Yum! Brands Is a Better Long-Term Investment than McDonald’s

Yum! Brands' heavier exposure in Africa gives it an edge over McDonald's.

Jan 7, 2014 at 9:55AM

The Center for Disease Control and Prevention, or CDC, estimates that more than one third of US adults (35.7%) are obese. Interestingly, this seemingly alarming statistic doesn't present any new insight--obesity has long been a thorn in the flesh of America. This explains the perpetual push and pull between restaurant chains, which have taken most of the blame, and various groups such as the Food and Drug Administration, or FDA.

In November, for instance, the FDA said trans fats were not safe. Trans fat, which has been blamed for clogging arteries by various experts, is an ingredient that has long been used to make pastries flaky and french fries crispy. The FDA's negative outlook on trans fat could lead to a ban, adding to a slew of other restrictions placed on US restaurant chains.

Although continued pressure on fast food chains from the FDA and other groups is good for Americans who want to get healthier, it has negatively affected fast food chains over the past several years.

McDonald's has been hit harder than you think
McDonald's (NYSE:MCD), which is heavily exposed to the US market, has arguably been hit the worst by health awareness in the US marketplace. Restructuring to address a market that demands healthier options is harder when you are bigger than your competitors.

Imagine the far-reaching effects that offering healthier options has had on McDonald's huge value chain; for instance, the company has thousands of suppliers of beef. This alone, not to mention restructuring costs, inhibits margin growth. Along with this, McDonald's gross margin has been on a steady decline ever since 2010; it came in at 40% in 2010, 39.6% in 2011, 39.2% in 2012, and 38.9% for the trailing twelve months.

In contrast, McDonald's return on equity, or ROE, the metric that measures a firm's efficiency at generating profits from every unit of shareholder's equity, has been increasing over the same period. How is this even possible when margins have been decreasing? McDonald has increased its leverage, or simply put, it has taken on more debt. Its debt/equity ratio has increased from 35% in 2009 to 38.6% in 2013. As a long-term buy-and-hold investor, McDonald's large debt position dampens the outlook for this company, especially now considering how unpredictable the fast food market has become.

Yum! Brands finds a sweet spot in emerging Africa
Yum! Brands (NYSE:YUM), on the other hand, has increased its exposure in emerging markets, particularly in Africa. As is, Yum! Brands has close to 1,000 KFC outlets in 18 different African countries. It plans to increase this number to as many as 1,200 outlets by 2014.

The fast food industry in Africa is growing rapidly. Euromonitor, a research firm, says that total fast food sales in the Middle East and Africa, including eat-in, home delivery, and take-away, increased from $14.5 billion in 2007 to about $21.5 billion in 2012.

More notably, however, the market factors are less complicated in Africa--they primarily include a youthful population and rising income levels. Health awareness is not a key market factor in Africa like it is in the US. This simple market structure presents unprecedented clarity into the future of fast food chains operating in Africa.

To sweeten the pot, income levels, the key demand driver in the African fast food industry, are rising significantly. For instance, Kenya's Social Class A, defined as households where the head holds a high managerial, administrative, or professional position, will increase by 28% between 2011 and 2020. This is impressive considering that China's Social Class A will increase by 4% over the same period, and worse still, Russia's will contract by 2%.

Yum! Brands, through KFC, has mastered the art of tailoring the menu to the market. This will allow it to penetrate the African market. KFC Nigeria, for instance, offers a jollof rice menu (jollof is an indigenous Nigerian meal). The same is true in India, where KFC outlets offer the veggie-zinger sandwich to appeal to the huge vegetarian population, which is estimated at 40% of the entire population. Yum! Brand's strong cash position relative to African competitors also gives it an edge in influencing lobbying activity and suppressing any negative views from groups within Africa.

Undoubtedly, Yum! Brands is uniquely positioned to capitalize on Africa's increased appetite for fast foods. This not only erects a new growth pillar for the company, but also provides a crucial lift for the entire business in the face of an unpredictable marketplace in the US and most of Europe.

Fool's takeaway
Although McDonald's is a good stock, increased uncertainty in the US fast food market will subject this company to more up-and-down swings going forward. Yum! Brands, however, has found value in a simpler emerging market with far greater growth potential. In the past five years (between December 2008 and December 2013) shares of Yum! Brands have gained around 134%. McDonald's, on the other hand, has gained around 52%over the same period. Yum! Brands' current stance in Africa will allow it to squeeze out even more returns for shareholders relative to McDonald's going forward, as has been the case over the past five years. That's why Yum! Brands is the better pick for a long-term buy-and-hold investor.

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Lennox Yieke has no position in any stocks mentioned. The Motley Fool recommends McDonald's. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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