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How You Can Beat the Cyclicality in the Restaurant Industry

After a weak 2012, the restaurant industry seems to be recuperating. Lower food-cost inflation, growing same-store sales (mainly on the back of extra value-for-price initiatives) and international expansion boosted the industry’s prospects for the year.

Actually, the National Restaurant Association expects a 3.8% year-over-year increase in total restaurant sales to $660.5 billion this year. In this context, I will take a look at Tim Hortons Inc. (USA) (NYSE:THI)Yum! Brands, Inc. (NYSE:YUM) and Darden Restaurants, Inc. (NYSE:DRI) in order to evaluate whether or not they stand as good long-term investment opportunities.

Tim Hortons Inc. (USA) (NYSE:THI)

Canadian value
Tim Hortons is the largest quick-service restaurant chain in Canada, with a market capitalization of $8.6 billion. Growth prospects for the company abound, not only in Canada but also in the U.S. and other international markets where the penetration potential is substantial.

In Canada, Tim Hortons benefits from its scale and its front-runner position in the industry. These features allow it to use leverage on suppliers, access superior retail real estate, and make hefty investments in advertising.

In the U.S., the restaurant chain faces two big problems: limited brand awareness and strong competition from Dunkin Brands Group Inc (NASDAQ:DNKN). However, a combination of quality and value should help it make a name for itself and allow it to successfully compete with Dunkin. Furthermore, with double the market capitalization, scale advantages still favor Tim Hortons.

Going forward, its franchise-based business model (approximately 99% of Tim Hortons’ restaurants are operated by franchisees) will provide the company with the necessary cash and predictability to weather the cycles inherent in the industry.

The management has put in motion several initiatives to invigorate growth. These developments include changes in key managerial positions (including the designation of Marc Caira as president and CEO), and the incursion into some Middle Eastern markets like Kuwait, among others.

After experiencing a 3 week uptrend, Tim Hortons now trades at 22 times its earnings, a slight discount to the industry average. I should also highlight that Tim Hortons boasts a ROE of 35%, versus Starbucks‘ 28.7% and Dunkin’ Brands’ 23.2%.Moreover, Tim Hortons yields 1.8% of the current stock price in the form of dividends. With such a compelling value proposition, this is a stock to add to your long-term portfolio.

Yum! Brands is a yummy investment
Yum! Brands is a quick-food behemoth with more than $32 billion in market cap. As the owner of several category leading brands like KFC, Taco Bell and Pizza Hut, brand awareness is not a problem for Yum!. The fame of these names should help it expand into new markets and continue to establish its dominance in some of its main markets, especially in China.

In China, proven distribution infrastructure and local site development teams should make the expansion easier, according to Morningstar. In other mature markets, like the U.S., menu innovations and refranchising initiatives should lead to wider margins for the upcoming years.

Emerging economies also provide plenty of opportunities for expansion as urban populations, disposable incomes and young populations grow. Actually, analysts believe that 50,000 Yum! locations are possible by 2020, with major growth opportunities coming from India and Africa.

Yum! also enjoys of scale advantages, which help it bargain with suppliers, reducing costs considerably. Although margins are just respectable (good, but not great), returns on equity are astonishing. The company boasts a ROE of 65.4%, more than double the industry average.

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