Investing in fast food stocks is really putting your money where your mouth is.
People love to hate these companies for being fast food restaurants. They focus on the price of a latte at Starbucks (NASDAQ:SBUX) or they talk about how unhealthy McDonald’s (NASDAQ:MCD) food is compared to home cooking.
If the zeitgeist moves in that direction, the popular quick-service chain could lose market share. All it takes is for one of those ideas to take hold and fast food restaurants across the board could see a downturn. It is the nature of the industry, but it also presents a challenge to investors.
On the plus side, when an industry is reactive, there is always opportunity to play the trends and add to the value of your total portfolio. Let’s take a look at Starbucks (ticker symbol: SBUX) and McDonald’s (ticker symbol: MCD) in greater detail.
In Q4, 2018 McDonald’s traded near the top of its 52-week range of $146.84 $178.70. That put the stock at almost 25x times its current earnings and around 20x times its future earnings.
In September 2018, McDonald’s announced that it would raise its quarterly dividend to $1.16 per share from $1.01 an increase of 15%. The company also said it was confident that it would be able to continue growing its sales.
One of the ways McDonald’s has been growing is by stealing customers from Starbucks. Bernstein analyst Sara H. Senatore says that the fast-food giant is attracting customers from the Seattle-based coffee chain with its inexpensive food and drink options. Afternoons have always been a struggle for Starbucks and McDonald’s seems to get the mix right with its $2 McCaf drinks and other value options.
“We’re seeing good performance across our business as our customers tell us that they value and appreciate the moves we’re making to elevate the McDonald’s experience,” says company CEO Steve Easterbrook after announcing 2Q18 results. “We’ve now marked 12 consecutive quarters of positive comparable sales, and we are confident that we’re executing the right strategy to achieve long-term, profitable growth.”
As good as that sounds, the company is still vulnerable to certain risks.
For one, McDonald’s needs to evolve strategically to grow revenue. Being a low-cost leader doesn’t leave much in the budget for high-quality ingredients.
The company can capitalize on economies of scale to a degree, but there are other concerns, like the issue of investment.
McDonald’s has been sinking tons of money into mobile ordering, in-store kiosks, and more while holding a large amount of debt on its balance sheet. The company will have to realize a return on those investments to make them worthwhile.
Then, there are the franchises.
One thing you should keep in mind about McDonald’s is the company’s business model.
It uses a franchise-based system to grow. Investors can purchase a franchise for a fee and McDonald’s gets a cut of the revenues.
McDonald’s business strategy is great for growing the company doesn’t need to spend a dime out of pocket but the company also has to trust that its franchisees are good wardens of the McDonald’s brand. They could let the Golden Arches down by not rolling out initiatives when corporate says so, not cleaning well or often enough, or hiring unfriendly people.
In contrast, Starbucks is NOT a franchise. The company owns most of its stores. The ones it does not own exist through licensing arrangements that allow, say, a bookstore, grocery chain, or airport to sell Starbucks coffee, but it is very picky about which locations qualify. They have to fit the brand image.
However, that “image” could be shifting. In September 2018, Starbucks announced a new “Greener Stores” framework and pledged to have 10,000 such stores in operation by 2025 (It currently has more than 28,700 stores worldwide).
The change will help boost its reputation for sustainability and give it a foothold in responsible consumerism as well as deliver significant cost savings. Starbucks is estimated to save $50 million in utilities alone on its new Greener Stores by eliminating the use of plastic straws, reducing water usage by 30%, and investing in renewable energy.
Like McDonald’s, Starbucks also offers a dividend. It pays out $0.36 per quarter after hiking its dividend by 20% its second increase by that much in a year and more than twice what it offered in 2015.
The move left some to wonder if the dividend increase didn’t have a bigger motive than rewarding shareholders. Same store sales growth has been paltry at just 1%, below analyst forecasts so the dividend sweetens the pot a bit.
The company is also dealing with a major departure. CEO Howard Schultz left the company. To add insult to injury, sales of its popular Frappuccinos have been down.
CEO Kevin Johnson is shifting the focus of the company from growth at all costs towards disciplined, sustainable, long-term value.
Under his watch, Starbucks is trimming down new store growth to 3% from the 4-6% pace it kept over the past four years.
It is also shutting down stores in over-saturated areas, adding them in under-served ones, and focusing on member loyalty. It is a conservative strategy that could pay off well.
Both McDonald’s and Starbucks have strong reasons for investors to be encouraged about their futures.
The former has been serving its niche well while Starbucks is adopting a much more mature strategy. Both companies could succeed going forward.