Sales at fast-food restaurants are going gangbusters again, reflecting the lessened need among 1 million newly employed U.S. workers to economize by eating every meal at home. With most of the stocks down from highs touched in March, the sector could be shaping up as a buy for investors. The trend has been good news for McDonald's ( MCD) and Yum! Brands ( YUM), each of which has reported a stellar quarter in the past two days. "As the recovery continues, it starts to filter down to restaurants ... people are getting jobs and are going out to eat more. They don't have to make lunch at home anymore," said Carl Sibilski, an analyst at Morningstar. The convenience and low price of fast food are two important considerations for the newly employed, particularly those in poorer-paying sectors, where most of the job creation has occurred. "It makes sense for people to eat there a lot. It's quick and always there -- just look for a very busy street," said Sibilski. McDonald's reported Wednesday that second-quarter earnings should be sharply higher than a year earlier and 3 cents above the Thomson First Call consensus. It also said systemwide same-store sales in the quarter rose 7.8%, its highest quarterly increase since 1987. The company expects to earn 47 cents a share in the current quarter vs. the consensus estimate for 44 cents a share. It earned 37 cents a share in the second quarter of 2003. Results will be released July 22. The improvement demonstrates the good timing of the company's revitalization plan, started in early 2003 by former chief executive Jim Cantalupo, who died suddenly three months ago of a heart attack. Cantalupo is credited with changing McDonald's overall strategy to improve existing restaurants rather than unending new-restaurant expansion. McDonald's recent strength also could be attributed to its menu changes, which include healthier salad options and smaller portions.
The company's announcement followed news Tuesday night from Yum! Brands that second-quarter earnings jumped 45% to 58 cents a share. Earnings before certain items surpassed analysts' estimate by 3 cents a share. Yum! runs the Taco Bell, KFC and Pizza Hut restaurant chains and credits its profit growth to a huge international expansion program. It currently has about 33,000 restaurants in 100 countries; McDonald's has about 3,000 fewer locations in the same number of countries. Year to date, Louisville, Ky.-based Yum! has added 537 new restaurants worldwide. China and the U.K. are its most profitable markets. Burger chain Wendy's ( WEN), on the other hand, isn't enjoying the same recent momentum as McDonald's and Yum!, although comps continue to be positive. The company reported a 2.3% increase in June same-store sales at U.S. company-owned restaurants. That's down from May's 6.7% increase and April's 8.3% to 8.4% gain. The company was still able to reiterate its full-year 2004 earnings expectation of $2.32 to $2.37 a share vs. the consensus for $2.35 a share. It will report quarterly earnings on July 22. Estimates are calling for 62 cents a share, which would be up from 53 cents a share last year. Wendy's contrast from the momentum seen at other fast-food chains can be attributed in part to McDonald's powerful turnaround, said Sibilski. "For a while, Wendy's was benefiting because McDonald's was neglecting their U.S. operations," he said. "Now they really have to fight for every percentage share of stomach that they get." But the analyst thinks Wendy's will be able to nudge out Burger King for the No. 2 spot in the restaurant sector in the next 12 months. That's due in part to the internal management changes that have become a constant at Burger King; it's on its ninth chief executive in 15 years.
While restaurant-sector stocks were trading at highs around March of this year, most are currently down from that mark, although still up from this time last year. Sibilski believes investors are worried about how the next phase of the economic rebound will impact them. "We're kind of at a precarious stage," he said. While the companies will likely enjoy pricing power in their menus as inflation rises, keeping prices competitive could be tricky. Wage inflation is nearly a given, too, boosting demand. Better wages, though, could increase competition for labor, a negative in a sector that has one of the highest employee-turnover levels, Sibilski noted. In the end, maintaining competitive pricing and a well-compensated staff will be a "balancing act" as the year pushes on, he said. Still, the stocks share a similar potential for growth. McDonald's forward price-to-earnings multiple is 14.42, based on expected full-year 2005 earnings of $1.85 a share, according to First Call. Its shares have gained roughly 16% from last year. At around $27, they are down about 10% from a March high of $29.85. At around $37, Yum! trades at 14.4 times projected full-year 2005 earnings of $2.57 a share. The shares are up 25% in the last 52 weeks and roughly flat with late-March, early-April levels. Meanwhile, at around $37, Wendy's shares are trading at 13.71 times expected full-year 2005 earnings of $2.61. The shares are up about 29% year over year and down 12% from March. Sibilski thinks the restaurant sector is a good one to be in right now, citing Brinker International ( EAT) and Darden Restaurants ( DRI) as other good buys.