McDonald's (MCD 0.18%) and PepsiCo (PEP -0.12%) are two iconic businesses that are recognized globally. Both face difficulties caused by the coronavirus pandemic, and are looking forward to a time when world economies return to normalcy.
During the pandemic, snack and beverage maker PepsiCo was helped by its portfolio of products. Increases in sales in its snack business helped offset some decreases in its beverage business. Meanwhile, McDonald's is enduring decreasing sales as many of its locations were restricted from allowing customers to dine in. The restaurant chain's saving grace was its drive-thru locations and its quick pivot to increase delivery capabilities.
Let's compare the profitability of each business and then look at their price multiples to determine which is a better buy.
If we consider the two companies based on profit margins, McDonald's has a clear edge. Its operating profit margin and net profit margin are far ahead of PepsiCo, and have been that way for the vast majority of the past 10 years. PepsiCo does hold the edge in gross profit margin, but McDonald's has been closing that gap since 2016.
Further, net profit margin is the most important ratio of the three because it determines how much of the company's sales is leftover to be disbursed to shareholders through dividends and share buybacks. Of course, the company also reinvests some of the net profit into the company.
McDonald's franchise model should help it continue to maintain higher profit margins compared to PepsiCo. Of the more than 39,000 McDonald's restaurants worldwide, 93% of them are operated by franchisees. While PepsiCo's more profitable FritoLay segment is experiencing robust growth as people consume more snacks at home during the pandemic, the gains might not be large enough to close the gap, and may only be temporary.
How about the price?
When comparing the two companies using the price-to-earnings ratio (P/E), the price-to-sales ratio (P/S), and the enterprise value-to-earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) ratio, McDonald's is selling at a premium to PepsiCo. Given the large disparity in profitability, a premium may be justified for McDonald's. Moreover, when you consider the differences in business models, it gives another leg to justify a premium. A franchising model is inherently more profitable because franchisees contribute to the bulk of the capital and pay royalties, usually based on a percentage of sales plus some fixed amount.
However, a price-to-sales ratio almost triple that of PepsiCo might be too much of a premium, especially when you consider that McDonald's is more exposed to negative outcomes from increasing coronavirus cases. Before the onset of the pandemic, in the larger markets, McDonald's received 70% of its orders from dine-in customers. If restaurants need to start closing again because of the recent surge in coronavirus cases, it would hurt McDonald's sales.
McDonald's is the more profitable business; there can be no doubt about that. Admittedly, the price of this consumer goods stock is more expensive in terms of P/S, P/E, and EV/EBITDA. However, the difference in profitability is wide enough to justify paying a higher price for its stock. Therefore, between these two stocks, your choice should be to buy McDonald's.