In Vogue: Fast Food
Posted on 20 January, 2010 | 55 Comments
Both shares of McDonald’s (MCD) and Burger King Holdings (BKC) have underperformed the Standard & Poor’s 500 index over the last year. However, Credit Suisse recently upgraded McD’s while cutting Burger King. At Frontwater we like both for various reasons.
Let’s first take a look at McDonalds…Earlier today, Credit Suisse upgraded McDonald’s to Outperform from Neutral and upped its price target to $71 from $69. Currently McDonald’s trades in the $63 range with an attractive 3.5% dividend yield. The restaurant operator maintained positive-traffic growth in 2009, while the rest of the industry saw declines. Credit Suisse thinks now is a good time to refocus attention on solid dividend payers with a dominant global platform. McDonald’s fits that bill.
So overall, lots to like about McDs…But if you think today’s price of $63 is a good buy, then certainly $55 or $57.50 has to be that much more attractive — in which case we encourage our investors to look at June 2010 $55 and $57.50 puts. These put options are typically trading anywhere from 70 cents to $1.40 per option…Sure the upside is not as great with selling puts but the risk is also that much lower. And at $55, we would be more than happy to own McDonalds.
Burger King is a bit of a different story than McDonalds. Burger King shares were down 3.3% today to $17.88.
But Burger King trades at a 12.8 price earnings multiple vs. McDonald’s 16 times. The resulting higher valuation for McDonalds may be justified as some analysts expect McDonald’s to get more of a lift from improving beverage sales and a general turn in the economy. Coffee sales continue to be a significant opportunity for McDonald’s. The higher-margin product now accounts for 5% of U.S. sales, up from 2% two years ago.
Still with the discount in P/E ratio, an investor might want to play Burger King through the use of put options. An April 2010 $17.50 put trades for $0.85 and basically implies share ownership in Burger King at a multiple below 12 — which in our opinion is quite attractive.
In conclusion, I would keep my eye on both companies and continue to watch the spreads in the P/E ratio. Probably the safest bet and most appealing from a risk reward perspective is selling McDonald put options. But for those who want exposure to the fast food industry, it is not a bad strategy to get exposure to both McDonalds and Burger King by owning shares in each — McDonalds’ for its higher growth potential and Burger King for its discount to the P/E multiple.
Jeff Kaminker
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