While the S&P-500 (SPY) and Nasdaq Composite (COMP) are on track for a significant losses this year, the Restaurant Sector has put together a solid performance, on track for just a 9% loss or an 1100 basis point outperformance vs. SPY.
This is despite starting off the year with a much worse performance, with the index briefly down 25% as of May, despite it trailing the S&P-500 and Nasdaq at the time.
The strong recovery in the sector can be attributed to the fact that inflation looks to have peaked, which is a huge benefit to restaurant margins.
Plus, valuations were already at their most attractive levels since March 2020 as of early 2022, with the index starting its bear market six months before the S&P 500 in July 2021.
Finally, while not all restaurant names are considered defensive, quite a few are lower-beta, pay attractive yields, and some benefit from a recessionary environment as they become trade-down beneficiaries.
In this update, we’ll look at two of the largest names in the sector and which looks like the better buy after this violent market-wide correction.
McDonald’s (MCD) and Burger King (QSR) have gone head to head for years from a competition standpoint regarding burger wars.
While McDonald’s has more than twice the number of restaurants globally and started out a decade earlier with Burger King being the copycat, there’s no clear consensus on the better restaurant operator among the two.
From strictly a same-store sales or wallet share standpoint in the United States, McDonald’s has been the undisputed leader, and Burger King has lagged over the past couple of years.
However, with similar prices, similar menus, and Burger King’s appearing to have more iconic fries while McDonald’s wins on burgers, it’s difficult to crown a leader.
That said, there are significant differences when it comes to investing in the brands, especially given that Burger King is just one piece of Restaurant Brands International’s portfolio, which also consists of Popeyes’s Louisiana Chicken, Tim Hortons, and the newly added Firehouse Subs.
In this article, we won’t try to answer the near-impossible question of which is the better burger chain, but we’ll highlight which stock looks healthier for one’s portfolio.
Outside of the obvious difference that Restaurant Brands International has four brands, and McDonald’s has just one brand, Restaurant Brands and McDonald’s have very similar business models. This is because both companies are restaurant franchisors with over 30,000 restaurants globally, and more than 90% of their restaurants are franchised.
That said, Restaurant Brands takes the edge slightly, with 99% of its restaurant base franchised vs. 95% for McDonald’s, making it slightly more inflation-resistant.
However, from a simplicity standpoint, one brand is better than four, given that excelling at one thing is always easier than excelling at four.
This is true even if Restaurant Brands has done a phenomenal with the three new additions to its portfolio: Tim Hortons (which is flourishing in China) Popeyes (which is just beginning its international expansion), and Firehouse Subs (which was ranked #1 for food quality across the sandwich QSR category in 2021, and #1 for “Food Taste & Flavor” by the Technomic Sandwich segment).
Still, McDonald’s has executed flawlessly with one brand and is a consistent marketing leader, giving it a slight edge from a simplicity standpoint.
Restaurant Brands - 1 / McDonald’s - 1
Regarding unit growth, Restaurant Brands has four brands with ~30,000 restaurants globally, while McDonald’s has one with ~40,000 restaurants, making it much more saturated than its coffee, chicken, sandwich, and burger peer.
Given that Restaurant Brands has more whitespace and younger brands which are still in the earlier innings of their growth stage, the company benefits from much higher growth. In fact, it hopes to grow to 40,000+ restaurants by 2028. Besides, this was before it acquired Firehouse Subs which immediately added 1300 restaurants.
In McDonald’s case, the company will be lucky to hit 50,000 restaurants by 2028, giving it a low single-digit unit growth rate vs. Restaurant Brands with mid-single-digit growth.
So, on a like-for-like basis, Restaurant Brands wins on growth.
Some investors might argue that McDonald’s continues to gnaw away at its competitor's same-store sales and gain market share, and when combined with same-store sales and unit growth, McDonald’s is actually higher growth than it looks on the surface.
Although a fair point, Restaurant Brands has unleashed a Reclaim The Flame Plan at Burger King, planning to invest $150MM in digital and advertising and $250MM towards restaurant tech, kitchen equipment, building enhancements, and remodels.
This could allow Burger King to claw back any market share losses that McDonald’s has gained post-pandemic. Hence, I think Restaurant Brands has the edge with higher unit growth and its lagging brand (Burger King) getting a refresh to help with a slower-than-planned turnaround.
Restaurant Brands - 2 / McDonald’s - 1
Positioning In The Current Environment
Moving to each company’s position in the current environment, Tim Hortons is a juggernaut with over 75% of the market share for coffee in Canada and while giving up burgers and fries might not be easy, giving up caffeine and sweets is even more difficult for most consumers.
So, in terms of Tim Hortons and McDonald’s alone, Tim Hortons wins.
However, Tim Hortons is just one piece of Restaurant Brands’ portfolio, and on average, McDonald’s is lower priced and more of a value than Burger King, Popeyes, and Firehouse Subs, with the latter being considered a premium option to Subway.
With consumers pulling back and looking to treat themselves at the lowest-cost possible, McDonald’s stands head and shoulders above its peers.
Not only does it have more locations (higher density and more golden arches) to lure consumers in, but it also has exceptional marketing and the best prices, hands down.
This makes dining out guilt-free with a nearly unnoticeable hit to one’s wallet.
This is a huge advantage when consumers are looking for every reason not to spend with personal savings rates at their lowest levels in nearly decades.
So, while Restaurant Brands is certainly positioned very well as a trade-down beneficiary, it doesn’t quite have McDonald’s positioning, and McDonald’s takes the edge in this category.
Restaurant Brands - 2 / McDonald’s - 2
Finally, when it comes to valuation, there is one undisputed leader, and it isn’t even close.
In fact, MCD currently trades at ~25.7x FY2023 earnings and ~23.6 FY2024 earnings, while QSR trades at ~21.3x FY2023 earnings and ~19.2x FY2024 earnings.
This is a massive difference, with investors paying more than four turns more for McDonald’s than Restaurant Brands on FY2024 earnings and an even higher multiple in FY2025, considering that QSR will continue to lead from a growth standpoint.
While this discount might have made sense before the appointment of Patrick Doyle as Chair, it makes little sense following the appointment, with QSR now having a sector giant at its helm, a company that delivered 1000%+ returns at Dominos, making it the top performing stock from 2010-2020.
Meanwhile, from a yield standpoint, investors are picking up an extra 1.1% yield per annum with QSR, with a 3.4% dividend yield vs. 2.3% for MCD.
However, with QSR having a very low payout ratio, especially with the addition of Firehouse Subs and a higher growth rate, I would expect a further rise in QSR’s dividend next year to push this yield closer to 3.8%.
Hence, not only does QSR trade at a deeper discount to fair value (24x FY2023 EPS estimates = $73.20 fair value), but it pays investors more to wait for this turnaround.
I see QSR as the clear leader on valuation, and with better growth at a more reasonable, I see QSR as the Winner between the two stocks.
Restaurant Brands - 3 / McDonald’s - 2
To summarize, for investors looking for safety, an attractive yield, and a solid growth story at a turnaround-like valuation, I see QSR as the more attractive option, and I would view any pullbacks below $60.00 as buying opportunities.
Disclosure: I am long QSR
Disclaimer: This article is the opinion of the contributor themselves. Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information in this writing.