Comparing the return of Burger King and McDonald’s (exhibit 1), we see a huge dispersion between the stock returns over the past year. In this article I will try to find out whether this dispersion is justified or whether we could classify one of the stocks as over or undervalued.
Exhibit 1: returns of Burger King (orange) and McDonalds (green).
The reason for the recent surge in the stock price of Burger King is the announcement of the acquisition of Canadian fast food chain Tim Hortons. All this for the sum of 11.4 billion dollars. Surprisingly, the stock price of both companies surged during this deal, which is a rarity. (exhibit 2) Leaving this recent surge aside, before this announcement there was still a +- 40% dispersion between the return of Burger King and that of McDonald’s.
Exhibit 2: both the stocks of Burger King (blue) and Tim Hortons (orange) go up
Should McDonald’s worry?
With their recent acquisition, Burger King will become the third largest fast food serving company. However, if we look at the actual numbers this sounds a lot better than it actually is.
Current earning releases by McDonald's did not really impress the investors. McDonald's has seen flat or even slightly negative growth rates for its US locations. Unlike McDonald's, both Burger King and Tim Hortons saw their same-store sales rise in their specific US segments by 0.4% and 5.9% respectively.
However, taking all this into account, McDonald’s should not worry too much about its expanding rival. Looking at the respective revenues and net income (see exhibit 3 and 4) it is clear that the new combined entity does not form much of a threat.
Exhibit 3: Quarterly revenues
Exhibit 4: Quarterly Net Income
Looking at the fundamentals (see exhibit 5) it is hard to justify the major divergence between Burger King and McDonald's. Especially when it comes to P/E ratios (both relative and absolute) Burger King is not the ideal candidate to see soaring returns in the future.
Exhibit 5: Fundamentals of Mcdonalds and Burger King.
Size does matter
This might not be the case in every industry, but in the food industry size certainly does matter. Constantly updated menus might give the illusion that there is a possibility of innovation in this sector. What is actually the case is that the same food gets shifted around and repackaged. In 2013 McDonald’s advertising budget accounted for almost 15% percent of the entire restaurant industry advertising budget in the US. Another way to put the size in perspective is by looking at the amount of stores. Burger King has over 13,000 locations worldwide. McDonald's trumps this figure with over 14,000 locations is the US alone.
Additionally, McDonald’s outperforms its competitors where it really counts: sales per unit. In the table below you can see the distance McDonald's takes from its closest competit
Exhibit 6: Mcdonalds ranks high when it comes to sales per unit. Burger King and Tim Hortonds do not. source
Perhaps one of the reasons we saw this major outperformance was due to the involvement of veteran investor Warren Buffett. Buffett helped the $11 billion dollar acquisition by plunking down $3 billion dollar for preferred stocks. For a long time McDonald’s could also be found in Buffett’s portfolio but he sold his shares in the late nineties. The 20% stock increase following the news of the acquisition with aid from Buffet reeks like an overshooting/overreaction to me.
Most important meal of the day
The breakfast market is one of the major growth markets for the fast-food restaurant industry, and McDonald's is winning at it. In 2013 breakfast visits increased for the fourth consecutive year. Over 12.5 billion breakfast visits were made to US foodservice outlets last year, a 3 percent gain from 2012. McDonald's makes more in its breakfast hours in sales annually than Burger King currently does overall.
Perhaps Burger King’s acquisition of Tim Hortons is an attempt to tap into this market. However, part of Burger King’s success this year was an overhaul of the menu by majorly simplifying it. It would be very contradictory to this strategy to start introducing a bunch of Tim Hortons foods to achieve ‘synergy’.
The dispersion between the stock returns of McDonald’s and Burger King looks far from. The outperformance of Burger King was already hard to justify. With the apparent overreaction of the acquisition of Tim Hortons (with the help of Warren Buffett) differences in returns start to truly look out of place. Shorting Burger King (BKW) combined with buying stocks of McDonald’s (MCD) will minimize your market risk and will yield return when stock returns converge.
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Gelein has been interested in the financial world and global economics since high school. For over 3 years he has been a member of a university investment team, of which one year he was the treasurer.