When it comes to restaurant stocks, few companies have done more for their long-term investors than McDonald's (MCD -0.05%). In the last decade, shares of the Golden Arches have provided investors with a total return in excess of 350%, which is more than triple that of the S&P 500.
So which stock could go on a McDonald's-like run over the next few years? We asked that question to a team of investors and they picked Activision Blizzard (ATVI), American Eagle Outfitters (AEO -2.20%), and Quintiles IMS Holdings (IQV 0.93%).
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Booming digital downloads
Daniel Miller (Activision Blizzard): Over the past decade there's been a pretty clear transition with fast food in the U.S.: People want to eat healthier and they often want a premium product. That's given rise to great investment opportunities in the fast-casual food industry and has forced older juggernauts such as McDonald's to adapt.
The video game industry is currently poised for a digital revolution and that could propel a stock such as Activision Blizzard well beyond McDonald's. In fact, over the past decade, we've seen this play out in terms of percentage of stock-price increase:
At the core of Activision's core investment thesis is the company's list of stable, popular, and highly valuable franchises across its portfolio of games -- it owns eight $1 billion-plus franchises. Those names include Call of Duty, Destiny, World of Warcraft, Diablo, Skylanders, and StarCraft among others. Even the lesser-known part of Activision Blizzard, its King Digital acquisition, has popular mobile games such as Candy Crush and Farm Heroes, and boasts two of the 10 highest-grossing games on U.S. app stores for 15 consecutive quarters.
Activision Blizzard appears poised to soar in the decade ahead, even in an environment of rising digital downloads and the expansion of the free-to-play (F2P) business model. As the industry has gone from a one-time video game purchase to a digital download, the company has proven it can adapt, bringing in recurring revenue through expansion packs and smaller microtransactions that help generate incremental revenue.
Consider that at the end of the second quarter, Activision's digital revenue was 79% of its trailing-12-month total revenue; the retail and other segments generated 15% and 6%, respectively. And because of Activision Blizzard's massive brand-name games, it can push these digital downloads to its loyal game-player base, which enables it to often bypass retailers and thus generate higher gross margins. (I can speak to that effect as a Destiny 2 pre-downloader myself.)
Sure, Activision will have to prove to investors that it can continue to innovate massively popular and profitable game franchises, and hopefully reinvigorate its longtime World of Warcraft user base -- which is important to its bottom line. But the rise of digital downloads, the booming game industry, and growing esports popularity should allow Activision to soar well beyond McDonald's.
This sales-rack stock could soon be a top performer
Sean Williams (American Eagle Outfitters): Fast-casual restaurant chain McDonald's has a laundry list of competitive advantages and a brand name that's recognized worldwide. The company's performance is tough to top. But if there's a stock that has a chance to soar more than McDonald's, my money's on teen-focused retailer American Eagle Outfitters.
Recently, American Eagle Outfitters has run into a brick wall (as have a number of mall-based retailers). Consumers' unwillingness to open up their wallets, combined with steadily increasing competition from the likes of Amazon.com and other e-tailers, has pressured American Eagle's margins and halved its stock price over the past five years.
However, American Eagle Outfitters has a number of advantages that should allow it to rebound before its peers, as well as outperform McDonald's. To begin with, American Eagle finds itself in the perfect price niche between its peers. On the high end of the price spectrum is Abercrombie & Fitch, which for years has had PR issues galore. On the low end, retailers like Aeropostale have needed to dramatically cut prices to drive business, but have cheapened their brand in the process. American Eagle Outfitters has done a good job of avoiding steep discounting, thus preserving its brand, while giving teens and parents an option that doesn't cost an arm and a leg.
At the same time, when American Eagle Outfitters does wind up with inventory that isn't what consumers want or doesn't fit with the current preferences in the U.S., it's been quick to discount and push out unwanted merchandise. It's extremely rare that the management team allows inventory issues to linger beyond two or three quarters.
Unlike its peers, American Eagle Outfitters also has an immaculate balance sheet. It ended the first quarter with $225 million in cash and no debt, and this includes the use of $110 million for the repurchase of its common stock during the first quarter. It's also capable of $300 million to $400 million in operating cash flow each year. This is a big reason why it has one of the most robust dividends of all retail stocks at 4.5%.
While the ride could be bumpy, American Eagle Outfitters has all the tools to succeed and outperform McDonald's stock over the long run.
A match made in heaven
Brian Feroldi (Quintiles IMS Holdings): Last year two very powerful healthcare companies joined forces and became a true industry juggernaut. Quintiles -- a leading provider of clinical research services -- merged with IMS Health -- the go-to provider of patient and prescription data. Both of these companies have been providing invaluable behind-the-scenes services to the biopharmaceutical industry for years. Now pharma and biotech companies of all sizes can get all the help they need from this one giant company.
Why do biopharma companies need help at all? The reason is that running through the regulatory gauntlet is an enormously complex and expensive challenge. Since the vast majority of compounds that enter clinical trials will fail, most companies are willing to pay through the nose to give their compound the best possible chance of success. Since Quintiles employs a worldwide army of experts that have decades of clinical development experience, it is the natural choice as a partner.
On the flip side, those same companies also need help with commercialization once they successfully bring a drug to market. This is where IMS Health's treasure trove of patient and prescription data comes in handy. Pharma companies can lean on IMS Health's data and analytical chops to help create a commercialization strategy that has the best chance of success.
Looking ahead, Quintiles' competitive position looks very strong, but the company is currently working its way through a number of merger-related challenges that are making its growth profile appear weak. That makes sense since management's attention is currently focused on rightsizing the business and rolling out new products. The lack of growth might frustrate Wall Street in the short term, but I'm convinced that the streamlined Quintiles will emerge poised to capture a meaningful amount of market share once the integration effort is complete. In addition, the margin expansion and the company's huge buyback program make me think that double-digit profit growth is achievable over the long term. If I'm right, then the stock's current price, with a forward P/E ratio of 18, looks like an attractive entry opportunity.
