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What are we looking for?

Billionaire investor Bill Ackman of Pershing Square Capital Management disclosed last week a stake in Nomad Foods, an acquisition vehicle for other food businesses, which could signal that more consolidation in the industry may be near. With that in mind, today we turn our attention to restaurant and food processing companies that are both profitable and efficiently run.

The screen

Only Canadian and U.S. companies with a market cap greater than $500-million were included. Next, I screened for firms that have a price/cash flow (P/CF) ratio of less than 20. This ratio is often a more reliable measure than the popular price-earnings (P/E) ratio because the cash a company generates from operations is a good measure of company liquidity and profitability. Cash flows are also less easily manipulated than earnings.

As a measure of profitability and efficiency, we looked for operating margins of greater than 5 per cent. This margin is a good gauge of how well a company manages its cost because it calculates how much cash is left over after paying for operating costs such as food and wages.

To help determine how well they deploy assets, I filtered companies with an asset turnover ratio of greater than one. A higher figure here suggests better use of production capacity and good inventory management. For example, a very busy restaurant operating at near capacity and going through food quickly would have high asset turnover.

Finally, I looked for an enterprise multiple of lower than 14. This measure is a ratio of enterprise value (EV) over EBITDA. EV/EBITDA is a good valuation metric because it is easier to compare companies with different leverages and it is a better measure of takeover value.

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What did we find?

Eighteen stocks in the food and restaurant industry passed my screen. Yum Brands Inc. operates more than 41,000 KFC, Pizza Hut and Taco Bell restaurants throughout the world. It has focused its growth in China and India; in China alone it operates more than 4,800 KFC restaurants – twice as many as McDonald's. So far this year, shares are up 25 per cent, compared with the S&P 500, which is up about 1 per cent.

Charles Martin, CFA, works in the financial and risk unit of Thomson Reuters and specializes in asset management.

Restaurant and food processing stocks

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