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McDonald's (NYSE: MCD ) has been the clear winner in the fast food space. Burger King (NYSE: BKW ) always played second fiddle, and despite many attempts to catch McDonald's, it always came up short. Eventually, it seemed as though Burger King was content to be No. 2. However, recently, Burger King has made many moves that indicate it might have a long-term game plan to become No. 1. This would be a difficult task since Burger King only has 13,000 locations with 11 million visitors per day versus McDonald's 35,000 locations with 69 million visitors per day. If you're an investor, you might want to go along for the ride. We'll examine if this would be a ride worth taking, and also take a look at Wendy's (NASDAQ: WEN ) , which is looking to improve in a completely different manner.
Innovation and global expansion
Last week, Burger King introduced its Big King after the media craze following the launch of Satisfries. Now, Burger King has struck again, this time with its BBQ Rib Sandwich. These innovations have good potential to drive new customers to Burger King restaurants. This doesn't refer to consumers who usually prefer casual and fine dining, but those who might be loyal to another fast food brand, yet want to try new items.
Burger King is also looking to capitalize on the enormous population (1.2 billion) and potential in India. Presently, Burger King has no presence in India. There is significant potential for top-line growth if Burger King succeeds in a country four times larger than the United States.
Burger King has partnered with Everstone Group to set up the supply chain and to roll out locations. Burger King has potential to grow its top line via innovation and global expansion, but that doesn't mean it's a better long-term investment than McDonald's.
Plan to win
For a decade, McDonald's has successfully implemented its "Plan to Win" strategy. The primary initiatives have been menu optimization, modernization of customer experience, and broadened accessibility. McDonald's believes in the "if it ain't broke don't fix it" concept.
Based on this strategy, McDonald's expects long-term annual systemwide sales growth of 3%-5%, operating income growth of 6%-7%, and return on incremental invested capital in the high teens.
In 2014, McDonald's expects capex of $2.9 billion-$3.0 billion, based on the opening of 1,500-1,600 new restaurants, the reimaging of 1,000 restaurants, and a G&A increase of $200 million due to employee expenses related to growth and the sponsorship of the Winter Olympics in Sochi.
Logically, McDonald's will aim to grow in under-penetrated emerging markets while also growing its presence in developed markets with high demand. Perhaps most important for investors is that McDonald's has generated an average of $7 billion per year in operating cash flow over the past three years.
Currently, McDonald's yields 3.3%, considerably higher than Burger King's 1.40%, and relatively higher than Wendy's 2.20%. Burger King has generated $347.5 million in operating cash flow over the past twelve months, well short of McDonald's. Wendy's is similar to Burger King in this regard, generating $318.48 million for the same time frame.
Bottom line growth likely
Wendy's has been aiming for growth with its Image Activation plan, which pertains to modernizing restaurants and enhancing the customer experience. However, that's somewhat old news and what's more exciting for investors now is Wendy's massive sale of company-owned restaurants.
Wendy's is on track to sell 425 company-owned restaurants by the second quarter of next year. If successful, this will lead to stronger free cash flow, expanding margins, improved earnings, and more predictable revenue in the form of a higher percentage of royalty and rental income. These are major positives, but don't necessarily suggest that Wendy's will present a better long-term investment opportunity than McDonald's.
The bottom line
If you're looking for top-line growth potential, you might want to consider Burger King thanks to its consistent innovation and future exposure to India. However, expectations are high with Burger King trading at 22 times forward earnings. Cash flow is also well short of McDonald's, and yield is only 1.40%.
If you're looking to invest in a company that's likely to see bottom-line improvements, consider Wendy's. However, Wendy's is trading at 30 times forward earnings, even more of a premium than Burger King. Wendy's also falls well short of McDonald's in regard to cash flow, but it does yield a decent 2.2%.
If you're looking for moderate top-line growth potential, but enormous cash flow that will lead to large shareholder returns, massive marketing power, and resiliency during economic downturns, consider McDonald's.
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