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Why You Shouldn’t Overlook These Fast Food Giants
Posted by: Patricio Kehoe (IP Logged)
Date: October 31, 2013 04:20PM

The quick service restaurant industry has been growing consistently, since the day McDonald’s Corporation (MCD) appeared in 1940. Over 70 years have passed, and the number of chain restaurants has increased vastly. Despite intense market competition, other players have risen to the challenge and succeeded, like Dunkin Brands Group Inc. (DNKN). So let’s take a look at where these two companies currently stand.

Hamburgers and Coke Are a Safe Bet

McDonald’s is the world’s largest and most famous quick-service restaurant in the world. As such, it has established a compelling global network for generating revenue, which includes more than 34,000 affiliate and company units in 120 countries, as well as licensing pacts. Despite a heavily challenging operating environment and fierce industry competitors like Yum Brands or Burger King, this company has withheld outstanding productivity levels. Its average trailing yearly sales of $2.6 million per restaurant, for example, outplays the industry average that stands at the $1 million mark.

This firm’s long-term success and growth is due to many factors, such as a large variety of food and beverage choices (thanks to menu innovations), 24-hour work policies and affordable prices. And the overall improvement of the customer’s experience has worked like a charm. Today you can choose between eating a McWrap or an Egg White Delight McMuffin, while browsing the Internet via the free wireless access. The result is consistent restaurant traffic, income boosts and increased productivity.

Another undeniable point in favour of this firm is their brand strength. Thanks to an unmatched advertising budget of $788 million per year, this company boasts one of the most known names worldwide. This has not only led to immediate consumer recognition, but also to an important amount of bargaining power with suppliers. Therefore, the quick-service restaurant can now obtain access to food and raw materials at highly competitive prices. Additionally, McDonalds is enthusiastic about expansion, which explains their $3 billion budget for 1,600 new units in emerging markets and China.

Although this company seems to have all odds in its favor, it is exposed to cyclical headwinds, with high unemployment rates and fickle commodity costs. However, possessing 45% of the land assets can provide an additional competitive buffer that other restaurants don’t have. Investment guru Joel Greenblatt recognized an opportunity when he bought the stock a few months ago, and currently the stock is trading at a price discount of 28%. And at that bargain price, with guaranteed company growth ahead, I feel very bullish about this company too.

Donuts and Coffee May Go a Long Way

Dunkin Brands is known for producing delicious snacks and beverages, as well as ice creams. Dunkin’ Donuts is its main revenue source, railing in 76% of total sales, while Baskin-Robbins brings home the rest of the pie. The firm operates through company-owned stores, as well as 17,600 franchisees worldwide that earn them steady royalty and rent payments. And this system seems to be paying off. With $8.8 billion earnings in sales last year, this firm is the second largest beverage and snack chain in the world.

Although its main competitor and market leader, Starbucks, holds the reigns in terms of revenue, Dunkin' Brands has established itself firmly in the Northeastern U.S market. With 70% of its Dunkin' Donuts locations in this area, the company has focused on its brand recognition among costumers. And so far, this strategy has paid off. Consumer preference for the enterprise’s products has allowed menu prices to increase, for example by offering pricier limited-time beverages, without disrupting the demand.

Expansion is another big item on this company’s list for future growth. Management has recently announced their plan to open 15,000 more Dunkin' Donuts units in the U.S, over the next years. Also, the firm is currently ranked as the fourth largest restaurant chain outside the U.S, after Yum Brands, McDonald’s, and Subway. Despite Baskin-Robbins’s vulnerability to changing consumer tastes and the fierce local competition of Starbucks, Dunkin’ Brands promises strong chances for further international growth.

In spite of facing the common industry risks of volatile food, energy and labor costs, the firm has been successful in attending to its customers' needs for decades. I feel bullish about this company’s future, but the time to jump in and purchase shares has passed. Currently trading at a 65% price premium relative to the industry average, the stock is overvalued. Investment guru Julian Robertson wasn’t too convinced by the stock’s outlook, as the 27% reduction of his shares in the firm demonstrate.

Two Good Picks, but One Sure Winner

Dunkin' Brands has proven to be a strong industry player in the past. The company even has a narrow economic moat, due to the recognized brand, pricing power and solid franchise system. However, there is just no competing against McDonald’s. Its market value is far superior, with large growth opportunities in the near future. Combined with stocks at a low purchasing price, I believe it’s the all-round winner.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.

Guru Discussed: Joel Greenblatt: Current Portfolio, Stock Picks
Stocks Discussed: MCD, DNKN,
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