Fast-Food Restaurants: Investing Essentials

Investing in fast-food restaurants may be easier and tastier than you think.

Aug 5, 2014 at 9:46AM

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Since the first drive-thru window opened in the late 1940s, this country has been obsessed with the convenience and low prices of fast-food restaurants. They're quick. They're typically light on the pocketbook. There is usually an open one nearby.

Fast-food restaurants are everywhere. They may also be in your portfolio.

What is the fast-food restaurants industry?

Fast food represents the largest segment of the restaurant industry. A whopping 78% of all dining establishments in this country are considered part of the quick-service restaurants, or QSR, family that many define as the fast-food sector. 

Burger joints are the chains that most consumers and investors associate with fast food. McDonald's is the world's biggest burger flipper, with more than 35,000 locations serving roughly 70 million customers in over 100 different countries on any given day. Burger King and Wendy's round out the three biggest players among hamburger restaurants, but that's naturally not the only specialty found under the fast-food restaurants umbrella. KFC (part of Yum! Brands), Chick-fil-A, and Popeyes Louisiana Kitchen are the largest chicken chains. Several taco, sandwich, and ethnic-food chains also fly the fast-food banner.

If a restaurant has a drive-thru window or you order at the counter, it used to be a pretty safe bet that you'd be chowing down on fast food within a few minutes of ordering. The exception these days is the growing fast-casual segment that has split off from the fast-food family. Fast casual is where gourmet burritos, casual dining-quality sandwiches, and other eats are paired up with the counter-based ordering speed and convenience of fast food.

How big is the fast-food restaurants industry?

Driving down the street of any densely populated city will show that there's no shortage of burger joints, chicken shops, and other fast-food options. With more than 300,000 quick-service restaurants across the country, you're never too far away from a pair of golden arches, Colonel Sanders' visage, or any of the iconic chain logos. 

This is an industry topping $200 billion in annual sales, according to Bloomberg. With more people on the go, lacking time to make meals at home, and trying to stretch their dining dollar, the industry should continue to grow.

How does the fast-food restaurants industry work?

Franchising is a big part of the industry. For example, a whopping 80% of McDonald's restaurants worldwide are owned by local franchisees as of the summer of 2014. 

It's easy to see why fast-food restaurants are a popular choice for potential owners. Despite the hefty up-front costs, ongoing royalty payments, and inability to veer off the set menu, these chains offer brand appeal backed by national marketing campaigns. Many franchisees would probably love to open their own place, but given the high failure rate of indie eateries, going the proven fast-food route is a safer business decision. 

Concept owners, in turn, benefit from franchisees as a cost-effective way to expand a brand while limiting the risk. They don't generate the kind of revenue or profitability that a concept owner would with company-owned eateries, but it's a popular way for a successful concept to scale quickly.

What drives the fast-food restaurants industry?

As one can imagine, food costs are a major component of any fast-food restaurant operation. Let's check out Carrols Restaurant Group, a publicly traded franchisee of 564 Burger King eateries. Food costs ate up 30% of sales in 2013. In other words, for every dollar spent at the register, $0.30 went for the raw food materials. This is a volatile component given the price swings of commodity costs. Another 31% of Carrols' sales went toward labor.

There is a groundswell of social support for employees in the fast-food industry to receive higher wages, but you may already see the challenge at the franchisee level to get by at current levels. Carrols spent another 7% in rent and 16% in other restaurant-related expenses. Then there are local advertising initiatives and corporate administrative overhead. Add it all up and there isn't much left on the bottom line.  

Even the mighty McDonald's can only milk so much of its sales to its bottom line. The stream of franchise royalties is naturally a high-margin business, but 83% of the chain's sales at company-owned locations in 2013 were swallowed up by the expenses at those locations in the same year.

This doesn't mean that the fast-food restaurants industry is a money pit for investors. The leading chains are consistently profitable, generating healthy cash flows to support operations. They are also historically steady all-weather performers. The industry isn't exactly a hotbed of growth, but the heating lamps offer just enough warmth to reward investors choosing the right chains at the right valuations.

Rick Munarriz has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and 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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