The Better Buy In Restaurant Titans

By Chad Henage - May 21, 2012 | Tickers: MCD, YUM | 0 Comments

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You can't ask for better brand names than McDonald's (NYSE: MCD) and concepts by Yum Brands (NYSE: YUM) like Taco Bell, KFC, and Pizza Hut. These restaurant names are recognized worldwide and are well loved by millions. Some might believe that these two companies have expanded everywhere possible, but that doesn't appear to be the case. Even with over 30,000 restaurants, I've found in the past that McDonald's only accounts for about 0.5% of the worldwide restaurants in its category. The question is, with great brands and room to expand, which one is the better buy today?

Looking just at the PEG ratio, it appears that Yum Brands is the slightly better value. The company has a higher expected growth rate, which makes the higher P/E ratio more palpable. There is a later test that we'll run that confirms that this higher growth rate for Yum Brands might be more attractive as well. (McDonald's – 1, Yum Brands – 2)

One way to gauge the earnings potential of a company is, to see how they've done versus analyst estimates in the last year. In theory, a company that outperforms estimates should be more highly valued. Look at how close this race is:

It's very close, but Yum Brands comes out ahead due to their higher average beat of estimates. This better relative performance, gives us reason to believe that the company may beat analysts expectations for growth in the future as well. (McDonald's – 1, Yum Brands – 2)

While earnings are important, dividends can play a vital role in investors overall returns. When it comes to dividends, there are really three pieces to the dividend. Let's compare these three pieces and see which company offers the best combination of traits: 

If you are looking for the best current yield, McDonald's is the clear winner. If you are looking for the safest dividend based on payout ratio, then Yum Brands wins. Since their dividend growth is nearly identical, which one is the best? While the lower payout ratio would seem to favor Yum Brands, this category goes to McDonald's. The reason is their lead in yield is too large. In theory, each company will increase their dividend with respect to their earnings growth. With McDonald's expected to grow at about 10% and Yum at 13%, if dividend increases follow these percentages, it will take over 20 years for Yum Brands to catch McDonald's in yield. Given this huge lead, McDonald's wins this category. (McDonald's – 2, Yum Brands – 1)

Usually comparing two company's free cash flow can give us an insight into who is the more efficient operator. In this case, both company's free cash flow per $1 of assets is exactly the same at $0.14. Since cash flow is nearly identical, let's compare the two companies balance sheets. Using the debt-to-equity ratio, we find McDonald's ratio is 0.84, while Yum Brands ratio is 1.64. With relatively twice as much debt, Yum Brands has to use more of their cash flow toward debt payments. This gives McDonald's the edge, and argues that the company can do more for their shareholders. (McDonald's – 2, Yum Brands – 1)

The final scores are McDonald's – 6 and Yum Brands – 6, it's a tie! In my mind the decision comes down to two things, the dividend and the balance sheet. McDonald's has a better dividend and a better balance sheet. In addition, McDonald's has something that Yum Brands can't say, and that is its lineup of McCafe beverages. While Yum Brands boasts 3 different food concepts, none of these restaurants has any specialty drink menu. The fact that McDonald's keeps expanding its McCafe beverages, gives customers a reason to stop at Mickey D's even if they would never order a burger. This gives McDonald's a new growth opportunity. People might eat 3-4 main meals a day, but they consume many more beverages. McDonald's already runs McCafe concepts overseas that offer just drinks and desserts. If the company decides to bring that smaller concept stateside, they could challenge Starbucks and Dunkin' Brands in the coffee space. This factor is a big reason to consider McDonald's, and serves as the tiebreaker in my opinion. Let me know what you think in the comments section below.

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