Why Casual Restaurants May Be Better Stocks Than Fast-Food Chains

Sit-down restaurants Brinker International and DineEquity are posting stronger growth than McDonald's, and may be better options in 2014.

Jan 31, 2014 at 9:00PM

Despite the frustratingly slow recovery in the labor market and U.S. economy more broadly, American consumers remain optimistic about their finances. For the most part, they've continued to spend. Consumer sentiment has shown remarkable resilience in recent months, as Americans finally begin to feel better about their finances.

As a result, consumer-discretionary stocks, or those that are reliant on the health of the consumer for profits, stand to prosper. And yet, not all consumer-discretionary stocks are created equal. This is especially true when it comes to restaurants.

There's a striking disparity emerging between fast-food chains such as McDonald's (NYSE:MCD) and sit-down restaurants such as DineEquity (NYSE:DIN) and Brinker International (NYSE:EAT). While McDonald's is infamously struggling to produce growth in the current economic climate, DineEquity and Brinker are having no such issues.

McDonald's investors are hungry for growth
In McDonald's most recent earnings report, the company showed notable weakness in its key growth metrics. The same-restaurant sales metric, which measures sales only at locations open at least a year, is perhaps the most important financial figure to gauge the way a restaurant stock is performing. By that measure, McDonald's latest report left much to be desired.

McDonald's global same-restaurant sales declined by 0.1% in the fourth quarter and inched up by 0.2% in 2013. McDonald's poor performance stands in contrast to DineEquity and Brinker International. DineEquity, operator of the IHOP and Applebee's brands, delivered a 0.1% same-restaurant sales decline at Applebee's over the first nine months of the fiscal year. This was more than offset by nearly 2% same-restaurant sales growth at IHOP in the same period.

Meanwhile, Brinker International, which operates the Chili's and Maggiano's brands, increased its same-restaurant sales by 0.8% in its fiscal second quarter.

What McDonald's needs to get back on track this year
McDonald's is desperately counting on its aggressive international expansion to make up for its lackluster growth last year. This is where McDonald's may have an advantage over much smaller rivals DineEquity and Brinker International. After all, the U.S. is a very saturated market, and McDonald's status as one of the largest and most valuable brands in the world means it has the size and scale to quickly and effectively break into the emerging markets.

DineEquity does not yet have an established international presence. While Brinker operates in 32 countries across the world, it plans to open just 34 to 39 international restaurants in fiscal 2014.

McDonald's plans to open at least 1,500 new restaurants as well as perform more than 1,000 renovations in the year ahead. McDonald's plans to spend up to $3 billion on this, and investors can bet most of it will be concentrated in the emerging markets. Management cites the company's Asia-Pacific, Middle East, and Africa region as its main target of capital expenditures in 2014.

However, McDonald's aggressive expansion is going to take time to pay off. Management expects January global comparable-store sales to be flat year over year. Meanwhile, DineEquity and Brinker International expect strong near-term performance to continue. For example, DineEquity projects flat same-restaurant sales at Applebee's for the full fiscal year along with solid 2.5% growth at IHOP.

Closing thoughts
While McDonald's retains its status as the largest and most well-known restaurant chain in the world, it's not growing as fast as investors would like. Recently, it's being outperformed by smaller sit-down chains such as DineEquity and Brinker International. Whether or not McDonald's will be successful at re-engineering growth in the future remains to be seen. That depends hugely on its international expansion efforts.

For the time being, investors have viable alternatives to choose from among restaurant stocks. DineEquity and Brinker International are seeing great success in the U.S. and aren't counting on strong international growth to improve their future bottom lines. It may be the case that DineEquity and Brinker International are starting to steal some of McDonald's thunder.

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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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Jun 12, 2015 at 5:01PM

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