Value Line is regarded as the best independent research available. More than just recommendations, Value Line provides the rationale behind its picks for greater understanding.
- Don D., California
Fine Points of the Fast Food Sector.
Fast food chains, also known as quick service restaurants (QSR), comprise the largest segment of the restaurant industry, and have registered a historical compound annual growth rate of 3% in sales. While the $120 billion sector has encountered problems of late, top-line growth is likely to bounce back to its historical average. What’s more, the recent recession has made competition as intense as ever.
Besides competition, the quick service restaurants industry is affected by changes in consumer tastes, national, regional, and local economic conditions, discretionary spending priorities, and demographic trends. Accordingly, success is often determined by varied menus, which offer something for everyone, and affordable selections during breakfast, lunch, and dinner. In order to cater to the widest demographic possible, companies either offer a plethora of products under one brand, or seek to establish multiple concepts, with each striving to attract consumers of various demographics.
In comparing both business models, we have determined that they have a lot in common. Companies from both sides of the aisle feature dine-in, carryout, and in some instances, drive-through or delivery services. Then, there are non-traditional units, which are typically licensed outlets that include express units and kiosks that have a more limited menu and operate in small non-traditional locations, like airports, gasoline stations, and colleges, where a full-scale outlet would not be practical. Too, multi-brand chains (YUM Brands (YUM)) and single concepts (McDonald’s (MCD - Free Analyst Report), Burger King Holdings (BKC)) remain focused on branded affordability, menu variety and beverage choice, convenience, and day-part (breakfast) expansion. Enterprises from both sides of the aisle utilize the combined purchasing power of their respective systems to acquire food and non-perishable items. Lastly, many in both realms tailor their menus to fit local/regional tastes. McDonald’s properties serve beer in Germany, and only pork and chicken in India.
Multi-brand operators, though, typically have a healthier appetite for acquisitions. In order to supplement core growth and balance the risk associated with growing solely in the highly competitive hamburger realm, Jack in the Box Inc. (JACK) acquired Qdoba Restaurant Corporation, operator and franchiser of Qdoba Mexican Grill a few years ago. Too, Arby’s acquired Wendy’s in 2008, with the stated purpose of generating synergies and overhead benefits. While management has devoted significant attention and resources to the consolidation of business practices and support functions, the combined business has yet to show signs of the turnaround. The aforementioned purchase of Qdoba has also failed to live up to expectations. These disappointing results are supposedly reflective of the recent recession. But then Chipotle Mexican Grill (CMG), another concept in the Mexican-food category, continues to churn out profits. Often times, companies make acquisitions for no other reason than to mitigate weakness at an existing brand. Over time, a large number of acquisitions in this sector have turned out to be ill conceived.
McDonald’s, too, has invested in new brands. However, it does not hold on to them for too long. Rather, the fast-food chain typically spin-off other businesses as they become successful. In recent years, it has disposed of Boston Market and Chipotle Mexican Grill, with investors being handsomely rewarded.
The respective management teams at Burger King and McDonald’s (as well as Sonic Corp. (SONC), to a lesser extent) have sought to better utilize their fixed cost base and mitigate labor, commodity, and energy costs. Moreover, this has led them to invest heavily in technology, with the intention of automating as much of the daily operations as possible. This has lowered the need for skilled workers in a labor-intensive sector. Too, it helped sustain operating margins, even during the recession. Here, many of the single brand chains have a notable advantage.
Single-brand companies also have an edge in name recognition. Both, McDonalds and Burger King have invested an enormous amount of capital into marketing, which has boosted visibility. McDonalds, for example, is well known throughout the world and its “Golden Arches” symbol transcends language barriers. This brand exposure is enhanced through a strong relationship with Hollywood. Promotions using feature film-related products, including toys and novelty items, are regularly used to attract customers and promote movies.
A major player in the sector with a multi-brand approach is YUM Brands, which operates three primary concepts (KFC, Pizza Hut, and Taco Bell) and has more than 37,000 (biggest by properties) locations globally. Moreover, a focus on numerous arenas has enabled its brands to become leaders in the chicken, pizza, and Mexican quick service restaurant categories. At YUM, each concept has proprietary menu items and dedicated marketing teams, which has helped to keep each concept’s offerings fresh.
In the single-brand space, McDonald’s, the largest quick service restaurant chain (by sales) has a stellar track record for making the right decisions at the right time. When the company felt its menu was getting stale, it refreshed it. Management kept its classic menu favorites, such as the Big Mac, and added a slew of new products, including Angus burgers. Too, a decision to boost business during the highly profitable breakfast period, with McCafe coffees and value-oriented beverage promotions, has been a tremendous success. In fact, McDonald’s history of successfully adding new products (including value offerings and healthier options) easily outpaces that of their peers in the quick service restaurant space.
In the single brand versus multiple brand comparison, there are companies in both realms that consistently report good results. Success in this highly competitive sector is often determined not only by the popularity of a particular brand, but also by the product offerings available under each concept, and an ability to automate as much of the daily process. Moreover, “being a Jack of all trades, master of none’’ reference applies to a few companies in the multi-brand realm. While they may have a portfolio of brands, single brand chains often offer a more diversified spate of products. That said, in this market, the whole (single brand) is stronger than “ the sum of its parts” (multi-brand). It would behoove investors, interested in the fast-food industry, to focus their attention on the single-brand space.