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McDonald’s, Tim Hortons parent nudge new highs

Both sell comfort and familiarity at a low price in a weakening economy.

The Big Three global fast-food chains emerged from the pandemic much stronger than when they entered it.

They adapted to changing circumstances by closing outlets, slimming  down menus and investing in technology to speed up online ordering and delivery.  As the global economy slides into recession, they still remain a bright spot for investors.

Harvest Portfolio’s James Learmonth says fast food companies are recession-resistant.. Credit: Supplied photo

 McDonalds Corp. (NYSE:MCD) turned in a surprisingly strong third quarter and will increase its dividend 10 per cent with the December payment.  Number two Restaurant Brands International Inc. (TSC:QSR) led by Tim Hortons and a revitalized Burger King brand, saw third quarter earnings rise 61 per cent. It  increased its dividend 3.6 per cent in August.  Number three YUM Brands (NYSE:YUM) is the laggard, facing stiff competition for its Kentucky Fried Chicken outside the US and struggling to reposition its Pizza Hut franchise.  Yum missed earnings estimate, hurt in part by a strong U.S. dollar, but raised its dividend 14% with the February payment.

The performance sent McDonald’s and Restaurant Brands to new highs this month. While the TSX Composite Index is down 9 per cent in the past year, Restaurant Brands stock is up 11 per cent and McDonald’s by 10 per cent. YUM is down 3 per cent.

“Quick serve restaurants aren’t recession-proof, but they are recession-resistant,” says James Learmonth, senior portfolio manager at Harvest Portfolio Group Ltd., in Oakville, Ont.

 “McDonald’s and Restaurant Brands in particular used the pandemic to make it easier and faster to order online which is an important driver of sales. You can pick it up or have it delivered. And then you’ve got enhanced loyalty rewards programs layered on top.”

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Even when considering differences between then and now such as inflation, pressure on wage bills and staff shortages, they conclude quick serve restaurants will continue to grow at the expense of fuller serve restaurants. Quick serve restaurants may see modest sales declines, while higher end casual dining will be under more pressure.

It all adds to the value proposition in a weakening economy: Quick service restaurants sell comfort and familiarity at a low price.  

In recent research note, RBC Capital Markets analyst Christopher Carril and associate analyst Khadijah Gibson looked back to 2008-2009 for clues on how the quick serve sector might perform in the near term.

 “Near-term we continue to view highly franchised fast food models as best-positioned to weather current uncertainty, given their focus on value and the benefit from trade-down [spending],” they wrote. 

Analysts say prices at quick serve restaurants are rising less than the cost of groceries. This is partly due to the fact they can take advantage of their size to negotiate better prices for such things as meat and chicken, French fries and condiments.

“When we go to the grocery store we buy in smaller sizes so we’re  price takers,” Mr. Learmonth says.

The quick serve increases have less impact on consumers because the amounts spent are smaller than those typically spent at a grocery stores and so are less noticeable.

Dan Ahrens, chief operating officer and a portfolio manager for AdvisorShares ETFs based in Bethesda, MD, says he was surprised by how well McDonald’s did in its latest quarter.

The chains global same-store sales increased 9.5 per cent in the third quarter and while both revenue and profit fell – in part because of a higher US dollar – both were well above estimates. It highlights the  strengths of the McDonald’s brand and efficiency of its  operations.

“McDonald’s and Burger King can turn up prices a little bit and people are still going to pay for that,” he says.

The recently launched AdvisorShares Restaurant ETF (NYSEarca: EATZ), has Arcos Dorados Holdings Inc., McDonald’s master franchisee in Latin America and the Caribbean as its largest holding. It also holds Restaurant Brands and Yum.

AdvisorShares ETFs. Dan Ahrens says McDonald’s recent strength surprised him. Credit: Supplied photo

 Mr. Ahrens sees challenges ahead for quick serve restaurants as they manage labour costs and supply chain difficulties. But he sees them as manageable.

“I liken fast food to beer sales,” he says “When the economy is strong, beer suffers as people more to high end liquors. In a recession, beer makes a comeback. If you’re looking at the restaurant sector, it’s fast food. It’s a lower price point which makes it an all-weather thing. “

Mr. Learmonth agrees that the sector has good prospects. Harvest holds McDonald’s in the  Harvest Brand Leaders ETF(TSX:HBL) and Restaurant Brands in the Harvest Canadian Equity Income Leaders ETF (TSX:HLIF). While both offer good prospects he gives the edge to McDonald’s.

“They are the gold standard in the category,” he says. “Their digital strategy has helped them to become more efficient and that will carry forward. They’ve got a massive global scale and can step in to support their European franchisees in particular as they struggle.

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This article appeared in the Globe Advisor section of the Globe & Mail’s Report on Business on Nov. 22, 2022. For reprint information please view this page.

Adam Mayers writes about investing and personal finance. He is a contributor to the Globe & Mail’s Globe Advisor and a contributing editor to Gordon Pape's Internet Wealth Builder newsletter. Adam was Business Editor and investment columnist at The Toronto Star and is the author of six books.

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