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More than three months ago, I argued that McDonald's (NYSE:MCD) was undervalued due to its global footprint and impressive innovation. From free Wi-Fi to menu updates and promotional efforts, McDonald's is led by an expert team that knows how to drive shareholder value while building an already-strong brand. Since the article was published (see here), the stock has appreciated by 13.2% while Yum! (NYSE:YUM) appreciated by 10.4% and the S&P 500 by 4%. While I maintain that the famous restaurant chain is still an attractive defensive stock to hedge against macro volatility, I find that the upside is limited at this point.

From a multiples perspective, restaurant stocks are fairly expensive - perhaps the price investors need to pay for reputation. McDonald's trades at a respective 19.1x and 17x pas tanned forward earnings while Yum! trades at a respective 22.6x and 18x past and forward earnings.

Both firms have betas below 1 and are thus relatively stable in terms of investment returns, but McDonald's has a meaningfully larger dividend yield at 2.9%. The main opportunity that Yum! has going for it is improving gross margins, which are 1,160 basis points below that of its competitor.

At the third quarter earnings call, McDonald's esteemed CEO, Jim Skinner, noted strong global results:

For the third quarter, global comparable sales were up 5%, and constant currency's operating income increased 8%, and EPS increased 6% to $1.45.

Our global success continues with every area in the world contributing. In the United States, comparable sales for the quarter were up 4.4%, and operating income grew 6%. In Europe, comparable sales for the quarter increased 4.9%, and operating income grew 6% in constant currencies. And in Asia/Pacific, Middle East and Africa, comp sales for the quarter increased 3.4%, and operating income grew 15% in constant currencies. And our momentum, I'm happy to say, is continuing into October with global comparable sales expected to be up 4% to 5%.

November same store sales rose 7.5% in November, about 290 bps higher than expectations. In addition, the firm is benefitting from solid pricing and promotion. Risks include slower volume in Europe and the United States and also margin declines. Although less than 20% of restaurants are owned-and-operated (which have higher margins than those licensed or franchised), this group made up 67.4% of the firm's 2012 revenues.

Consensus estimates for McDonald's EPS are that it will grow by 13.4% to $5.23 in 2011 and then by 9.6% and 9.8% more in the following two years. Of the 16 revisions to estimates, all but one went up. Assuming a multiple of 18x and a conservative 2012 EPS of $5.66, the rough intrinsic value of the stock is $101.88, implying 4.5% upside. However, if the multiple were to fall to a more reasonable level of 16x and 2012 EPS turns out to be 4.4% below the consensus at $5.48, the stock would depreciate by 10.1%. Accordingly, I recommend holding out for now, despite the solid "buy" recommendation on the Street.

Yum! has impressive cash flow and 2012 will likely be an inflection point for the firm due to particularly weak performance in 2011. Input volatility, margins, and slower-than-expected demand in China remain very real concern, but I anticipate that fourth quarter same store growth in China will be around 15%.

Moreover, I like the firm's emphasis on expansion and building new stores over improving existing ones. Around 58% of EBIT now comes from emerging market and the Little Sheep brand remains a major catalyst going forward.

Consensus estimates for Yum!'s EPS are that it will grow by 13.4% to $2.87 in 2011 and then by 12.5% and 14.6% more in the following two years. If the multiple were to fall to 19.1x - where McDonald's is trading at now - and 2012 EPS turns out to be 7.4% below the consensus, the firm would be fairly valued. The Street also rates shares a solid "buy".

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Limited Upside For McDonald's, Yum Brands