Why Yum Stock Gets the Benefit of a Doubt, and McDonald’s Doesn’t
Quick, which is the better long-term investment: the most efficient, well-run company in an industry, or the one that’s not as good but improving? For the past several years, the fast-food industry’s gold standard, McDonald’s (MCD), has lagged considerably behind the wannabe, YUM! Brands (YUM), in shareholder returns. It’s falling further behind this year.
The usual reasons for a wannabe to outrun a stalwart don’t seem to apply here. Yes, Yum, with its $32.2 billion market cap, is little more than a third the size of McDonald’s. But revenue growth over four years has been roughly equivalent for the two companies. Until late last year, profit growth was too.
Both companies offered dividend increases along the way to attract investors. McDonald’s consistently offered a superior dividend yield – 3.5% now, compared to Yum’s 1.9% -- but that hasn’t been enough to make it the better investment.
McDonald’s two earnings misses this year have led to several downgrades on the shares, even as analysts continue to refer to the company as “best-in-class” and the “gold standard” of the industry. McDonald’s ability to beat both analyst forecasts and its competitors throughout the worst of the recession give it a revered spot among value investors, who appreciate the consistency. Its profit margins and cash flow remain superior to Yum and most others in this business. For company stores, operating margins at McDonald’s were 18.9% in 2011, compared to 16.1% at Yum. Here’s a look at the overall performance of each:
But it’s going to be difficult for the company to maintain steady growth with Europe in a recession and Asia growth slowing considerably, especially after reporting some eight-plus years of steadily increasing same store sales. Such gains can’t continue indefinitely. McDonald’s CEO Donald Thompson warned that October comparable sales already are turning negative.
Meanwhile, Yum has attracted about as many buy recommendations, making it the more popular pick among analysts these days. Yum’s CEO revised his full-year earnings forecast upward. A big reason for his long-term optimism comes from the company’s big push into China, where it will open some 750 restaurants this year. But it also comes from the understanding that KFCs and Pizza Huts are not nearly as profitable as they should be. “We have 38,000 restaurants with underutilized assets,” he told analysts post-earnings. Same store sales will rise as it adds products like breakfast and makes the operations more efficient.
In other words, Yum can grow by doing what McDonald’s has already done. This would not be such a problem for McDonald’s investors if the share prices of the two companies reflected this difference in growth prospects. At the moment, though, McDonald’s shares are not significantly cheaper than Yum’s.
There’s no guarantee that Yum can pull off a McDonald’s-level improvement, and conservative investors may prefer to stick with the company with more proven ability. Because no company can get too good at running its business.
Dee Gill is a contributing editor at YCharts, which includes the just-released YCharts Pro Platinum for professional investors.