Some firms now enjoy the benefits of restructuring; others should see earnings shift up later in 2006, analysts say.
David [email protected]
Area of Coverage: Consumer Services — Restaurants
Outlook: Generally, we continue to favor the global brand companies with superior brand and capital management, stable cash flow from franchise business models, and international sources of growth.
Effectively, all the fast-food stocks that we are recommending have restructuring programs — with "re-franchising" of restaurants being a common strategy. This is where they are selling company-operated restaurants to franchisees and boosting return and earnings stability in the process. We look at that as a nice value creation kicker for our buys over the next two to three years.Below average industry sales growth in the casual-dining sector has compelled several major casual-dining chains to focus harder on brand and media strategy along with menu innovation. Fast-food companies, and Darden Restaurants in casual dining, have been a little ahead of the game and have addressed brand and menu strategies earlier.
Fast-food restaurant companies such as McDonald's have improved their capital strategy with re-franchising, and casual dining companies may be next to improve capital decisions. For casual dining chains, slowing down unit growth and re-franchising should be next on the to-do list. In summary, this overall backdrop of corporate self-improvement and international profit contribution are positives for relative EPS in the restaurant sector; so, too, are food costs in the U.S.
Buys: Applebee's International (APPB), McDonald's (MCD), Wendy's International (WEN) and Yum Brands (YUM)
Top Pick: Yum Brands
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Why YUM Brands? We see high- quality 13 percent EPS growth in 2006 being driven by accelerating sales momentum in China and high-single-digit-profit growth from the U.S. Other factors supporting profitability include lower food costs. For the medium to long term, we see YUM evolving over the next few years into more of the "China/Taco Bell/franchised-income" company and less of a "company-operated U.S. KFC/ Pizza Hut" company. The China business will be growing, profit-wise, close to 25 percent per year. We believe that investors are well-served in buying YUM now at slightly-above a market multiple.
Linda Bolton-Weiser
Oppenheimer & Co.
212-668-8162, [email protected]
Area of Coverage: Consumer Products — Household Products
Outlook: Historically, this group outperforms during times of declining interest rates. The group outperformed the S&P by 22 percent in '01 and by 28 percent in '02. In the rising rate environment of the last couple of years, however, the group has been a slight underperformer. The group's earnings strength relative to the S&P 500 has been very poor in the last few years: But, this is actually projected to turn positive in the second half of '06.
The cost of raw materials also affects group performance. The current cost of plastic resin — assuming no change going forward — would indicate some relief of raw materials cost pressure in the second half of the year. But if the price of oil remains high and plastic resin costs follow, then all bets are off on that.
