Can Yum! Brands Be the Breakfast of Champions?

Taco Bell, a division of Yum! Brands (YUM 0.15%), has thrown down the breakfast gauntlet and is taking the challenge right to McDonald's (MCD -0.91%). Highlighted by an advertising campaign featuring "real life" Ronald McDonald's, the quick-service chain intends to capture market share of the breakfast menu.

Tacos for breakfast?
Taco Bell's new line of breakfast foods is comprised of 12 new products, including the Waffle Taco and the AM Crunchwrap. These items are designed to compete with McDonald's infamous Egg McMuffin. However, the question remains as to whether Taco Bell can steal McDonald's bacon. But the move is also designed to foster future growth of Yum! Brands in the U.S.

Yum! reported results for the first quarter ended March 22 last week. The company reported earnings per share of $0.87 along with revenue of $2.72 billion. In addition to Taco Bell, the company's divisions include KFC and Pizza Hut.

The company noted that it has restructured its financial reporting by combining its international and U.S. divisions into three "global brand divisions" -- KFC, Pizza Hut, and Taco Bell -- while China and India continue to be separate divisions.

This is important to note because Yum! sees enormous growth potential in these markets.

In China, for example, management stated that same-store sales grew by 9% in the first quarter and that Yum! expects to open 700 new stores in China in 2014.

Meanwhile, Taco Bell accounted for 21% of Yum!'s total operating profit -- 97% of which was generated in the U.S. But getting into the breakfast game appears to be a needed ingredient, because same-store sales fell by 1% in the first quarter. Like other chain restaurants, however, Yum! attributed the dip to the harsh winter weather.

Moreover, the company also reported that operating profit fell by 16%, with 5% of that figure stemming from "franchise incentives" in connection with the breakfast launch. In short, Yum! has a lot riding on the Waffle Taco's success in the domestic breakfast market place.

Who's afraid of the Waffle Taco?
McDonald's does not seem too worried about the Taco Bell breakfast challenge. During the company's earnings call last week, McDonald's CEO Don Thompson said the company hasn't seen an impact from new competitors in the breakfast game.

Thompson was also quick to highlight the difference between McDonald's and the other quick-service breakfasts because the company cooks fresh eggs and other items on site, while the other chains use mostly frozen products.

"We crack fresh eggs, we grill sausage and bacon, we bake biscuits and we toast muffins," Thompson said.

Moreover, McDonald's plans to beef up its breakfast marketing, so to speak, by focusing on its coffee -- a move that appears to be designed to take the challenge to Dunkin' Brands (DNKN) in the breakfast wars.

For the first quarter, McDonald's sales at established U.S. locations fell 1.7%, while global sales were up by 0.5% -- partially offset by gains in Europe. Meanwhile, breakfast is a growing category in the industry, and McDonald's is digging in to defend its turf.

Beyond the breakfast bowl, McDonald's intends to focus its marketing efforts on the core menu featuring the Big Mac, Egg McMuffin, and fries, since 40% of all sales are driven by these items.

What's cooking at Dunkin' Donuts?
Dunkin' Brands has moved beyond making the doughnuts and also offers a variety of morning-time items along with its long history of serving hot and reliable coffee.

Moreover, Dunkin' has been upping its game by offering healthier items in order to compete more effectively with Starbucks. In fact, Dunkin' even tried to get into the gluten-free space last year by test marketing a gluten-free cinnamon doughnut as well as a blueberry muffin. But the goodies apparently weren't popular with customers, and the company pulled those products back earlier this year.

Like its competitors, Dunkin' had a rough first quarter, which it also blamed on the heavy winter weather. In its recent financial report, the company said comparable-store sales grew by a humble 1.2% along with a 6.2% rise in revenue. Nigel Travis, chairman and CEO of Dunkin' Brands, said: "We had a difficult first quarter with our comparable store sales growth in the U.S. significantly affected by severe weather in the regions of the country where most of our Dunkin' Donuts restaurants are located. However, we remain confident that we will hit our targets for the full year."

Final Foolish takeaway
Investors should take note that the quick-service chains all face challenges domestically to boost sales. And serving breakfast has become an important ingredient in doing so. But it remains to be seen if Taco Bell will emerge victoriously from the breakfast war. That said, it appears Yum! Brands is well poised to grow internationally, especially with its China division.

While Dunkin' Brands also has a plan for growth, its main rival, Starbucks, has a number of initiatives under way to diversify its beverage lines. Finally, the biggest challenge for Yum!, McDonald's, and Dunkin' is the fact that consumers are becoming increasingly aware of the need to eat healthier, and investors in retail dining might also consider other healthy alternatives.