A Fast-Food Showdown

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 |  Includes: MCD, YUM
by: Pragmatic Bear

The fast food industry is one of my favorite areas of the broader financial markets. The business models for the companies in this industry are extremely sound. The products they make have three tremendous factors that make them successful; they are relatively inexpensive, they are very filling, and they have an addictive nature. These factors have driven the profits of this industry for years. The two major players in this industry are McDonald's (NYSE:MCD) and YUM Brands! (NYSE:YUM). Both of these stocks have been moving strongly upward since the begging of last year. I would like to analyze both these companies and see how they stack up against each other as well as the broader market.

McDonald's

Company Overview: McDonald's continues to thrive despite an increasingly challenging environment for restaurant operators. Although we doubt the company can duplicate the 1,000 basis points of operating margin expansion it posted during the past five years, we are optimistic that it is capable of generating excellent returns on invested capital over an extended horizon. Our confidence stems from unrivaled scale advantages, an incredibly strong brand, and ample international growth opportunities. We don't expect these qualities to abate anytime soon, thus earning McDonald's the widest economic moat in the restaurant category.

MorningStar's Take: McDonald's generates revenue through company-owned restaurants, franchise royalties, and licensing pacts. Restaurants offer a uniform value-priced menu, with some regional variations. As of September, there were 33,100 locations in 117 countries, including 26,800 franchisees/affiliates units and 6,400 company units.

Fundamentals:

  • Forward P/E Ratio = 15.8
  • P/CF Ratio = 14.8
  • Market Cap = 102.2 Billion
  • Price VS. 52-Week High = $101.12 - 102.22
  • Debt to Equity = .6
  • Dividend Yield = 2.77%
  • Years Increasing Payouts = 35
  • 5 year Dividend Growth Rate = 20.4%

Fiscal Year 2011 and Fourth Quarter Earnings: McDonald's released its 2011 full year and Q4 earnings report on January 24, 2012. This is what it had to say about the very successful 2011.

During 2011, McDonald's continued momentum drove higher profitability and market share gains as we fortified our leadership position around the world," said McDonald's Chief Executive Officer Jim Skinner. "The ongoing strength of McDonald's results is rooted in our Plan to Win with a relentless focus on what matters most to our customers. We are enhancing the customer experience - from our menu and service to our value and convenience - while giving more people more reasons to visit McDonald's more often.

For the 4th quarter McDonald's had some fantastic results. These included:

  • Global comparable sales increased 7.5%, with the U.S. up 7.1%, Europe up 7.3% and Asia/Pacific, Middle East and Africa up 6.9%
  • Consolidated revenue increased 10% (10% in constant currencies)
  • Consolidated operating income increase of 14% (14% in constant currencies) with the U.S. up 15%, Europe up 10% (12% in constant currencies) and APMEA up 22% (19% in constant currencies)
  • Diluted earnings per share of $1.33, up 15% (15% in constant currencies)

The company broke down results according to geographic region.

"McDonald's U.S. delivered strong results for the fourth quarter and year, including the segment's highest annual comparable sales performance since 2006. Throughout 2011, the U.S. reinforced the Company's dedication to everyday value, showcased core and new product offerings, increased convenience and further upgraded McDonald's restaurant portfolio with fresh, modern designs that enhance brand relevance.

Europe generated strong comparable sales results and market share gains for the quarter and year in the face of ongoing economic uncertainty. France, the U.K., Russia and Germany led the segment's operating income growth for both periods. Emphasis on unique promotional food events, fourth-tier menu development and restaurant reimaging continued to provide an appealing customer experience and contributed to the segment's performance.

Asia/Pacific, Middle East and Africa posted strong comparable sales for the quarter and year and delivered double-digit operating income growth for both periods, led by stronger results in many markets. Results across the segment were driven by robust value platforms, brand differentiating conveniences and locally-relevant menu options."

Stock Performance: McDonald's certainly had a year to remember in 2011. The company saw its share price drive up over 30% last year. This gave it the distinguished honor of being the best-performing component of the Dow Jones Industrial Average. Since the beginning of the New Year, MCD has leveled off and has hovered around the $100 -$102 area.

Recent News: On February 8, 2012, McDonald's released its Comparable Store Sales data for January. The results showed a broad increase in comp store sales, which is a very positive sign for MCD. This is what Chief Executive Officer Jim Skinner had to say about it.

"January marks another month of sustained sales growth, demonstrating the ongoing appeal of McDonald's winning combination of value, menu variety and convenience, Our focus on enhancing the McDonald's experience through great-tasting, affordable food and beverage choices served in increasingly modernized restaurants is helping make McDonald's our customers' favorite place and way to eat and drink."

  • U.S. up 7.8%
  • Europe up 4.0%
  • Asia/Pacific, Middle East and Africa up 7.3%

Final Thoughts: McDonald's is a household name that is the preeminent player in the fast-food industry. Throughout 2011 the company pushed higher and higher on better and better quarterly earnings reports. It doesn't seem that MCD is looking to disappoint us in 2012. It represents a solid value stock that still offers investors the possibility of substantial capital appreciation. However, there are a few areas of concern that investors in McDonald's need to be aware of. Rising commodity costs have been shown to cut into the profits of the fast-food industry and Mcdonald's is not immune to this. Also I have some reservations about buying a stock that is this close to its 52-week high. Ideally, I would like to see a little cooling off in the price in order to provide a more manageable entry point. MCD is a powerhouse of a corporation and could be potentially a very profitable addition to a diversified portfolio.

YUM Brands!

Company Overview: Yum remains a well-diversified player in the global quick-service restaurant industry. Several of the company's brands--including KFC, Pizza Hut, and Taco Bell--occupy the leading market position in their respective domestic categories. Moreover, we believe these brands have sizable international appeal, which should help the company extend its leadership in China, and several other emerging markets. Although rivalry among QSR operators is on the rise globally, we remain optimistic about Yum's ability to generate positive economic returns thanks to one of the rare economic moats in the restaurant industry.

MorningStar's Take: With more than 38,100 units in 110 countries, Yum Brands operates the largest quick-service restaurant system in the world based on number of units. It generates revenue through company-owned restaurants, franchise fees, and licensing arrangements. Concepts include KFC (17,000 units), Pizza Hut (13,500), and Taco Bell (5,900). Yum generated $37 billion in system sales in 2010 (48% U.S., 37% YRI, 14% China) and $2 billion in operating profit before corporate expenses (33% U.S.)

Fundamentals:

  • Forward P/E Ratio = 25.40
  • P/CF Ratio = 14.4
  • Market Cap = 29.7 Billion
  • Price VS. 52-Week High = $65.49 - 65.79
  • Debt to Equity = 1.5
  • Dividend Yield = 1.76%
  • Years Increasing Payouts = 8
  • 5 year Dividend Growth Rate = 31.3%

Fiscal Year 2011 and Fourth-Quarter Earnings: YUM Brands reported its 2011 fiscal year and Q4 earnings on Tuesday February 6, 2012. The year as well as the quarter for YUM has been looked upon in an extremely positive light. Here were some of the highlights from 2011.

  • Worldwide system sales grew 7%, prior to foreign currency translation, including 29% in China and 8% at YRI. System sales in the U.S. were even.
  • Same-store sales grew 19% in China, 3% at YRI and declined 1% in the U.S.
  • Record international development with 1,561 new restaurants, including 656 in China and 905 at YRI.
  • Worldwide operating profit grew 8%, including a positive impact from foreign currency translation of $77 million. Prior to foreign currency translation, operating profit grew 4%, including 15% in China and 9% at YRI, offsetting a 12% decline in the U.S.
  • Worldwide restaurant margin declined 0.9 points to 16.0%.
  • Increased annual dividend rate to $1.14 per share. This marked the seventh consecutive year it increased the dividend at a double-digit rate since initiating a dividend in 2004.
  • Repurchased 14.3 million shares totaling $733 million at an average price of $51.
  • Remained an industry leader with return on invested capital of over 22%.

CEO David Novak summed it up when he stated "I'm pleased to report full-year EPS growth of 14%, making 2011 the 10th consecutive year we exceeded our annual target of at least 10%." For YUM the story of 2011 was the remarkable growth the company saw in China. The company opened 656 restaurants in 2011 and grew the operating by 15% as well as boosting same-store sales by 19%. The story with YUM is clearly all about China.

Some of the highlights for the fourth quarter:

  • Worldwide system sales grew 11%, prior to foreign currency translation, including 33% in China, 10% at YRI and 6% in the U.S.
  • Same-store sales grew 21% in China, 3% at YRI and 1% in the U.S.
  • Operating profit grew 15% in China and 12% at YRI, prior to foreign currency translation. Operating profit grew 10% in the U.S.
  • Worldwide restaurant margin declined 1.1 percentage points to 14.3%.

Stock Performance: YUM saw its share price jump by nearly 20% in 2011. This is a fantastic return considering that the averages were basically flat for the year. Since January 1, the stock has tacked on another 9.2% following the markets upward. YUM is currently pushing against its 52-week high. This rapid rise has pushed the valuation markers for YUM to near record levels.

Final Thoughts: YUM is a fantastic company that really seems to get it. It is doubling down on its China bet by opening stores at a torrid pace. This continued process has made the Pizza Hut and KFC recognized brands behind the bamboo curtain. It is a preemptive strike to capture the market of the future. I mean how could you not want to expose your company to the largest population center on the planet? For me YUM has the same concerns as MCD. Currently, they are both sitting at high valuations and are both highly impacted by the cost of commodities. However, if you are looking for a recession resistant stock that provides a dividend and some fantastic overseas growth, look no further than YUM.

Final Comparison: As you can tell by my writing I have the utmost respect for both of these great companies. In fact I wouldn't mind being involved in both of them simply as a way to get more diversification. However, since the title of the article is a fast food showdown I have forced myself to put them head to head and decide a favorite. As much as I love the overwhelming overseas expansion that YUM is promoting it is not enough to pull me away from McDonald's. McDonald's is selling at a significant discount to YUM Brands while offering a higher dividend yield. While McDonald's is not expanding in China as fast as YUM, it still has a growing presence there. With all that in mind I will take McDonald's over YUM if I had to but I'd rather take them both. As I mentioned I think both these stocks like the broader market have run up too quickly recently. I would look for a pull back in the share price before entering into a purchase.

*I would like to thank Morningstar for the valuation and ratio metrics. Also I would like to thank DRiP Investing Resource Center for its list of U.S. Dividend Champions.

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