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3 Outperforming Restaurant Companies With Increasing Gross Margins

On Tuesday, a day where major fast-food chains like McDonald's Corp. (NYSE:MCD) and Chipotle Mexican Grill Inc. (NYSE:CMG) report earnings, three stocks that have outperformed the Standard & Poor's 500 Index by at least 5% over the past six months and have increasing gross margins according to the All-in-One Screener are McDonald's, Wingstop Inc. (NASDAQ:WING) and Yum Brands Inc. (NYSE:YUM).


Major Pershing Square holding Chipotle reports earnings

Chipotle, a major holding of Bill Ackman (Trades, Portfolio)'s Pershing Square Capital Management, said third-quarter revenues were $1.4 billion, up 14.6% from the prior-year quarter. Despite this, shares declined on the heels of the Newport Beach, California-based company reporting that given the longer construction timeline associated with the Chipotlane, the company's drive-through product, Chipotle expects total openings for the year to fall at or slightly below the guidance range of 140 to 155 openings.

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Ackman's firm has not released its third-quarter portfolio as the deadline is 45 days after the quarter ends. According to GuruFocus Real-Time Picks, a Premium feature, Pershing Square disclosed a holding of 1,724,310 shares as of Sept. 27, down 58,400 shares from the second quarter. While shares averaged $704.23 during the June quarter and traded around $815.49 on Sept. 27, shares of Chipotle traded around $823 at the aftermarket low.

Although the fast-food burrito chain has a profitability rank of 8, driven primarily by margins and returns outperforming as much as 77% of global competitors, GuruFocus warns that Chipotle's gross profit margin and operating margin have declined in the double-digits per year on average over the past five years based on loglinear regression.

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Screener identifies companies with growing profit margins

Berkshire Hathaway Inc. (NYSE:BRK.A)(NYSE:BRK.B) co-managers Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) listed four criteria for their value screen for "good companies at fair prices": predictable revenue and earnings growth, strong competitive advantages, no meaningful debt when growing its business and attractive price-earnings-to-growth ratios.

Competitive advantage refers to anything that allows a company to distinguish itself from competitors. A company that has durable competitive advantages is more likely to increase gross profit margins than one with no competitive advantage. On the flip side, companies whose gross margins are declining can signal loss of competitive power, which in turn can result in lower profitability.

As of Tuesday, the All-in-One Screener listed three restaurants with a 10-year median return on capital of at least 20%, a profitability rank of at least 7, a five-year gross margin growth rate of at least 4% and a six-month relative to S&P 500 return of at least 5%.

McDonald's

According to the Screener, McDonald's outperformed the S&P 500 by 5.46% over the past six months. Despite this, shares of McDonald's tumbled 5.04% from Monday's close of $209.84 on the heels of reporting earnings that fell short of analyst estimates. CNBC noted that the Chicago-based fast-food chain reported its first earnings miss over the past two years. The decline in McDonald's shares helped the Dow close 39.54 points lower than Monday's close of 26,827.64.

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The company reported net income of $1.608 billion during the September quarter, down 2% from the prior-year quarter as lower gains on sales of restaurant businesses in the U.S. offset strong growth in sales-driven franchised margin dollars. McDonald's said it terminated its "2 for $5 Mix and Match promotion," which the company said was a "key sales driver" for the first half of the year.

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GuruFocus ranks McDonald's profitability 9 out of 10 on several positive investing signs, which include profit margins outperforming over 97% of global competitors and a return on assets that outperform 94.08% of global restaurants. Additionally, operating margins have increased approximately 6.80% per year over the past five years and are outperforming over 98% of global peers.

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Gurus with large holdings in McDonald's include Pioneer Investments (Trades, Portfolio), Steven Cohen (Trades, Portfolio) and PRIMECAP Management (Trades, Portfolio).

Wingstop

The Screener reports that Wingstop outperformed the S&P 500 by approximately 13.17% over the past six months.

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The Dallas-based restaurant chain operates fast-casual restaurants that serve chicken wings, fries and sides. GuruFocus ranks Wingstop's profitability 8 out of 10 on several positive investing signs, which include operating margins and returns on assets that outperform over 93% of global competitors.

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Yum Brands

The Screener reports that Yum Brands outperformed the S&P 500 by approximately 6.11% over the past six months.

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The Louisville, Kentucky-based company operates fast-food chains like KFC, Pizza Hut and Taco Bell. GuruFocus ranks the company's profitability 8 out of 10 on several positive investing signs, which include profit margins and returns outperforming over 96% of global competitors. Despite this, Yum Brands' three-year revenue growth rate of 6.1% outperforms just 61.13% of global restaurants.

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Disclosure: No positions.

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This article first appeared on GuruFocus.