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Investment Ideas

We all have our opinions on who has the tastiest hamburger, but which burger joint is the best investment for your portfolio?  Let’s take a look at some well-known burger makers to see which is may fill up your portfolio with profits.

General trends:

Before getting started, let’s examine the macro trend in sales at eating and drinking establishments.  The first graphic displays retail sales at food service and drinking places as reported by the Commerce Department.   The graphic displays the year over year change on a three month average basis (it is smoothed). Notice that sales have lost momentum, but are still positive. Year ago comparisons will not get easy until about January 2014. Sequentially, the level of sales is below the peak seen in April 2013, and confirms a softening trend in sales.   The recent reduction in gasoline prices may help bolster sales, but is somewhat offset by the reduction in refinance activity.  According to the Department of Energy, the average retail price of gasoline was $3.49/gallon compared to $3.82/gallon a year ago in the last week of measure.  Wage growth has also turned higher, which could be a benefit to demand at the margin.  

On a brighter tone, the Restaurant Performance index put out by the National Restaurant Association is above the 100.0 level suggesting on-going expansion in the industry.  The index is off the recent high, but still in positive territory.  However, there was a reduction in the outlook for sales volume over the next six months.  37% saw higher sales in the next six months compared to 46% in July, while 9% saw lower sales compared to 11% in July.

Valuation analysis:

It’s easy to find a hamburger on the menu at most every restaurant, but the list below focusses on names where the hamburger is a major part of the business.  Let’s start the analysis by examining valuation.  The table below highlights the hamburger chain, the PEG ratio, the forward 12 month PE ratio, and the price to sales ratio as of September 24th.

(click table to enlarge)

PEG Ratio:

The PEG ratio is the price to earnings to growth rate ratio.  This measure will help us understand the premium or discount to earnings growth investors are willing to pay to own their restaurant name.  Notice that Red Robin (RRGB - Analyst Report) and McDonald’s (MCD - Analyst Report) have the highest PEG ratios, while Jack in The Box (JACK - Snapshot Report) and Burger King (BKW - Analyst Report) have the lowest PEG ratios.   However, relative to their median value, BKW was trading at the lowest premium, while RRGB was priced at the highest premium.  Given that BKW has not been public for a long time, the median values for BKW needs to be taken cautiously.  RRGB looks expensive both relative to his historical median and compared to the group.  Looking at the cheapest measure based on the PEG ratio is less easy. Although JACK has the lowest PEG, it is trading at a premium to its median value.  Wendy’s (WEN - Analyst Report) has a lower PEG ratio than MCD, but was trading at a higher premium to its median value.

Forward 12 Month PE ratio:

Based on forward 12 month PE ratio, MCD is trading at the lowest valuation in the group and was at a slight discount to its median.  It stands out as cheapest both on an absolute and relative basis.  WEN has the highest forward PE ratio and is carrying a relatively large premium to its median.  WEN, Sonic (SONC - Snapshot Report), JACK, and RRGB all had current forward PE ratios 30% or more to their median.  MCD looks like the value in the group based on this measure.  

Price to sales ratio:

The price to sales ratio shows RRGB with the most inexpensive value just below 1.0, but SONC with the only discount to its median value.  BKW had the highest price to sales ratio followed MCD and SONC. JACK had a relatively low price to sales ratio to the group, but the ratio was high to the historical median. RRGB also had a healthy premium to its median.

Valuation measures are mixed:

Setting up a position ranking for each company relative to its peers and taking an average, JACK posted the cheapest valuation followed by SONC.  WEN was most expensive.   A value of 1 was assigned to the company with the lowest fundamental valuation maker, and a value of 6 was given to the company with the highest fundamental valuation indicator.  An average was taken of the three measures and the company with the lowest average was deemed most inexpensive, while the company with the highest average was deemed most expensive.

The same process was performed on the discount/premiums to median values.  In this case, MCD was the cheapest followed by BKW and SONC (tie).  JACK and RRGB were most expensive.  Remember, the history on BKW is limited.

Even though JACK looks cheap compared to the group, compared to its historical valuation it is on the expensive side.  SONC actually ranked well compared to the group (second place) and based on its historical pricing (third behind BKW).   Like its $1 menu, MCD was also attractive as it is trading cheap compared to its historical measures and came in third place compared to its peers.  One could argue, but SONC and MCD come up as winners using valuation based on the peer group and relative to history.

Earnings Revisions:

Earnings revisions have varied for the group over the last thirty days.  The table below displays the number of analyst revisions and the change in earnings estimates for this year and next year as of September 24th. There is also a column highlighting the growth rate in earnings per share for the coming fiscal year.

(Click table to enlarge)

Notice that SONC has seen the greatest number of upward revisions and the consensus estimate for both this year and next year were each revised up $.02 to $0.72 and $0.84 respectively. The consensus EPS for RRGB were also raised and there were upward revisions for WEN and MCD. 

Looking at earnings revisions SONC seems to be the stronger choice than MCD, although JACK, RRGB, and BKW are also Zacks Rank #2 stocks (Strong Buy).

Earnings per share growth is expected to be the strongest for JACK followed by WEN and RRGB.  The EPS growth outlook at JACK may help explain its elevated valuation relative to its history.  The market is pricing vibrant sales growth.  MCD had its weakest EPS growth.

Gross margin comment:

The last gross margin at SONC was in line with the median, while MCD has seen a relatively firm gross margin.  JACK has seen the strongest gross margin relative to the median.  RRGB and WEN have seen gross margin erosion relative to trend with RRGB the largest.   The outlook for EPS growth and gross margin expansion at JACK suggests that investors may want to take a look at this name.  JACK could be a dark horse candidate to perform well.  

In conclusion:

SONC looks to be the tastiest stock based on a mixture of valuation and earnings estimate revisions.  The company has guided EPS growth in the 14% to 15% area for fiscal year 2014 and is projecting low single digit same store sales growth.  2012 and 2011 same store sales growth was 2.8% and 1.8% respectively.  Management is also looking for gross margin to expand 75 to 100 bps in the coming year.

Technically speaking, SONC has run up sharply in recent months, but old highs near $17 may be seen as a support area on a pull back.   The stock made a high in the $26 area in 2007.

 

Nick held shares of McDonald’s Corporation at time of publication. His views and holdings can change at any time.

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