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Why McDonald's Is the Best Buy in the Fast-Food Sector

By Demitri Kalogeropoulos - Dec 21, 2017 at 10:00AM

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The industry leader has everything investors crave: positive business momentum, rising profitability, and healthy cash returns.

If you're seeking exposure to the fast-food industry, you'll find no shortage of variety on the market. You could purchase a large, diversified company like Yum! Brands (owner of KFC, Taco Bell, and Pizza Hut) or pick a highly focused chain like Shake Shack.

Among business models, investment choices run the gamut from entirely company-owned Chipotle to Restaurant Brands, whose Burger King and Tim Hortons brands are almost exclusively operated by franchisees.

Each of these stocks, for different reasons, could make a good long-term investment. But the standout choice in the industry is clear. A McDonald's (MCD -1.61%) purchase today comes with a tantalizing mix of brand strength, improving finances, and market-thumping operating momentum.

Five young adults share a fast food meal.

Image source: Getty Images.

Growing strong

Mikey D's has re-established itself at the top of the industry in terms of revenue growth. Comparable-store sales rose 6% last quarter to nearly match the prior quarter's 6.6% spike that was the chain's fastest expansion pace in years. Even Yum! Brands' hit KFC franchise couldn't beat that result, since it grew by just 4% in the third quarter.

McDonald's is lifting revenue the hard way, too: by gaining customers. In fact, diner traffic has been consistently positive across each of its geographic regions throughout 2017. Guest count growth accelerated to a 2.1% pace in the most recent quarter, at a time when Shake Shack endured a 3.8% decline.

Chart showing improving traffic trends.

Data source: McDonald's. 2017 is for the first three quarters of the year. Chart by author. 

Sales are benefiting from an improved menu that hits a wide range of price points that peers just can't match. So it makes sense that the fast-food titan is doubling down on that strategy with a new value menu that spans choices from $1 drinks to $3 premium sandwiches.

Improving finances

Meanwhile, McDonald's is finding ways to make its lucrative business model even more profitable. Operating margin is approaching 40% of sales in fiscal 2017, up from 33% a year ago. Its current 24% profit margin puts it on top of the industry -- while making it one of the most profitable companies in the Dow.

MCD Profit Margin (TTM) Chart

MCD Profit Margin (TTM) data by YCharts.

The chain sold off hundreds company-owned locations to franchisees in 2017 in a move that reduces revenue but increases earnings as the sales base tilts toward high-margin royalty and rent fees. CEO Steve Easterbrook and his team see more room to continue this financial strategy over the next few years, too. Specifically, they believe the refranchising process will help McDonald's reach an operating margin in the mid-40% range by the end of 2019. By then, McDonald's restaurant base will be about 5% company-owned, compared to 15% at the start of 2017.

That financial improvement, and the dividends and cash returns it will support, might be enough on its own to make Mickey D's a compelling investment today. But investors should be at least as excited about the company's aggressive growth plans. The chain is determined to keep its hard-won market positioning through menu innovations and pricing strategies that keep competitors rushing to catch up.

Management is hoping to use its huge store footprint as a base to become one of the world's largest delivery services. Ideally, the combination of online ordering and home delivery will extend the brand to new customers while allowing for more menu experimentation. There's no guarantee that any of these initiatives will pay off, but McDonald's ample resources and unmatched brand power give it flexibility to try a few bold ideas as it extends its business rebound into another year.

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Stocks Mentioned

McDonald's Corporation Stock Quote
McDonald's Corporation
$243.06 (-1.61%) $-3.97
Yum! Brands, Inc. Stock Quote
Yum! Brands, Inc.
$113.36 (-2.48%) $-2.88
Shake Shack Inc. Stock Quote
Shake Shack Inc.
$40.26 (-1.83%) $0.75

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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