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The Big Three global fast-food chains emerged from the pandemic much stronger than when they entered it.
They adapted to changing circumstances by closing outlets, slimming down menus and investing in technology to speed up online ordering and delivery. As the global economy slides into recession, they still remain a bright spot for investors.
McDonalds Corp. MCD-N turned in a surprisingly strong third quarter (Q3) and will increase its dividend by 10 per cent in the December payment. Restaurant Brands International Inc. (RBI) QSR-T, led by Tim Hortons and a revitalized Burger King brand, saw Q3 earnings rise by 61 per cent. It increased its dividend by 3.6 per cent in August. Yum! Brands Inc. YUM-N is the laggard, facing stiff competition for its Kentucky Fried Chicken restaurants outside the U.S. and struggling to reposition the Pizza Hut franchise. Yum! missed earnings estimates, hurt in part by a strong U.S. dollar, but raised its dividend by 14 percent in the February payment.
McDonald’s and RBI’s strong earnings took their stocks to new highs this month. While the S&P/TSX Composite Index is down by 7 per cent in the past year, RBI’s stock is up by 24 per cent and McDonald’s is higher by 8 per cent. Yum! is down by 3 per cent.
“Quick-serve restaurants aren’t recession-proof, but they are recession-resistant,” says James Learmonth, senior portfolio manager at Harvest Portfolios Group Inc. in Oakville, Ont.
“McDonald’s and Restaurant Brands, in particular, used the pandemic to make it easier and faster to order online, which is an important driver of sales. You can pick it up or have it delivered. And then you’ve got enhanced loyalty rewards programs layered on top.”
It all adds to the value proposition in a weakening economy – quick-service restaurants sell comfort and familiarity at a low price.
In a recent research note, RBC Capital Markets senior restaurants equity research analyst Christopher Carril and equity research associate Khadijah Gibson looked back to 2008-09 for clues on how the quick-serve sector might perform in the near term.
Even when considering differences between then and now, such as inflation, pressure on wage bills and staff shortages, they conclude that quick-serve restaurants will continue to grow at the expense of fuller-serve restaurants. Quick-serve restaurants may see modest sales declines, while higher-end casual dining will be under more pressure.
“[In the] near-term, we continue to view highly franchised fast food models as best positioned to weather current uncertainty, given their focus on value and the benefit from trade-down [spending],” they wrote.
Analysts say prices at quick-serve restaurants are rising less than the cost of groceries. That’s due, in part, to the fact they can take advantage of their size to negotiate better prices for things such as meat, french fries and condiments.
“When we go to the grocery store, we buy in smaller sizes so we’re price takers,” Mr. Learmonth says.
The quick-serve price increases have less impact on consumers because the amounts spent are smaller than those typically spent at grocery stores and, so, are less noticeable.
‘People are still going to pay’
Dan Ahrens, managing director and chief operating officer at AdvisorShares Investments LLC in Bethesda, Md., says he was surprised by how well McDonald’s did in its latest quarter. The chain’s global same-store sales increased by 9.5 per cent in Q3. And while both revenue and profit fell – in part because of a higher U.S. dollar – both were well above estimates. It highlights the strength of the McDonald’s brand and the efficiency of its operations.
“McDonald’s and Burger King can turn up prices a little bit and people are still going to pay for that,” he says.
The recently launched AdvisorShares Restaurant ETF EATZ-A has Arcos Dorados Holdings Inc. – McDonald’s master franchisee in Latin America and the Caribbean – as its largest holding. It also holds RBI and Yum!
Mr. Ahrens sees challenges ahead for quick-serve restaurants as they manage labour costs and supply chain difficulties. But he sees them as manageable.
“I liken fast food to beer sales. When the economy is strong, beer suffers as people turn more to high-end liquors. In a recession, beer makes a comeback,” he says. “If you’re looking at the restaurant sector, it’s fast food. It’s a lower price point, which makes it an all-weather thing.”
Mr. Learmonth also thinks the sector has good prospects. Harvest ETFs holds McDonald’s in Harvest Brand Leaders Plus Income ETF HBF-T and RBI in Harvest Canadian Equity Income Leaders ETF HLIF-T. While both offer good prospects, he gives the edge to McDonald’s.
“It’s the gold standard in the category. McDonald’s digital strategy has helped it become more efficient, and that will carry forward,” he says. “It has a massive global scale and can step in to support their European franchisees, in particular, as they struggle.”
Adam Mayers is a contributing editor to the Internet Wealth Builder investment newsletter.
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