Stock price chng. last year | | Recommended now | | | | | | | Krispy Kreme Doughnuts (KKD, news, msgs) | $1.2 billion | $20.07 | 20.7 | 4.5 | 48.90% | | Wendy's International (WEN, news, msgs) | $3.9 billion | $34.64 | 15 | 14 | 21.80% | | Checkers Drive-In Restaurants (CHKR, news, msgs) | $136 million | $11.28 | 13.3 | 19.9 | 7.20% | | Yum! Brands (YUM, news, msgs) | $10 billion | $37.24 | 16.2 | 53.9 | 27.90% | | Hold the mustard | | | | | | | Cosi (COSI, news, msgs) | $201 million | $6.60 | -22.9 | NA | 398.50% | | Starbucks (SBUX, news, msgs) | $17.1 billion | $43.37 | 47.8 | 13.9 | 78.20% | | Nathan's Famous (NATH, news, msgs) | $31 million | $6.06 | NA | NA | 62.60% | | Jack in the Box (JBX, news, msgs) | $1 billion | $29.90 | 13.8 | 14 | 33.20% | | Steak n Shake (SNS, news, msgs) | $492 million | $17.95 | 17.5 | 11.4 | 20.90% | | McDonald's (MCD, news, msgs) | $33.9 billion | $26.94 | 15.7 | 13.4 | 20.10% | | Papa John's Int'l (PZZA, news, msgs) | $512 million | $29.06 | 15 | 20.4 | 3.90% | | Panera Bread (PNRA, news, msgs) | $1.1 billion | $37.13 | 29 | 15.7 | -7.40% | | Triarc (TRY, news, msgs) | $420 million | $10.28 | NA | NA | -65.30% |
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Two burger stocks to look at
Moving to the traditional burger group, McDonalds is enjoying a nice turnaround. At 15.7 times estimated 2004 earnings and long-term growth of 8%, however, the stock seems close to fully priced at current levels. Sonic is also fully priced, while Jack in the Box, Nathans and Steak N Shake suffer from relatively low operating margins and high debt levels.
That leaves two stocks worthy of consideration -- Wendys and Checkers. The former offers the best combination of growth and value, sporting a PE/growth multiple of about 1.0. And with the stock offering a dividend yield of 1.33%, its also one of the more conservative alternatives in the group.
As for Checkers, it is relatively cheap at 0.71 times trailing sales and only 13.4 times this years earnings. One reason for the discounted valuations is that earnings are projected to slide by nearly 23% this year. However, its return on equity of 21.8% is also among the best in the industry, and earnings are expected to bounce back smartly next year. Consequently, investors taking the long view might want to gobble up some shares.
Finally, in the alternative segment, the best choice is Yum! Brands. Unlike the others, Yum! offers diversified food choices, which shelter it from unexpected dietary shifts. Its debt/equity level is a bit high. The company generates enough free cash, however, to help pay down debt, and its margins and return on equity are among the highest in the group. Valuations are also reasonable, though not cheap.
So, even if youre thinking of cutting back on your calorie intake to look better at the beach, dont be quick to dismiss the fast-food industry from your portfolio. Recent gains have been healthy, and favorable industry trends suggest that earnings growth and stock prices will continue to appreciate in the months to come.
At the time of publication, Robert Walberg did not own or control shares of any of the equities mentioned in this column.
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