Part four of the "Stock A vs. Stock B" series pits three restaurant industry heavyweights: McDonald's Corporation (MCD) vs. Darden Restaurants, Inc (DRI). vs. Yum! Brands, Inc (YUM). As always, please feel free to leave your comments and suggestions below and be a part of a good discussion.
Brief Company Histories:
McDonald's Corporation needs no introduction. (Most) Kids and adults equally love the "golden arches" for its taste and convenience.
Darden Restaurants, Inc (based near Orlando, Florida), owns many restaurant chains, including Olive Garden, Red Lobster and LongHorn Steakhouse. DRI has 1,800 restaurants in North America.
Yum! Brands, Inc (based in Louisville, Kentucky) operates famous chains like Taco Bell and Pizza Hut. A fact that many do not know is that Yum! was a spinoff from PepsiCo (PEP) in 1997, under the name "Tricon Global Restaurants, Inc."
Pros of MCD:
Dividend Champion: MCD's status as a dividend champion is well documented. Dividend growth investors love the company's ability to pay increasing dividends consistently.
A staple: Even though MCD is listed as a "Consumer Discretionary" stock, it's more of a staple these days. People line up to get their fast and cheap burgers. The stock has a low beta of 0.31, indicating external situations do not affect the stock adversely. If anything, harder economic conditions would force more people to eat at MCD.
Cons of MCD:
The "Health" equation: While McDonald's has introduced some "healthy" options in its menu, there is no doubt that the health conscious consumers would limit or even completely eliminate any visit to McDonald's. Although the company is no stranger to obesity lawsuits, there is no denying more and more consumers are getting health conscious. Panera Bread Company (PNRA) and Chipotle Mexican Grill (CMG) are two big names that dominate the "healthy" eat outs category.
More competition: While the entire restaurant industry is filled with players of all size and type, MCD in particular faces stiff direct competition from the likes of Wendy's (WEN) and Burger King.
Pros of DRI:
Higher Current Yield: As of now, Darden's yields the highest at 3.5% while YUM and MCD yield less than 2% and 3% respectively. MCD's lower current yield can be attributed to the stock's price run up in 2011. DRI, like MCD and to a lesser extent YUM as well, has a history of repeatedly increasing dividends.
Book value per share: Of the three companies, Darden's Book value per share reflects the stock is deeply undervalued right now. In such circumstances with low expectations, even a moderately better than expected performance will boost the stock.
Cons of DRI:
Olive Garden: Yes, Olive Garden is DRI's "Golden Boy". But the company is over reliant on this particular chain and it showed in the company's performance recently when Olive Garden took a hit, even though Red Lobster and LongHorn Steakhouse did very well.
Not much Growth: DRI's growth is almost restricted to the North American market, though the company has been expanding in the middle east specifically through franchising.
Pros of YUM:
Aggressive International Expansion: Both MCD and YUM have a significant presence outside the US. While MCD already generates about 60% of its revenues from outside the US, YUM has been expanding vigorously, particularly in China.
Higher Return on Equity: As mentioned in the previous article, a higher return on equity means a company is able to generate more profits on the shareholder's equity. YUM's ROE is stupendous, at about 75%. Its even more impressive when we note MCD has a ROE of about 40%, while Darden lags at 25%.
Cons of YUM:
Valuation: YUM trades at a rich premium, with a PE of almost 24. MCD and DRI trade at lower than the industry's average of about 20. Yes, the company has significant growth potential in China (and Africa) but MCD has comparable growth catalysts as well. Also, YUM yields the lowest out of the three stocks.
Debt/Equity: YUM has the highest Debt/Equity ratio amongst the three companies. Even though this can be attributed to their expansion and capital needs, history shows companies with consistently high debt/equity ratio underperform their peers.
Decision: Darden is currently a part of our portfolio, purchased during one of its many hiccups in 2011. But that doesn't mean MCD is not on the radar, it's just that the stock has run up too much recently that we are looking at a better entry point. YUM, however is richly valued at the moment and is caught between the dividend and capital growth juggernaut McDonald's and the higher yielding Darden. However, YUM would be a very nice addition to the portfolio on any meaningful pullback and a significant dividend increase.
Disclosure: I am long DRI.
