For fast food giants emerging markets hold key to growth

When it comes to growth, the Big Three global fast-food chains are all of one mind.

McDonald’s (NYSE: MCD),Yum! (NYSE: YUM!) led by its flagship Kentucky Fried Chicken brand and Restaurant Brands International (TSX, NYSE: QSR) by Tim Hortons, are all heading east to emerging markets. While the pandemic has slowed them down, their expansion in these markets is an unstoppable force, analysts say.

All three are adapting menus to local tastes, finding domestic partners and reducing operational risks through master franchisees in these markets. The strategies are aimed at cashing in on a demographic dividend of large, young populations with rising incomes.

“How quickly they expand is very dependent on Covid, but it seems to me that they are on track and weathering the storm relatively well,” says Daniel Sacke, vice-president and portfolio manager with The Sacke Wealth Advisory Group at BMO Nesbitt Burns Inc. in Toronto.

McDonald’s has been the best performer of the big three throughout the pandemic. It is seen as the gold standard of the global fast-food industry with 37,000 restaurants in 120 countries. It has 44 per cent of its outlets in Asia or other emerging markets although the U.S. remains its largest single market.

McDonald’s has improved margins, slimmed down menus, made drive-through times faster and invested in technology to improve digital ordering, pickup and delivery. It recently launched a loyalty program which attracted 21 million members within a few months of launch.

Mr. Sacke points to McDonald’s 45-year string of dividend increases as proof of its staying power, including increases in each of the last two years.

“McDonald’s is high quality, it is defensive and it is resilient,” Mr. Sacke says.  

Dan Ahrens, a portfolio manager for AdvisorShares ETFs based in Bethesda, MD agrees that McDonald’s is the gold standard and that emerging markets are a strategy for growth. But, he also  believes there is plenty of room for the chains to grow in North America.

Mr. Ahrens manages the recently launched AdvisorShares Restaurant ETF (NYSEarca: EATZ), an ETF betting on a post-covid dining out rebound and long term trends that favour more of the same. The actively managed fund holds each of the Big Three, but its top holdings include two pizza chains – Dominos Pizza Inc. (NYSE:DPZ) and Papa Johns International Inc. (NDQ: PZZA) This is because as as a single product choice that is mainly takeout or delivery they skirt some of the pandemic’s ups and downs.

“McDonald’s is always going to be the big kid on the block,” he says. “But I think Restaurant Brands has made some really wise acquisitions. They can’t run internationally with Tim Hortons, although it’s always going to be their bread and butter in Canada, so they’re smart to pick up other brands for the international growth.”

Restaurant Brands is the third largest global chain with 27,000 stores in 100 countries. About 70 per cent are Burger Kings and 19 per cent are Tim Hortons. The other 11 per cent are Popeye’s Louisiana Kitchens. This month it acquired the Florida-based Firehouse Subs chain for US $1 billion. In August it revealed plans to spin off Tim Hortons China in a deal valued at  $1.7 billion.

Pre-pandemic RBI announced an agreement with a partner to open 1,500 Popeyes restaurants in China over the next 10 years. Popeyes is the last of RBI’s brands to enter the Chinese market.

Burger King has been in China since 2005 and has more than 1,200 restaurants.  It has also expanded into emerging markets in eastern Europe, including Estonia, Latvia, and Lithuania. Tim Hortons opened its first Chinese outlet in Shanghai in 2019  

Mr. Ahrens says the spinoffs shift operating control to local partners who can adapt more quickly to changing local tastes. The parent receives an ongoing royalty payment.

“China in particular is coming with geopolitical risks, so a long term revenue stream at arm’s length has an advantage,” Mr. Ahrens says.

 Yum Brands! Inc., the second largest chain by revenues is the holding company that owns Taco Bell, KFC and Pizza Hut. It has 22 per cent of all stores in China and 27 per cent of all KFC sales are now generated in China. In November 2016, Yum spun off the Chinese operations, forming Yum China (NYSE: YUMC) which pays a 3 per cent royalty on revenues to the parent.

Yum has an ambitious expansion program and through the third quarter had opened 1,534 new stores in international markets. Nearly 1,000 of these were in China, almost all of which were franchised.  A recent initiative is the expansion of its coffee shop chain through a partnership with the Italy’s Lavazza chain.

 While Mr. Sacke favours McDonald’s, he likes Yum’s momentum and, like McDonald’s its investment in mobile and online technologies. He noted that 35 per cent of YUM’s sales are now generated through online ordering more than double the pre-pandemic level.  

“For all three players, the issues are inflation in wages, the pandemic and commodity price inflation, The winner swill be the companies that can deal with all three effectively,” he says.

This is an edited version of an that article appeared in the Globe Advisor section of the Globe & Mail’s Report on Business on Jan. 4, 2022. For reprint information please view this page.