When looking at restaurant stocks, one could hardly find two more formidable fast-food empires than McDonald's (MCD -0.33%) and Yum! Brands (YUM -0.43%). With almost 39,000 locations and over 50,000 locations, respectively, these mature businesses have moved beyond their high-growth phase.
Therefore, much of a McDonald's or Yum! Brands investment choice comes down to profits, and what the company does with them. Following the money, which of these two stocks is the better buy today?
Surviving the coronavirus
The COVID-19 shutdown makes it hard to be a restaurant company these days. Monthly restaurant sales were down 27% year over year in March and 49% in April, according to the U.S. Census Bureau. Sales were down at McDonald's and Yum! as well, but both companies have the financial strength to survive this lean time. Yum! just declared a dividend in line with its last payout. And McDonald's hasn't cut its dividend, though we're still waiting for an announcement for its next one.
Paying a full dividend on time suggests it's financially strong despite the coronavirus. But corporate liquidity isn't the only consideration here. Both companies are 98% franchised, so the franchisees' financial health is crucial as well. Unfortunately, we aren't privy to that information. But both companies are assisting franchisees by deferring payments. McDonald's deferrals total over $1 billion, and Yum! is offering two months' grace for now.
I'd say McDonald's and Yum! are equally likely to make it through this period with their businesses intact, though it'll be a lower-profit year. First-quarter earnings per share fell 68% at Yum! and 15% at McDonald's. McDonald's is forecasting negative cash flow for the upcoming second quarter, and Yum! has withdrawn all guidance.
In 2019, prior to the coronavirus, Yum! had EPS of $4.14. McDonald's had EPS of $7.88. How these companies allocate these ongoing profits will largely determine future shareholder returns.
Different kinds of acquisitions
Acquiring another company is a good option for cash-rich companies. Speaking of acquisitions, both McDonald's and Yum! made large purchases in the past year, but they couldn't be more different. McDonald's bought a pair of technology companies, while Yum! acquired a hamburger chain to join its existing Pizza Hut, KFC, and Taco Bell brands.
In March 2019, McDonald's announced its acquisition of Dynamic Yield, a decision-logic technology company. Later, it bought Apprente, a voice technology company. Both of these purchases were intended to augment McDonald's sales by increasing customer throughput, boosting order accuracy, and growing sales through suggestive selling.
In January, Yum! announced its acquisition of The Habit Burger Grill for $375 million. In contrast to McDonald's acquisitions to improve operations, Yum! bought the burger joint to further diversify.
McDonald's acquisitions immediately make an impact. The company doesn't drill down into its comparable-restaurant sales growth. It only said technology improvements contributed to its global comps growth of 5.9% in 2019. But consider that the company had over $100 billion in sales in 2019. Just a 1% comps gain would more than justify the $300 million McDonald's reportedly paid for Dynamic Yield.
It will take longer for the Yum! acquisition of The Habit to pay off -- particularly with how COVID-19 has impacted restaurants since January -- but the upside is higher. The Habit has less than 300 restaurants, but went public with aspirations of 2,000 locations. As a stand-alone company, it never meaningfully grew profits, but perhaps under Yum! Brands' wing, it can be more successful. Most locations are company owned, but Yum! will leverage its existing franchise network to unlock The Habit's growth potential.
I like Yum! Brands' acquisition of The Habit better than the acquisitions McDonald's made. It gives it more diversification and a long-term growth opportunity.
Finally, we briefly touch on return of capital to shareholders via share buybacks and dividends. Over the last three full years, McDonald's has returned $24.8 billion to shareholders. Over that span, Yum! returned $6.1 billion. But consider that net cash from operations for the last three years was $20.7 billion for McDonald's and $3.5 billion for Yum! Brands.
That's not necessarily a problem, as the companies have ways to finance this. My point is: I'm not sure one is more generous with its cash than the other. Both are returning more money than operations generate.
Regarding dividend yield, McDonald's is higher at 2.8%. But not by much. Yum! still has a respectable 2.1% dividend yield.
To conclude, I choose Yum! Brands as the better buy. I like the company's diversification across brands, and its acquisition of The Habit. That said, I'm not sure this consumer-discretionary stock can beat the market, due to its slow top-line growth. But I do think it can outperform McDonald's.