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Perusing the Profit Menu at Fast-Food Chains

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Striking McDonald's workers are creating quite a stir.

Their planned protest in front of company headquarters during today's annual shareholders' meeting prompted management to tell 3,200 employees to stay home. Some 2,000 protesters say they'll picket the Oak Brook, Illinois, campus to demand both higher pay and the right to unionize.

This latest escalation follows a mass protest on May 15 by thousands of fast-food workers globally, including demonstrations in 150 U.S. cities. They say the national average fast-food worker wage of $9.08 per hour ($18,880 per year) does not constitute a "livable" wage.

As politicians debate whether protesters are justified, we as investors debate whether McDonald's Corp. (MCD) can afford a potential increase, especially since $15 is nearly double what many employees earn. McDonald's profit margins are the highest in the industry at 18 percent, suggesting the company enjoys a far wider cushion against cost increases than its peers. On the other hand, profits are forecast to grow only 3.6 percent this year, well below average. So while McDonald's could presumably afford the increase, making up the difference could prove more difficult.

We admit this is a highly complex issue with significant political undertones, and our analysis barely scratches the surface. That said, we note three other fast-food restaurants which may be in an even more challenging position than McDonald's should workers prevail. All three lag peers in terms of both profit margin and profit growth.

The critical issue for investors is cash flow. Some restaurants can afford to pay more, others cannot. Given an average 2014 valuation for the restaurant group of 24.4 times earnings (compared to 16.3 times for the S&P 500 Index), we are cautious of the group.

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