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Ask the Investor

Question: “Are restaurant stocks a good investment?”

By: Ryan Fulmer
Sunday, February 4, 2018

Often as I have been driving around town, I wonder how all of these restaurants survive! Everywhere you look there are new restaurants in Stark County.  However, it does not matter whether the restaurant is new or old because there will be a 6o minute wait.

If you have had similar experiences, it may not surprise you to know that Ohio has one of the highest fast-food ratios with 3.78 restaurants per 10,000 individuals. If you are wondering, Kentucky placed first with 4.14 fast-food restaurants. So, perhaps we are a little biased in Stark County!

Despite what might appear as oversaturation of restaurants, the stocks as a group have done quite well over the last few years. A few companies that stand-out during the previous five years include: Wendy’s (+220%), McDonald’s (+87%), Pizza Hut/Taco Bell/KFC (+83%), Burger King / Tim Horton’s (+55%). 

Fast-food restaurants are considered Consumer Discretionary stocks because their sales tend to fluctuate based on the “discretion” of how their patrons are feeling. If patrons are getting raises and able to work more hours, they are more inclined to eat-out versus making dinner at home.

Other factors that affect fast-food stocks are wages and food price inflation, changes to personal income, and the relative competition within a geographic market.

Consumer spending significantly influences restaurants sales; let’s take a quick look at how an improving economy and recent tax cuts are likely to change spending.

Continued hiring by companies is a good indicator of economic strength. Total nonfarm payrolls have continued to improve at about 1.4% on a year-over-year basis. The trend has been consistent and might explain why wages and salaries increased 4.5% in November and 3.6% in October.

When both of these factors are combined, it paints a good picture of an indicator called disposable personal income. In July 2017, growth in disposable personal income increased 2.40% year-over-year, but over the last six months, it has grown each month to 3.87% in December. 

Lower taxes will affect take-home income, and in 2018 some economists expect the tax-cuts to stimulate disposable income growth by an additional 0.30%, or a level that we have not seen since late 2014.

The macroeconomic picture looks quite favorable for the fast-food space, so which stocks might benefit?

Even though McDonald’s stock has done well over the last few years, we think the relatively new CEO, Steve Easterbrook, will continue his turnaround of a comparatively stable franchise. Over the next few years, we believe McDonald’s same-store-sales (SSS) will continue to rise given the supportive economy, as well as strategic initiatives like additional refranchising, remodels, and continued product evolution (e.g., fresh beef).

Management has a track-record of growing its dividends and repurchasing shares, which we think could be well over $20BN between now and 2019. 

It might be worth reviewing the investment merits of McDonald’s in the context of your overall goals and risk tolerance.

 

Source: Dun and Bradstreet / “FindTheBest,” Goldman Sachs Research, Barclay’s Research

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