By Jonathan Chen
This morning J.P. Morgan put out a research note on Yum! Brands (NYSE:YUM), but also included in the note was McDonald's (NYSE:MCD), as J.P. Morgan compares which is the better fast food play.
According to J.P. Morgan, Yum Brands is the better play in the short to medium term, but McDonald's is likely to do better over the long haul. J.P. Morgan rates both at Overweight, and has a $65 and $89 price target, respectively.
In the note, J.P. Morgan writes, "After YTD stock performance of 17% for MCD and 9% for YUM vs. -7% for the S&P, we are concluding that YUM now has better 6-12 month upside. We continue to recommend MCD as a core holding, a stance since 2003, but that the combination of China's consumer/currency, lack of potentially volatile Europe exposure, India opportunity, and potential restructuring presents a stronger case for YUM near-term."
J.P. Morgan talks about the exposure that Yum has to China, with it accounting for 43% of its 2011 operating income. It only accounts for 3% of McDonald's operating income. It is abundantly clear that from previous earnings reports, that China is extremely important to Yum! Brands, with the Chinese devouring Pizza Hut, KFC, and Taco Bell at every chance they get. McDonald's is trying to expand into China to compete with Yum, but for right now, Yum is the undisputed leader. With all of this, it begs the question: With China slowing down, does this help or hurt Yum?
It is clear to anyone that China is slowing, and slowing fast. Just look at the price of copper. Despite yesterday's dead cat bounce, this chart of copper clearly shows something is wrong in the East. With China slowing, its citizens may eat out less, and this could be a negative for Yum, which derives such a heavy portion of its earnings from the world's most populous nation. J.P. Morgan did take this into account, saying, "To us, our expectations for 5% comps for YUM in China in F12 occur even with slowing economic growth, but not a significant contraction."
Despite concerns about China, Yum! must be fairly confident in its cash flow position, as it just recently announced a14% increase in its quarterly dividend, raising it to 28.5 cents per share per quarter.
However, if the global economy slows even more, McDonald's may be better positioned than Yum, given it has a more diverse portfolio of restaurants and franchises, as opposed to Yum. It also is a leader in technology, and is consistently expanding its menu, with new products, and higher margin products, such as lemonade and coffee.
That does not mean all is well in the land of the Golden Arches either. Recently, the company missed same-store-sales for the second time in three months, leading some investors to wonder whether the McDonald's growth engine is over.
What do you think? Is Yum a better stock over McDonald's? Let us know in the comments.
Traders who believe that China will not slow down as much as people think might want to consider the following trades:
- Yum may do better as J.P. Morgan indicated, with China accounting for nearly half of its operating income. Chinese GDP is going to slow, but how much it slows, no one knows. Traders may want to take advantage of overblown fears if they think it is not as bad as imagined.
Traders who believe that the global economy will slow, or potentially go into a deep recession may consider alternate positions:
- If the global economy takes a downturn, consumers will trade down, and they may see McDonald's as the one name to go to, even more so than Yum.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.