Quick-service restaurants (QSRs) have garnered strong momentum following news on the development of COVID-19 vaccines last month.  After suffering near-death business setbacks early in the year, the industry is now trending up due to the rollout and mass distribution of coronavirus vaccines.

Despite store closures and decline in traffic on account of social-distancing protocols, McDonald’s Corporation (MCD) and Shake Shack, Inc. (SHAK), two of the world’s prominent fast-food restaurant companies, have fared better than traditional restaurant chains and managed to stay afloat amid the pandemic by rapidly integrating digital sales, delivery services and takeaways.

MCD is one of the world’s leading global foodservice retailers with more than 39,000 locations in more than 100 countries worldwide. Its restaurants offer various food products and beverages, as well as a breakfast menu. Approximately 93% of MCD’s restaurants are franchised and operated by independent local business owners. The company functions through three segments – U.S., International Operated Markets, and International Developmental Licensed Markets & Corporate.

SHAK owns, operates, and licenses Shake Shack restaurants (Shacks) in the United States and internationally. It is one of the most popular burger-chains that also offers hot dogs, crinkle cut fries, craft beer, beverages, and other products. The company has more than 300 domestic stores, and more than 100 international locations including London, Hong Kong, Shanghai, Dubai, and more.

Both stocks have generated decent returns over the past three years. While MCD returned 33.1% over this period, SHAK gained 96.7%. Regarding year-to-date performance, SHAK is a clear winner with 47.9% returns versus MCD’s 9.9%. But which of these stocks is a better pick now? Let us find out.

Latest Movements  

Last month, MCD announced a new growth strategy, Accelerating the Arches, which encompasses all aspects of the company’s business as the leading global omni-channel restaurant brand. However, the company has also asked its franchisees to shoulder more costs in 2021 and beyond. MCD expects its franchisees to pay technology investment expenses it previously covered and bear a portion of worker career training program costs despite beaten-down sales and pandemic-led shutdowns.

SHAK is investing in fast-tracking digital initiatives by eyeing artificial intelligence and machine learning to optimize its payments facilities and boost its ordering and pickup capabilities in its  latest Order to Eat Tracker. In the third quarter, the company opened six system-wide Shacks, comprising four domestic company-operated Shacks and two net licensed Shacks.

Recent Financial Results

In the third quarter, ended September 30, 2020, MCD’s revenue increased 43.6% sequentially to $5.4 billion, due to higher sales-driven restaurant margins in the United States. This was as partly offset by poor sales performance in the other two segments because of the pandemic. Franchised restaurants contributed 56.2% to the top-line. EPS came in at $2.35, rising 261.5% compared to the prior quarter.

SHAK’s revenue for the third quarter grew 41.6% sequentially to $130 million. A significant portion of the revenue increase came from its digital sales as company-owned digital channels tripled compared to prior year. While same-store sales continue to decline, they have improved sequentially every month since April. In addition, SHAK reported a loss of $0.15 per share, representing a significant improvement from a quarter-ago loss of $0.43 per share.

Past and Expected Financial Performance

MCD’s revenue has declined at a CAGR of 6.8%, over the past three years. However, the company’s total assets have grown at a CAGR of 15.9% during the same period.

Analysts expect the MCD’s revenue to increase 0.7% in the current quarter and 13.9% next year, but to fall 8.4% in the current year. The company’s EPS is expected to fall 20.8% in the current year but rise 34.3% next year.

SHAK’s revenue and total assets have grown at a CAGR of 15.4% and 23.8%, respectively, over the past three years.

Analysts expect SHAK’s revenue to increase 2.1% in the current quarter and 40.7% next year, but to fall 12.5% in the current year. The company’s EPS is expected to decline 194.4% in the current year and then grow 129.4% next year.

SHAK has an edge over MCD here.

Profitability      

MCD’s trailing-12-month revenue is more than 36 times SHAK’s. Moreover, MCD is more profitable with a gross profit margin of 51.4% versus SHAK’s 31.5%.

Valuation

In terms of trailing P/S, MCD is currently trading at 8.30x, 35.4% more expensive than SHAK, which is currently trading at 6.13x. Also, SHAK is less expensive in terms of trailing-12-month EV/Sales (6.98x versus 10.80x).

However, in terms of trailing-12-month price/cash flow, SHAK’s 74.85x is 192% higher than MCD’s 25.63x.

POWR Ratings

While MCD is rated “Buy” in our proprietary POWR Ratings system, SHAK is rated “Strong Buy.” Here are how the four components of our overall POWR Rating are graded for MCD and CMG:

MCD has an “A” for Trade Grade, “B” for Buy & Hold Grade and Industry Rank, and a “C” for Peer Grade. In the 49-stock Restaurants industry, it is ranked #14.

SHAK has an “A” for Trade Grade, Buy & Hold Grade and Peer Grade, and a “B” for Industry Rank. It is ranked #7 in the same industry.

The Winner

Both MCD and SHAK are good long-term investments considering their global market dominance, rapid adoption to digital sales, and the steadily recovering food-service industry. However, SHAK appears to be a better buy based on the factors discussed here.

While MCD is a bigger and more established player and is a relatively cheaper option to bet on right now, SHAK is aggressively expanding by not only improving sales at existing restaurants but also by opening stores at new locations. It has one of the strongest balance sheets compared to its peers, with ample liquidity and no debt, which should fuel its growth.

SHAK is accelerating its upgrade plans by investing in new store designs, expanding drive-thru and walk-up windows, and pick-up and delivery features, to differentiate itself from just “a roadside burger joint.” As a result, we believe, SHAK is well-poised to outperform MCD in the long run.

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MCD shares were trading at $211.75 per share on Thursday morning, down $0.27 (-0.13%). Year-to-date, MCD has gained 9.83%, versus a 16.54% rise in the benchmark S&P 500 index during the same period.

About the Author: Sidharath Gupta

Sidharath’s passion for the markets and his love of words guided him to becoming a financial journalist. He began his career as an Equity Analyst, researching stocks and preparing in-depth research reports. Sidharath is currently pursuing the CFA program to deepen his knowledge of financial anlaysis and investment strategies. More...

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