Four fast food chains that seem poised for super-sized gains

As the industry continues to bloom, these stocks appear as compelling growth stories.

Vikram Barhat 19 February, 2016 | 6:00PM
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The fast pace of modern life has taken a big bite out of mealtime indulgences. Most of us are grabbing a meal on the go or eating at our workstations. As more people seek convenient meal options -- precooked or preheated and served to-go -- the fast food restaurant industry continues to bloom.

The U.S. fast food restaurant market racked up nearly US$191 billion in revenue in 2013, according to market research firm IBISWorld. By 2018, this figure is forecasted to exceed US$210 billion, generating increasing revenue year after year.

The fast food industry is not without its challenges, most of which are posed by economic uncertainty and changing perceptions about health. However, many fast food chains have continued to grow by adopting new practices and offering new products through menu innovation. They are also expanding their global footprint to fast growing emerging markets in order to offset sluggishness in the more saturated developed markets.

Some of these companies are compelling growth stories with double-digit annual revenue growth and a healthy cash flow, making them attractive potential investments, according to Morningstar equity research.

Starbucks Corp.
Ticker SBUX
Current yield 1.25%
Forward P/E 26.2
Price US$57.63
Fair value US$65
Data as of Feb. 17, 2016

 Starbucks Corp. (SBUX) is the world's largest coffee chain that sells coffee, cold blended beverages, food and accessories. The company also retails packaged and single-serve coffee, tea, juice and pastries through its own stores, and markets bottled beverages and ice creams through partnerships.

Starbucks recently announced its plans to open 500 stores in China this year. "Starbucks' international opportunities are undeniable--particularly in China, India, Japan and Brazil," said R.J. Hottovy, sector strategist at Morningstar, in a report.

Hottovy forecasted average annual top-line growth of 10% and operating margins nearing the mid-20s over the next 10 years. "The company is just starting to scratch the surface of its longer-term channel, brand, geographic and technological growth potential," he said, noting that despite its ambitious growth plans, the company can sustain a 40% to 45% dividend payout, with average annual dividend growth in mid-teens over the next decade.

Starbucks has "strong brand equity, bargaining clout with suppliers of all kinds and a leverageable model," all of which extend to international markets, said Hottovy, who recently raised the stock's fair value from US$64 to US$65, implying a 3% free cash flow yield.

Yum Brands Inc.
Ticker YUM
Current yield 2.44%
Forward P/E 17.3
Price US$71.20
Fair value US$92
Data as of Feb. 17, 2016

 Yum Brands Inc. (YUM) operates one of the largest global quick-service restaurant systems including KFC, Pizza Hut and Taco Bell. The chain generated US$44 billion in system-wide sales during 2015 and US$2.2 billion in adjusted operating profit. Yum plans to separate into two publicly traded companies--Yum Brands and Yum China--in 2016.

Although competition is on the rise, Yum offers one of the more compelling global growth stories in its sector, said Hottovy, who is particularly sanguine about the firm's China expansion as a driver of growth. "We remain optimistic about Yum China's longer-term potential given a fragmented restaurant industry, an expanding China middle class, urbanization trends and the market becoming conducive to franchising," he said.

However, Yum is more than a China story. "With ample advertising resources, a consistent customer experience and a menu tailored for geographic preferences, Yum possesses some of the most universally recognized brands in the quick-service restaurant category," Hottovy said in a Morningstar equity report.

Intangible assets inherent in its brand portfolio, solid franchise network, clout with suppliers and scalability create a sustainable competitive advantage for Yum Brands, said Hottovy who puts the stock's worth at US$92, which implies enterprise value/EBITDA of 13 times, and around 3% free cash flow yield.

Dunkin' Brands Group Inc.
Ticker DNKN
Current yield 2.41%
Forward P/E 17.0
Price US$44
Fair value US$48
Data as of Feb. 17, 2016

 Dunkin' Brands (DNKN) sells hot and cold coffee, baked goods and ice cream through Dunkin' Donuts (76% of revenue) and Baskin-Robbins (23%). The company, which also generates revenue through franchise royalties and rent payments, clocked a staggering US$9.8 billion in system-wide sales in 2014, making it the second-largest global beverage and snack chain.

"Dunkin' Brands offers investors an intriguing cash flow growth story backed by the intangible assets inherent in the Dunkin' Donuts brand and a strong franchisee system," Hottovy said in a report.

The group reported nearly US$811 million in revenue for 2015, an 8.5% jump over the previous year. "Dunkin's strong free cash flow generation and lack of near-term debt maturities should also drive total shareholder returns through dividend increases," said the report.

Buoyed by its 2015 performance, the management declared a quarterly cash dividend of US$0.30 per share, a 13% increase, payable on March 16.

Dunkin' boasts category-leading annual operating margins of close to 49%, which Hottovy forecasted to expand to 57% by 2024, with returns on invested capital in the mid- to high 20s. He estimates the stock's fair value to be US$48, which incorporates an enterprise value/adjusted EBITDA multiple of 14 times, and around 5% free cash flow yield.

Restaurant Brands International Inc.
Ticker QSR
Current yield 1.22%
Forward P/E -
Price US$47.30
Fair value US$55
Data as of Feb. 17, 2016

The third-largest quick service restaurant chain,  Restaurant Brands International Inc. (QSR) is the parent company of Burger King and Tim Hortons. The global fast food chain generated US$23.5 billion in sales from its 19,500 restaurants in 2014.

The consolidation of the Burger King and Tim Hortons franchisee systems created sizeable unit growth and cost reduction opportunities, as well as the potential to add to its brands portfolio over time, said a Morningstar equity report.

"Backed by its strong brand recognition, consistent customer experience and a menu balancing core choices with locally relevant menu choices, Burger King is among the handful of restaurant brands to be successfully replicated across the globe," Hottovy said the report.

Hottovy said Burger King's global reach, with a large network of franchisees in the United States, Latin America and Europe, will help boost the Tim Hortons brand outside of Canada. On the other hand, "the acquisition of Tim Hortons enhances Restaurant Brands' longer-term cash flow potential," he added.

The company is set for an explosive growth by way of international expansion. The Morningstar report projected the company could have approximately 31,000 restaurants around the world (23,400 Burger King and 7,600 Tim Hortons locations) over the next 10 years, implying mid-single-digit annual growth, and operating margin expansion from around 40% at present to the low 50s, achieved through greater economies of scale in emerging markets.

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About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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