McDonald's (MCD) has been one of my favorite consumer services investments due to its visible earnings, deep-industry knowledge, and leading brand name. It has 60% less volatility than the broader market and an attractive dividend among peers at 2.8%. Like McDonald's, Yum (YUM) is also rated a "buy" on the Street. Based on my multiples analysis and review of the fundamentals, I find that it will still be outperformed by McDonald's.
From a multiples perspective, McDonald's is the cheaper of the two. It trades at a respective 19x and 15.8x past and forward earnings. Yum trades at a respective 23.8x and 17.5x past and forward earnings while having a dividend yield that is roughly 100 bps lower than that of its competitor at 1.8%. A word of caution, however: While Wendy's (WEN) is trading at 21.6x forward earnings, McDonald's is still valued at roughly its historical 5-year average PE multiple. Thus, room for multiples appreciation may be limited.
On the fourth quarter earnings call, Yum's management noted strong performance, particularly in China:
I'm pleased to announce we delivered 14% earnings per share growth in 2011, marking the 10th consecutive year we exceeded our annual target of at least 10%… The facts are we have a portfolio of brands with leadership positions in China and other emerging markets with a long, long runway for growth…
First, our leadership position in China and in other emerging markets. Over half of our operating profit is now generated in China and the 72 other emerging countries in which we operate throughout the world. Yum!'s strongest businesses are located where the highest growth is expected to occur in the years ahead. This is a very powerful combination. We view China as the best restaurant growth opportunity of the 21st century. Our brands further strengthened their category-leading positions with a record 656 new restaurants and extraordinary same-store sales growth of 19% this past year.
Fortunately, inflationary costs for labor and food has been relatively modest in China compared to expectations. And, furthermore, commodity costs have been indicating signs of easing. Taco's business is starting show signs of life with comps turning positive late 4Q11. Core EBIT growth of 17% was record-breaking. Simply put, this was an excellent conclusion to the year.
Going forward, ROIC is set to expand by around 600 bps to 44.5% in 2013 as net debt declines by around $200M. For the first quarter, comps in China are looking to be trending in the solid double-digits, crushing the single-digit expectations.
Consensus estimates for Yum's EPS forecast that it will grow by 13.9% to $3.27 in 2012 and then by 14.7% and 16.3% in the following two years. Assuming a multiple of 19x and a conservative 2013 EPS of $3.72, the rough intrinsic value of the stock is $70.68, implying 8.3% upside.
McDonald's similarly had a strong close to the year. Global comparable sales rose 5.6%, continuing the growth momentum for nearly a decade now. December results were also the best since January 2004 with comps up 9.8% domestically and 10.7% in Europe. The main problem that McDonald's faces is in reducing costs in an environment replete with growing tax, inflation, and FX headwinds.
Consensus estimates for McDonald's EPS forecast that it will grow by 8.7% to $5.73 in 2012 and then by 10.3% and 10.4% in the following two years. Assuming a multiple of 19x and a conservative 2013 EPS of $6.26, the rough intrinsic value of the stock is $118.94, implying 19% upside.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
