Four fast-food stocks with an appetite for growth

Despite the ongoing market volatility, it’s hard to miss that fast-food stocks have been on a tear this year. Year to date, some of these stocks have gained as much as 50%, far outpacing the S&P 500, as of August 22.

The increase in appetite for casual and convenient dining and the rise of app-happy urban consumers, are fuelling the growth of the global fast-food market, projected to expand from about US$540 billion in 2016 to more than US$690 billion in 2022, swelling 4.20% annually.

The leading constituents of the fast-food space are well positioned to benefit from emerging trends. That most of these companies have been able to grow their revenue and profits in the face of unrelenting stock market volatility and economic uncertainty is a testament to their resilience and compelling growth prospects, including proactively exploring and expanding to new geographies to tap faster growing, underserved markets. Most of these stocks are fairly valued, so any dip in stock price might be a good entry point for investors.

A dominant player in the US$84 billion global quick-service pizza category, Domino’s (DPZ) holds nearly 15% market share. The company generated US$13.5 billion in retail sales in 2018 through its network of nearly 16,000 stores across the world.

“Domino’s Pizza is well-positioned in the highly competitive global restaurant industry,” says a Morningstar equity report, noting that the firm can ward off intense competition by leveraging its strong brand, a cohesive franchisee system, and its cost advantages rooted in superior technology.

The pizza restaurant chain is focused on unit growth, same-store sales, improving unit economics, and boost returns on capital, which should further enable it to align with evolving consumer preferences, the report adds.

By “improving its consumer value proposition through technology and menu options,” the company will be able to withstand increasing competition as “more cuisines become available through aggregator services,” says Morningstar sector strategist, R.J. Hottovy, who puts the stock’s fair value at US$275 and projects return on invested capital to average a staggering 80% over the next decade, far outpacing the 8% estimated cost of capital.

A global chain of more than 30,600 stores, Starbucks (SBUX) sells coffee, espresso, teas, cold blended beverages, food, and accessories. The Americas are expected to account for 69% of total 2019 revenue, followed by the China-Asia Pacific segment (20%), channel development (7%), and Europe-Middle East-Africa (4%).

Despite uneven U.S. traffic trends and intensifying competition in China, Starbucks remains a compelling consumer growth story. The company is “poised for top-line growth and margin expansion through menu innovations, sustainable cost advantages, and evolution into a diversified retail and consumer packaged goods platform,” says a Morningstar report.

While already a dominant player in the U.S., the java juggernaut still has meaningful domestic growth potential driven by new store formats, new menu innovations, greater mobile and digital offerings, as well as a delivery partnership with Uber Eats.

Yet, Starbucks is much more than a U.S. retail story. “It’s just scratching the surface of its long-term channel and geographic growth potential,” says Hottovy, adding the company’s core retail competencies should put it in “a position to capture retail and wholesale market share in China and many other emerging consumer markets,” says Hottovy, who recently raised the stock’s fair value from US$80 to US$90. 

Wide-moat Yum Brands (YUM) operates one of the largest global quick-service restaurant networks with 48,000 restaurant locations. The chain, whose core brands include KFC (53% of total sales), Pizza Hut (25%) and Taco Bell (22%), rang up US$49.2 billion in sales in 2018. In 2016, Yum split into two publicly traded companies--Yum Brands and Yum China.

Although competition is heating up worldwide, “Yum Brands offers one of the more dynamic global consumer growth stories, even after the separation of Yum China,” says a Morningstar equity report, stressing the company is much more than a China growth story.

With the consolidation of the KFC, Pizza Hut, and Taco Bell brands at the global level, Yum Brands has developed into one of the top players in the quick-service restaurant space. The fast-food chain is well positioned to accelerate its sales growth through measures such as “new daypart expansion, mobile engagement, product development efforts, and a delivery partnership with GrubHub,” says Hottovy, who recently raised the stock’s fair value from US$105 to US$110, prompted by more optimistic near-term comps at Taco Bell and KFC due to expanded delivery capabilities, mobile ordering, and value platforms. 

Burger behemoth McDonald’s (MCD) generates revenue through company-owned restaurants, franchise royalties, and licensing pacts. The company, which has more than 38,100 locations in 120 countries, is the largest restaurant chain in the world and enjoys leading market share in most countries in which it operates, except China.

Of late, the Golden Arches has been focused on web ordering, table service and curbside delivery, as well as mobile ordering and payments and delivery alternatives, steps it refers to as “velocity growth accelerators,” says a Morningstar equity report. Part of its turnaround plan, these initiatives, among others, have already started to make McDonald’s a more agile organization better aligned with evolving consumer restaurant preferences, the report adds.

Positive global comparable sales growth over the past two years shows that early results of the initiatives have been promising. “We’re particularly encouraged that the sales improvement hasn’t been a function of a single factor but rather a combination of recipe changes using higher-quality ingredients, incremental labour investments and training (improving speed of service and order accuracy), and new technologies,” says Hottovy, who recently raised the stock’s fair value estimate from US$205 to US$215, prompted by more optimistic near-term comparable sales estimates stemming from McDonald’s various velocity accelerators.