What Fast-Food Stocks Need for a Strong 2014

Due to changing consumer preferences in the United States, it's clear that international growth is imperative for the major fast-food companies.

Jan 6, 2014 at 10:00AM

Fast-food stocks had a challenging 2013, for a variety of reasons. McDonald's (NYSE:MCD) saw limited same-store sales growth because of the rapidly evolving consumer landscape, in which North American consumers continue to opt for healthier food choices. At the same time, Yum! Brands (NYSE:YUM) struggled under the weight of an investigation in China pertaining to the safety of its Kentucky Fried Chicken. This caused business to deteriorate in China in 2013.

While at first glance the outlook for fast-food stocks might seem glum heading into 2014, investors shouldn't worry. There's plenty of growth left for the taking, thanks to strong international potential, particularly in emerging markets.

Why international expansion is critical this year
While it's reasonable to suggest that continued trends toward healthier lifestyles in North America will keep a lid on domestic growth, there's plenty of growth to be had for Yum! Brands and McDonald's. This is because of international expansion, which will be key for their future growth. Each company understands that American consumers are changing their eating habits, and is taking swift action to evolve.

For instance, Yum! Brands plans aggressive international expansion in the upcoming year. Yum! Brands expects global capital expenditures to total $1.2 billion, which will largely be spent on new locations. The company expects to open at least 1,850 new restaurants outside the U.S. in the year ahead, which includes 700 new units in China and 150 new units in India. This compels management to expect 20% earnings growth in the upcoming year.

Meanwhile, McDonald's will spend as much as $3 billion next year on at least 1,500 new restaurant openings, the vast majority of which will be in the emerging markets. Management believes it has an opportunity to leverage its world-class brand in underpenetrated emerging markets. Because of these initiatives, McDonald's guides investors for at least 3% to 5% systemwide sales growth and 6% to 7% operating income growth.

Why Wendy's may be vulnerable
Wendy's (NASDAQ:WEN) may be at a disadvantage because of its relatively cautious stance on international expansion. To be sure, Wendy's had a fantastic 2013, as its turnaround efforts materialized. The company made progress in transitioning to the highly profitable franchise model, and improved its balance sheet. However, there's only so much growth to be had in North America, where Wendy's generates the vast majority of its profits.

Wendy's opened 45 international locations in 2013, but closed between 15 and 20 locations. Clearly, the net effect of its international expansion efforts are negligible. Wendy's will likely see benefits from its franchise transformation strategy, which will continue into the first half of the year, but its growth trajectory is questionable.

Growth initiatives are key to shareholder rewards
Yum! Brands, McDonald's, and Wendy's each pay dividends and spend plenty on share buybacks. The potential for growth of these shareholder programs, however, is subject to overall profit growth. In the case of Yum! Brands and McDonald's, shareholders are likely to continue receiving the large amounts of cash they're accustomed to.

Yum! Brands expects to reduce its average diluted shares outstanding by 1% due to share repurchases. McDonald's, of course, is well-known for its generous shareholder policies. For all of 2013, McDonald's expects to return between $4.5 billion and $5 billion to investors through the combination of dividends and share buybacks.

To summarize, for U.S.-based fast-food companies, expansion is critical for future growth. There's no denying that consumer preferences are evolving in the United States. That means that industry heavyweights such as Yum! Brands and McDonald's face intense pressure to grow in emerging markets. While Wendy's has been successful in its turnaround efforts, shareholders are concerned that it may not be able to meaningfully expand outside North America.

Our top pick for 2014
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Fool contributor Bob Ciura owns shares of McDonald's. The Motley Fool recommends and owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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