Fast-food giant McDonald's (NYSE:MCD) and beverage empire Keurig Dr Pepper (NASDAQ:KDP) aren't competitors. In fact, these two companies work together. Earlier in 2020, KDP started selling McDonald's McCafe in the U.S. as a licensed brand. This partnership allows McDonald's to further grow its grocery store and at-home consumption presence, while KDP gets yet another brand into the Keurig brewer ecosystem.
Both McDonald's and Keurig Dr Pepper have brand recognition from consumers, having been in business for decades. But which is the better stock to buy today? In a close battle, I'd choose KDP. Here's why.
Very similar valuations
The COVID-19 pandemic has thrown growth rates and valuations all out of whack for the time being. Therefore, it's helpful to go back in time a little. In 2019, McDonald's full-year revenue was flat year over year. Keurig Dr Pepper performed slightly better, but net sales growth was still meager at 0.9% year over year on a pro forma basis (pro forma is an attempt to make the numbers more comparable given Keurig Green Mountain merged with Dr Pepper Snapple Group in mid-2018).
The point is both McDonald's and Keurig Dr Pepper were slow growers pre-pandemic, and maybe that's why they share similar valuations. One of the most used valuation metrics for mature businesses like these companies is the price-to-earnings ratio. Take a company's stock price and divide it by its earnings per share (EPS). It lets investors know the premium they're paying for the underlying profits of the business.
McDonald's currently trades at a trailing P/E of 35.3. Keurig Dr Pepper trades at a P/E of 34.6.
Another quasi-valuation metric is dividend yield. A dividend yield is the percentage investors receive as a dividend payment relative to the current stock price. For example, a $100 stock paying a $1 dividend results in a dividend yield of 1%. It's not typically thought of as a valuation metric, but a high dividend yield can sometimes indicate low investor sentiment for the business, and vice versa.
So how do McDonald's and KDP investors feel about these businesses? The former has a dividend yield of 2.2%. The latter has a yield of 2.1% -- practically the same.
Using these two backward-looking metrics, neither McDonald's or Keurig Dr Pepper appears to offer a superior opportunity for value investors. Therefore, we must look forward to determine the better buy.
Different growth prospects
McDonald's management has considerable experience in growing the top line.Consider its recent technology acquisitions of Dynamic Yield and Apprente. These purchases were made to do things like up-sell customers and shave seconds off of drive-thru wait times. In isolation, it's small. But moves like these provide comparable-sales growth at restaurants year in and year out. In 2019, global comp sales grew 5.9%.
McDonald's comp-sales growth is good for franchisees, as they see their revenue increase. But it does little to grow corporate revenue -- hence it was flat. For shareholders, there's not much McDonald's can do to meaningfully grow revenue. Rather, it just seeks to consistently tweak operations to boost profits, reduce the share count through buybacks, and keep paying and growing the dividend.
I doubt Keurig Dr Pepper will ever be called a growth stock again, but it does have stronger growth prospects. Consider its Keurig division. In the second quarter last year, sales for its single-cup coffee brewers surged 19% from the year before. This second quarter, sales went up again by 11.6%. These one-time purchases allow for ongoing growth in K-Cups (the single-brew coffee pods), up 9.5% in Q2.
In 2019, KDP estimates 2 million U.S. households got a Keurig brewer for the first time. These represent much of the growth it's had in brewers, and brings total U.S. households using Keurig to 30 million. According to Statista, there's currently over 120 million U.S. households, meaning Keurig brewer penetration is under 25%. In short, there's still room for growth in the company's coffee business.
This discussion ignores the gains Keurig Dr Pepper has made in carbonated soft drinks, but is enough to demonstrate it's growing, albeit modestly. This is in line with the company's guidance of 3% to 4% annual revenue growth. However, thanks to the merger, it seeks to reduce costs and debt to grow EPS 13% to 15% annually. And in the two years since the merger, management has overdelivered, with closer to 20% annual growth.
And the winner is
Investors could certainly do worse than a McDonald's investment. Given its management history, it can deliver positive returns. But given its growth, I'd wager its returns will trail the market average. For roughly the same valuation and dividend, Keurig Dr Pepper offers slightly better upside and is the better stock to buy today.