As the 2020s begin, a new era is dawning for the restaurant industry. Mobile ordering, ghost kitchens (an operation with no dining room, set up for delivery only), and the delivery wars are creating a new dynamic for businesses to navigate, and not all players are adapting with the times -- even though money spent paying someone else to do the cooking is greater than ever before, exceeding spending at grocery stores in 2019.
That's nothing new, though. Food preparation has always been a fiercely competitive industry. For some restaurant stocks, rapid changes in consumer tastes mean lots of new business. Three brands that were built for 21st century-style eating out are Starbucks (SBUX -1.73%), Domino's Pizza (DPZ -1.73%), and Yum China (YUMC 4.37%).
Growing coffee culture through digital channels
Starbucks needs no introduction. The world's largest coffee chain and one of the largest restaurant brands is still very much in growth mode, especially in China where hundreds of new stores are opening every year. Even though Starbucks is facing new competition from China's own upstart -- Luckin Brands -- there is plenty of room for both companies to win. The country's 1.4 billion residents are still mostly tea drinkers, and coffee culture has a lot of open space to expand into in the years ahead.
As for specific results, Starbucks' sales were up 7% year over year during its fiscal 2020 first quarter, led by a 16% increase in store count in China and a 3% increase in comparable sales (foot traffic and average guest ticket size at existing stores). Coronavirus has cast some shade on operations there in the short term, but the future looks bright for the coffee giant in China.
More impressive to me, though, was Starbucks' 6% comps surge on its home turf in the U.S. With 15,188 locations at the end of 2019 -- nearly half of Starbucks' total global store count -- a 6% growth rate is nothing to balk at for an operation already so large and well entrenched in American culture. Starbucks is pulling it off by fine-tuning its app, digital rewards, and rotating menu, and it's getting smarter at predicting what customers want by rolling out artificial intelligence-enabled equipment at its stores this year. At the end of the first quarter, the number of Starbucks rewards members in the U.S. was up 16% year over year to 18.9 million.
The digital success in America provides a template for success in other markets around the globe. After this latest report card, Starbucks stock is off its all-time highs by nearly 15% and trades for 28.1 times forward earnings estimates. It's a premium valuation but one worth ponying up for as the world's leading coffee maker still has plenty of growth left in the tank.
The original delivery superstar still does it best
Where Starbucks has been winning with its digital app and ordering capabilities, other businesses have been finding success with digital ordering and delivery. Consumers seeking convenience has led to the rise of new delivery services, and even local mom-and-pop shops have been signing up to services like DoorDash to ride the wave.
Often forgotten, though, is Domino's Pizza -- the leader in pizza delivery and one of the most experienced delivery companies around. Domino's has been driving pies to customers for decades and knows a thing or two about efficiently getting a hot meal to its customers.
One of the complaints about third-party food delivery services is just that: the timing. Oftentimes, food does not make it to a diner until long after the restaurant (or an increasing number of ghost kitchens) is finished preparing the meal, meaning the meals are lukewarm or cold. Domino's strategy in recent years has been what it calls "fortressing," opening up new stores in existing markets so that it's as close as possible to customers. That speeds up delivery time, increases the odds that the pizza arrives hot, and helps Domino's stay top-of-mind for those looking for a meal brought to them.
Of course, aggressive expansion in existing markets runs the risk of Domino's cannibalizing its own sales. That is one culprit for the 2.4% comps growth in the U.S. in the third quarter, down from 6.3% a year ago, and 1.7% comps growth internationally, down from 3.3% a year ago. Growth is growth, though, and even Domino's slower pacing is still faster than the industry average. I like the pizza empire's chances to come out on top in the delivery wars. Ahead of end-of-2019 earnings on Feb. 20, Domino's stock is trading for 27.3 times forward earnings.
The world's biggest digital restaurant following is in China
For our last restaurant, we'll head back to China -- this time discussing a pure play on the world's most populous nation. Yum China is the sole licensee of KFC, Pizza Hut, and Taco Bell in China and the largest restaurant operator in the country.
Yum China recently reported its full-year 2019 results, putting up a 4% increase in full-year revenue. Comps were up 4% at KFC, and even the struggling Pizza Hut grew comps by 1% in the year (excluding negative currency exchange rates). Adjusted earnings per share were up 7% year over year, or up 23% when including equity investment gains and losses.
It was a momentous year for Yum China with positive results bucking the slowing Chinese economy in the past year. The company started growing its own coffee brand COFFii & JOI, opened new fast-food stores inside gas stations, experimented with Taco Bell (which now has seven stores in Shanghai), and invested in its wholly-owned brands like Little Sheep, which now has 300 stores in 11 countries. And of course, there was the main goal of expanding KFC and Pizza Hut, which ended 2019 with 624 and 41 net new openings, respectively. In total, Yum China was operating 9,200 restaurants at the end of the year, up from 8,484 a year ago and making solid progress toward its long-term goal of 20,000 locations.
As for digital, Yum China boasts a massive following. The KFC and Pizza Hut loyalty programs and apps had 215 million (up 35% year over year) and 70 million (up 33%) users, respectively, at the end of 2019. Orders via digital platforms accounted for 61% of total sales in Yum China's fourth quarter, and delivery accounted for 23% of sales (up from 20% last year). Yum China's digital footprint and delivery network is massive and still growing fast. This global leader trades for 22.7 times trailing 12-month adjusted earnings. Management did say it sees significant disruption from the coronavirus outbreak with a third of its stores temporarily shuttered and those still open generating as little as half of the sales they did a year ago. That is sure to create some short-term volatility in the stock, which I see as a buying opportunity for the long haul.